August 19, 2011 - 12:58am EST by
2011 2012
Price: 16.19 EPS $0.00 $0.00
Shares Out. (in M): 2,636 P/E 0.0x 0.0x
Market Cap (in $M): 42,667 P/FCF 12.9x 0.0x
Net Debt (in $M): 2,815 EBIT 4,975 5,525
TEV ($): 35,300 TEV/EBIT 7.1x 5.9x

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I am long News Corporation.

The phone hacking scandal at News of the World and a schizophrenic market are creating an interesting opportunity. While the scandal is very serious for the parties involved, it is noise to the News Corporation as a whole and a net positive for the stock in that it has caused a renewed focus on operations and capital allocation.

The thesis is quite simple: low valuation + great assets + near-term growth drivers + rapid equity shrink = asymmetric risk/reward.

Attractive Valuation
-I get a $20-21 SOTP based on comps, which I will not detail because it is only theoretical
-NWSA trades for 7.1X FY11 and <5.9X FY12 EBIT (7.7% TTM FCF yield).

Great Assets
-Fox News Channel (FNC) is the second most important cable channel in the US behind ESPN. Fair and balanced or not, FNC has more viewers than CNN, MSNBC and CNBC combined.
-Fox International is growing rapidly with a $1b EBIT goal by 2015 compared to ~$500mm in FY11. 58% of profits come from emerging markets. Review this carefully:
-News Corps content is growing more valuable thanks to new monetization opportunities (digital distribution such as Netflix, retransmission fees and repurposing for international)
-News Corps 43% ROIC and 15% EBIT margin reflect a quality business
-News Corps' businesses, generally, have good pricing power
-Publishing is a bad business, but News appears more focused on cost control than in the past and the WSJ franchise appears to be making a smooth digital transition
-The EBIT mix is 45% domestic cable networks, 10% international cable networks, 19% filmed entertainment, 14% broadcast television, 5% Sky Italia, 20% publishing and -12% "other"

Near -Term Growth Drivers
-FNC will renegotiate approximately 50% of their affiliate agreements by summer 2012; Goldman anticipates a 35% price hike. Chase Carey has made it clear that FNC will extract full value in these negotiations and with the explosive 2012 elections coming up, an argument can be made that FNC is the most important cable channel in the world for the next 18 months.
-Advertising markets remains strong for both cable networks and broadcast networks which saw low double digit CPM increases in the 2011 upfronts
-Retransmission fees are changing the economics of broadcasting from bad (cyclical and mature advertising-based business with high fixed costs) to good (high contribution margin recurring retransmission consent revenues layered on top) which is expected to drive EBIT from $680M to $1B probably by FY14. FY12 will face tough comps (Superbowl, 2010 elections), but the 2012 elections, continued progress on owned stations retrans fees and better progress on affiliate station retrans fees will generate growth.
-Management is guiding to "operating income growth rate for fiscal 2012 to be in the low to mid-teens range, above the $4.975 billion fiscal 2011" which works out to $5.5-5.7B
-Long-term upside potential in Fox International and immature cable networks such as Nat Geo, Nat Geo Wild, Fox Soccer, Fox Business, etc

Rapid Equity Shrink
News began a $5B buyback on 8/15/2011 and early indications are that they are buying 10% of the daily volume and on pace for completion in 80 business days (8-K on 8/17). Additionally, they are targeting a capital structure 2-3 years out of 2-2.5X gross leverage (currently 2.5X and EBITDA is growing) and excess cash of $2-3B (currently $12.7B). So 3 years from today, they will have excess capital of $20B+ assuming they generate over $10B of FCF. Most of this cash will be allocated to buybacks as M&A and other investment demands will be modest. $20B is about 47% of News' market cap. Assuming they buy in $6.5b per year and further assuming an average repurchase price of $18, $21 and $25 the share count of 2.636M drops to 2.275M, 1.869M and 1.519M by FY13 for a 42% reduction. I've seen this movie before; Chase employed a similar strategy at DTV. Don't worry about increasing leverage because only $1.4B of debt comes due within 5 years and over $9b is not due prior to 2019.

Putting it together
Okay, so EBIT is growing 11-15% for FY12 (mgmt guidance) and lets assume 6% in FY13 and 3% in FY14 (just using conservative assumptions). This gets us to EBIT of $6-6.25B in FY13. Net debt will be about $12.5B and there are $10.2B of other investments (39% BSkyB, 50% Sky Deutschland, 44% SkyNetwork, 49% NDS, 32% Hulu, others) less minority interest and pension. At 8-10X EBIT you get a per share value range of $26-35. At $14 NWSA trades for 4.7X EBITDA vs. peers much higher so I think that's the downside case unless we get a Lehman-liquidation event out of Europe.

"So what," you say, "what's changed? Is't Murdoch still in charge?"
I believe Chase Carey's influence at the company is growing by the day. For anyone unfamiliar with Chase, read through recent conference call and sell-side conference presentations, evaluate his track record at DTV and Google him (click on some paid links, I am long that too). Chase is a great CEO. He's a smart strategic thinker, a good operator and effective at capital allocation. Specific to NWSA he appears to be the driving force behind many of the important recent decisions like jettisoning MySpace, closing News of the World, driving retransmission fees, pursuing "full value" for FOX News affiliate fees and digitally distributed content, dialing back on the empire building strategy and implementing a significant buyback.

Issues: NOTW scandal, Murdoch related-party deals, empire building past, economy (as i write this the FT reports on "Clouds gather over media's advertising rebound" but 2 major changes since 08/09 are 1) cable network ebit increased from 25% to 55% of total and tv broadcasting, which fell off a cliff due to advertising, has a more sustainable business model with retransmission fees)

There are 2 classes: I prefer NWSA over NWS because I am cheap, although one should monitor the spread since NWS confers superior voting rights. 

As usual there is a lot of background material I am omitting that you should review, which is generally available on the web. In particular, read Chase's comments on the Q4 call (



Execution on the massive buyback
Earnings growth
Resolution of NOTW phone hacking scandal
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