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December 28, 2007

Why I Bought News Corporation

Back in July, I wrote a review of News Corporation for RealMoney.com outlining the bull case. The analysis remains relevant today so in light of the purchase of News Corporation shares for Northlake clients earlier this week, I am reproducing the article so you can learn more about this new holding….

I like News Corporation because it offers the fastest earnings growth among the mega cap media stocks but trades at the same P-E multiple as its peers on 2008 earnings. Furthermore, the company is active in M&A with a decent chance for a major transaction that would unlock value in MySpace. Since the Dow Jones (DJ) deal was announced, the shares have sat out the rally giving back gains made earlier this year. I think the weakness in the shares, down 10% since late May, has set up a great buying opportunity.

Some investors are concerned about the high price being paid for DJ and the strategic implications of the deal. However, I think they are overlooking NWS's recent announcements of asset sales (TV stations and Eastern European billboards) that will sell at similar premiums to DJ and finance half of the DJ deal. Additionally, the DJ deal represents just 10% of NWS market cap so I don’t view it as unusually risky even if it fails to offer the synergies that Rupert Murdoch must be expecting....

....Here is an overview of News Corporation's businesses based on 2008 estimates I compiled from a few of my favorite analysts:

Key assets include 20th Century Fox, the FOX TV Network and owned and operated TV stations, cable networks including Fox News and FX, Sky Italia, newspapers in the UK and Australia, and Fox Interactive Media which includes MySpace and is included in Other.

The bull case for NWS is pretty simple. As can be seen in the following table, NWS will have by far the fastest earnings growth among the megacap diversified entertainment conglomerates but the stock trades at the same multiple as the rest of the group:

Earnings growth began to accelerate last quarter with EPS gain 24%. June quarter earnings are expected to show again of at least 26%. The earnings growth is a combination of double digit top line gains, expanding margins, and the benefits of share buybacks. Key drivers of the earnings acceleration are Sky Italia, the cable networks, and MySpace. SkyItalia is the largest satellite TV provider in Italy. Multichannel penetration in Italy is low so there is plenty of room to grow. As subscriber growth continues margins are beginning to expand sharply. NWS has seen this movie before via its investments in satellite TV in Asia, England, and Latin America. The cable networks growth is being driven mostly by sharp increases in affiliate fees at Fox News. Recent deals reached with major cable operators like Time Warner (TWX) and Comcast (CMCSA) have tripled the monthly fee they pay NWS for each subscriber and bring the fee to levels long enjoyed by CNN. MySpace is benefiting from its multi-year deal with Google (GOOG) and additional monetization efforts on the heavily trafficked site.

NWS has the same combination of revenue growth, margin expansion, and share repurchase that investors have been rewarding at DIS which has risen 130% from the fall 2002 lows. NWS shares have enjoyed similar performance although the company has not had three years of consistent double digit operating income growth like DIS. Instead, I think that NWS share gains have been driven by the re-orienting of the asset portfolio toward higher long-term growth. Therefore, I think that as NWS replaces DIS as the fastest growing entertainment conglomerate the P-E multiple should expand driving significant further gains in the stock price.

One other factor supporting higher share prices is that the private market value of the company is well above current trading values if recent deal multiples are applied to the company's operations. NWS has a balanced mix of content and distribution assets that don’t seem likely to change much regardless of the outcome of the DJ takeover attempt. In fact, I think it is more likely that the asset base is rationalized via more divestitures like the TV stations, Eastern European billboards, and the DirecTV (DTV) divestiture in the deal with Liberty Capital (LCAPA). Next up could be a deal to merge MySpace into Yahoo! (YHOO) or something similar. Each of these deals simplifies NWS's capital structure and reaffirms underlying asset value making it easier for investors to reward the industry leading earnings growth.

Posted by Steve Birenberg at December 28, 2007 08:32 AM in NWS