Clearly, Fox has been a huge winner since news first broke that the Murdochs were pursuing a sale of most of the company late last year. But even though the bidding war is finally over, I believe FOX shares still represent an attractive merger arb investment opportunity in the near term, while simultaneously offering a compelling long term investment opportunity to purchase the post-DIS merger New Fox at a huge discount.
Fox shareholders will receive ~$38/share from the Disney deal, in 50% cash and 50% DIS stock subject to individual proration based on shareholders’ cash vs. stock elections. The stock portion is subject to a collar between DIS share price range of $93.52-$114.32.
The DoJ has already indicated they had reached preliminary terms for approval, and Fox and Disney shareholders approved the deal on July 27. The deal has a strong possibility to close before year-end.
After the merger of most of Fox’s assets into Disney, New Fox will principally consist of the Fox broadcast network, local O&O stations, and cable channels Fox News, Fox Business, and Big Ten Network (51%).
Multiple Avenues to Upside at Deal Clsoure:
-DIS share price:
At $116 as of writing, DIS already trades modestly above the high end of the collar. This translates to $0.28 in incremental value per FOX share assuming one receives 50% consideration in DIS shares, and up to $0.56/share if we are able to receive a 100% stock consideration. Without a strong view on uspide to DIS shares, I believe the best option for FOX shareholders to capture on the asymmetric upside from the DIS merger shares (the collar eliminates 20% downside risk to DIS shares) is to sell calls. Selling Nov18 or Jan19 $115 calls could generate in the neighborhood of $5/call.
-Tax Sharing Arrangement:
According to the merger's tax sharing agreement, Fox shareholders will be compensated to the extent that the tax bill from the spinoff of New Fox is below $6.5 billion (with reciprocal liability in the unlikely scenario the tax bill is above $8.5 billion). The deal was struck prior to passage of the Tax Reform Act, which will materially lower the liability. The ultimate tax liability will depend on the initial price that New Fox shares trade at immediately post-merger (and to a lesser extent, divestiture taxes). Based on the currently depressed Fox share price this could translate to up to $3 billion (~$1.50/share) in incremental value. The adjustment will be directly incorporated into the final consideration Fox shareholders receive from DIS when the deal closes. To the extent Fox shares trade higher immediately post-close, this will obviously more than offset the higher tax liability.
-FOX/FOXA discount likely to close:
FOX shares currently trade at a modest ~$0.50/share discount to FOXA (non-voting, although somewhat more liquid) shares. Shares will be treated equally in the merger consideration, meaning the discount translates to ~7% on a pro forma New FOX/FOXA basis. This is well above the historical gap, and as a reference, NWS shares actually trade at a modest premium to NWSA shares. I would expect the deal closure to produce $0.25-$0.50/share incremental upside at FOX (low risk, meaningful upside on a pro forma basis).
As illustrated in the preceding table, the merger arb IRR could be very compelling under multiple scenarios.
LT Upside at New Fox
At ~$7 pro forma for the merger consideration, I estimate New Fox currently trades at ~6.5x pro forma forward EBITDA of ~$3 billion, or ~6x after backing out the PV of the NOLs generated by the tax liability. On a FCF basis, New Fox could yield ~15%.
This valuation would already be lower than lower quality broadcast affiliate companies trade at, let alone the other big 4 networks, and even more so compared to cable companies. New Fox will be a much slimmer company focused on live programming--sports and news--which should be relatively resilient to changing media consumption patterns. Fox News will be New Fox’s largest contributor, by far. Fox News is “Must-Have” content in virtually any bundle, for obvious reasons. As Rupert Murdoch described late last year: “No one can afford to drop Fox News. Charlie Ergen tried it for 6 weeks and lost 150K customers…We’ve lost some of our stars and none of our audience.” Fox News also generates the large majority of revenue from affiliate fees, limiting macroeconomic downside risk.
Additional levers for value creation at New Fox include retrans and reverse retrans compensation growth; acquiring affiliates at accretive multiples, aided by a contractual step-up in retrans rates; and further recapture of the broadcast value chain through acquisition and conversion of independent stations to O&Os and/or recapture of sub fees via vMVPD (negotiated by networks, not affiliates) or OTT distribution.
Given these factors, it is is not difficult to argue that New Fox deserves to trade at a premium to CBS etc. and a double-digit EV/EBITDA multiple. At a more conservative 9x EBITDA or 10x FCF, I estimate New Fox should be worth ~$11/share. This represents ~60% upside from the current price after backing out the anticipated merger consideration.
I do not hold a position with the issuer such as employment, directorship, or consultancy. I and/or others I advise hold a material investment in the issuer's securities.
-Filing of New Fox Form 10 in the next few months should help clarify the discount.