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News Corporation (NWSA)

Due to the fact that the company is all set to benefit from the forthcoming split of its business into entertainment and publishing companies (whose individual stocks are set to trade at roughly $22 and $3 per share respectively), we recommend that our investors buy News Corp. The split would benefit the entertainment company in particular, as it would no longer be pulled down by the slower publishing business.

Company Profile:

NWSA is a diversified media company, which publishes newspapers, magazines and books, and engages in television broadcasting. The company has operations in the Entertainment Industry as well. It operates through six segments: Cable Network Programming, Filmed Entertainment, Television, Direct Broadcast Satellite Television, Publishing and Other. The News Corporation operates primarily in the United States, Continental Europe, the United Kingdom, Australia, Asia and Latin America. It had total assets as of March 31, 2012, of approximately $61 billion, and total annual revenue of approximately $34 billion.

  1. The Cable Network Programming segment includes production and licensing of different programming like news, business news, sports, general entertainment, and movie programming for distribution through cable television, and direct broadcast satellite operators, primarily in the United States, Latin America, Europe and Asia.
  2. The company's Filmed Entertainment segment produces and acquires live-action and animated motion pictures for distribution and licensing in the entertainment media, as well as produces and licenses television programming worldwide.
  3. Its Television segment operates 27 broadcast television stations in the United States. The Direct Broadcast Satellite Television segment consists of the distribution of programming services via satellite and broadband directly to subscribers in Italy.
  4. Its Publishing segment provides newspapers in the U.K., Australia and the U.S., as well as book publishing services and integrated marketing services.
  5. The Other segment consists of the company's digital media properties and an advertising business, which offers outdoor advertising locations mainly throughout Russia and Eastern Europe.

Financial Performance

All NWSA segments are doing well, except for television and publishing. Cable network programming, filmed entertainment and direct broadcast television all saw increased operating income in their segments [$111 million (15%), $24 million and $23 million respectively] compared with the third quarter last year. Only television and publishing segments showed a reduced net income. Television reported third-quarter segment operating income of $171 million, a decrease of $21 million versus the same period a year ago. The main reason behind this is the absence of the National Football League Super Bowl this year, and the falling ratings for American Idol. However, this segment is continuing to grow internationally, although the pace of growth has slowed in the U.S.

Publishing reported a third-quarter $94 million increase compared with the $36 million reported a year ago. This is because the company incurred a $125 million litigation settlement charge last year. Excluding this charge, the segment's operating income decreased $31 million from last year's third quarter, driven by local currency advertising revenue declines at the Australian and U.K. newspapers, as well as the closure of The News of the World in the U.K.

Overall, NWSA reported a third-quarter total segment operating income increase of 23% over the results reported a year ago. The third quarter net income was also up to $0.38 per share, compared with $0.24 per share last year. These results were better than those expected by Wall Street (e.g there was an expectation of $0.30 per share).

Latest News and the Expected Outcomes

NWSA announced its decision to separate its publishing and entertainment businesses last week. News Corp. will place its newspapers, as well as its book publishing, education and marketing concerns, into the new publishing company. The film and television assets will go to the entertainment company. It is expected that the split will take a year to complete.

This will immensely benefit the stock since the fast-growing and lucrative entertainment business would not be pulled down by the older publishing segment. The publishing company will stand out while competing in an industry that is experiencing contraction. The entertainment company will not be tainted with the publishing scandals, and the so-called Murdoch discount will not affect it. This division will have large brands like 20th Century Fox, Fox broadcast Network and the Fox News Channel. Operating income from the broadcast network alone can increase six-fold by 2017, Miller Tabak estimates, while income from the entire TV segment should rise by around 20%.

Investors should look to buy shares of the pre-split News Corp. When the company splits, investors will receive a share in each company for each share they currently own.

There are not many concerns over the future management of the new companies. Although Murdoch will take up position as chairman for each company, and the CEO of the media business, the well-liked Chief Operating Officer Chase Carey is staying on and will likely succeed Murdoch. There are no reservations about Murdoch's son being the heir to all his businesses.

Needham analyst Laura Martin estimates that with the Murdoch discount, the stock is undervalued by about $5. Investors who buy now can earn a quick return as the gap closes. At the end of June, the stock rose more than 8% over speculation that the company would break up.

Shares of the new entertainment business should trade between $19 and $24, analysts say. Nomura's Michael Nathanson is of the opinion that the company would achieve operating income of $5.8 billion in 2013, which is about half of Disney's (DIS) projected figures and well above CBS corporation (CBS) and Viacom (VIAB). Moreover, according to Murdoch himself, News Corp.'s aggressive share buybacks will continue, which increases shareholder value. In the past few years, News Corp. authorized $10 billion in stock repurchases.

The market is still not sure how the $15.2 billion debt and $10.7 billion in cash at present will be divided among the two new companies. A debt-free position will give the publishing company a leg up from its peers, like The New York Times Co. (NYT). In spite of the uncertainty, analysts expect the new publishing company to trade between $2 and $3.50 per share.

Challenges Ahead

The challenges that lay ahead for NewsCorp. and Murdoch primarily consist of litigation. The 81-year-old chief executive has been declared "not a fit person" to lead an international company by the British Parliamentary committee that conducted its own phone-hacking investigation, a statement that threatens the company's minority stake in BSkyB.

Similarly, in the U.S., federal prosecutors in Manhattan are monitoring News Corp.'s cooperation with British authorities, under the theory that bribery of police officials in the U.K. could constitute an infringement of the U.S. Foreign Corrupt Practices Act, due to which the company will continue incurring millions of dollars in litigation expenses until the dust clears ($63 million were incurred for the first three months in 2012). The financial future, however, is brighter than the situation a year ago, during the depths of the phone-hacking crisis when Murdoch's leadership was being questioned, and the share price plummeted 25 percent in just over a month to $13.62 on August 8, 2011.

Since then, the share price has soared, closing at $22.85 yesterday in the Nasdaq Stock Market.

Upcoming Catalyst

  1. The split into two separate entities will take a year's time to complete, contingent on approval being attained from shareholders, as well as the IRS and other regulators.
  2. NWSA increased its buyback authorization from $5 billion to $10 billion, leaving $6.1b remaining. NWSA is targeting to acquire the additional $5 billion of Class A shares by the end of June 2013. The company has enough cash to carry that out with total cash at $10.6 billion at the moment.

Valuation and Investment Strategy

Currently, the stock is trading at a forward P/E of 13.4x, which is a bit conservative. Below is a graph showing NWSA's P/E compared with its peers in the diversified entertainment business over the past year.

The dividend yield for NWSA is low at 0.8%, compared with its competitors, but it makes up for that by using share repurchases, which are the highest among peers like Viacom (VIA.B), CBS and Disney.

In a bullish scenario, we expect a price of $24 (current P/E of 16x and EPS estimate of $1.5). Moreover, once the split happens, a person holding a single share of NWSA will have one share of the entertainment company's stock worth roughly $22, and a single share of the publishing company worth roughly $3, resulting in a total of $25 per share. We recommend buying News Corporation because of the impending benefits that can be reaped once the company splits.

Source: News Corp Split Gives Fox Overdue Independence


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