INVESTMENT THESIS
Fox Corp. (NGS: FOXA). The ‘new’ Fox Corp. has entered a new era as a smaller company focused on U.S. cable and broadcast television after the 2019 Disney asset sale. We think the key to growth for the new company will be to continue to build highly engaged audiences in news, sports, and live event programming, the exact types of programming that are ‘appointment television’ rather than susceptible to delayed viewing, and therefore more attractive to advertisers. However, COVID-19 has not only diminished advertising demand in general, but has also led to the cancellation or postponement of sporting events – the kind of programming that Fox doubled down on with the asset sale to Disney. While Fox management can certainly breathe a sigh of relief with the return of NFL and college football, it remains unclear how persistent COVID-19 uncertainties could affect sporting event schedules. Meanwhile, Fox has been busy making acquisitions both in line with its current business and further afield, perhaps to diversify revenue away from the cyclical U.S. advertising market. The executive reins also seem to have passed to CEO Lachlan Murdoch from founder and Chairman Rupert Murdoch.
RECENT DEVELOPMENTS
Fox reported results for fiscal 1Q21 (September 30) on November 3. Strong 10% growth in affiliate fee revenue was partially offset by a 7% decline in advertising revenue. Management touted the popularity and reach of Fox News as a primary revenue driver, even as COVID-19 led to the postponement of live sports events and the delay in airing FOX Network scripted entertainment content. While these COVID-19 effects may have hurt revenue, the lower costs due to the postponements led to stellar adjusted EBITDA growth of 36%, to $1.17 billion. The EBITDA margin expanded at an equally eye-popping rate, rising 11 percentage points to 43%. Non-GAAP EPS rose 42% to $1.18. GAAP EPS rose to $1.83 from $0.80 in 1Q20. The disparity between 1Q non-GAAP and GAAP results reflects an $0.86 per share gain in equity in affiliates, which is excluded from non-GAAP results.
While COVID-19 stay-at-home restrictions resulted in increased ratings and engagement across the company’s networks and platforms both linear and digital, they also led to significantly lower demand for advertising as sporting events were delayed or cancelled and as advertisers generally have pulled back in the face of economic recession. As live sports have tentatively resumed, with NASCAR and Major League Baseball particularly important to Fox, advertising began to recover in 1Q21. Ad spending was also helped by political advertising related to the presidential election.
EARNINGS & GROWTH ANALYSIS
The ‘new’ Fox is essentially split into four businesses: Fox News Media (including Fox News and Fox Business News), Fox Sports, Fox Entertainment (the FOX national broadcast network), and Fox-owned and operated TV stations. CEO Lachlan Murdoch and COO John Nallen have set the tone for Fox as a ‘growth company over the long term.’ The key to this growth will be to continue to build highly engaged audiences in news, sports, and live event programming, the exact types of programming that are ‘appointment television’ rather than susceptible to delayed viewing, and thus more attractive to advertisers. COVID-19 has obviously impacted sports and live event revenue in FY20 and as cases again spike in the U.S., pandemic uncertainties remain salient. For the long term, Fox will rely on its stable of brands, including Fox News, the most watched cable news channel, and its panoply of sports programming. Management expects the company to generate 50% of its revenue from affiliate fees, including subscription and retransmission consent fees; 45% from advertising (national and local); and 5% from other miscellaneous sources. Some 70% of advertising revenue is expected to come from live news and sports. As one would expect, programming will be the largest expense, at 75% of the cost base. Within programming expense, sports will comprise 65%, news 18%, and entertainment 17%. We note that the cable channels – from Fox News to the sports channels – are likely to be the company’s profit drivers as cable network programming accounted for 86% of total segment EBITDA in FY20.
While Fox originally sought to differentiate itself from the rest of Hollywood by choosing not to build its own broad-based direct-to-consumer streaming service, the Tubi acquisition is a clear indication of its about-face on that decision. The rest of Hollywood, including Disney, Comcast/NBC Universal, CBS, and Dish, have already sought to key into the cord-cutter/streaming-video phenomenon by building their own direct-to-consumer streaming services. Fox can no longer ignore the burgeoning popularity of streaming video, the value of direct-to-consumer (DTC) relationships, or the acceleration in consumer cord-cutting. Fox has already begun the digital distribution of its premier channel, Fox News, and its related digital channel, Fox Nation. Fox Bet is another nascent DTC initiative. Another differentiator between Fox and its competitors has been the unceremonious jettisoning of its studio assets, including its television studio, although the company has retained its FOX national television network.
On May 8, 2019, Fox Sports announced a new partnership to exploit opportunities in legal digital sports wagering and iGaming. Fox is partnering with The Stars Group (TSG), a Canadian provider of online and mobile betting, poker, casino, and other gaming-related services. Fox Sports is licensing certain trademarks to the partnership, which offers a free-to-play game with cash prizes for correctly predicting the outcome of sports games, and a service called FOX Bet, which enables users to place real-money wagers on a wide range of sporting events in U.S. states where it is legal to do so. As part of the deal, Fox invested $236 million to purchase 14.35 million shares of TSG, a 4.99% interest. Fox also retains the right to acquire up to a 50% interest in TSG’s U.S. business. After the closing, TSG merged with an Irish bookmaking company called Flutter, and, after an incremental $100 million investment, Fox held a 3% interest in the parent company. Fox also has the right to acquire an 18.5% equity interest in another Flutter subsidiary, FanDuel, a daily fantasy sports site.
Fox is admittedly partnering in sports betting in order to build a new revenue stream and diversify its revenue sources, which have become much more narrowly clustered around U.S. broadcast and cable television than before the Disney asset sale. Eighteen U.S. states allow legal sports betting. Recent court rulings have allowed states to make their own regulations, and more and more states are jumping on the legalized sports-betting bandwagon. Fox management expects legal sports betting to be a roughly $7 billion market by 2025, with an additional $1 billion opportunity in marketing and sponsorship. While one could certainly argue about the tarnishing of the Fox Sports brand as it becomes closely associated with sports gambling (particularly given its large presence not just in professional sports but also in college football), the opportunity to diversify into a rapidly expanding market is probably too good for management to resist. COVID-19 fears about traveling to casinos could also be a boon to online sports betting.
Although Fox management has expressed a preference for organic growth over M&A, the string of recent tuck-in acquisitions have belied this bias. The Bento Box acquisition was the simple vertical integration of a supplier into Fox and right in line with the company’s business. Still, it is unclear why the company is so rapidly reinvesting in production assets right after selling its former production assets to Disney. The company’s other recent deals, with The Stars Group and Credible, are much further afield. We understand management’s interest in diversifying revenue away from the cyclical U.S. advertising market. At the same time, we believe that it runs the risk of investing in businesses outside its existing area of expertise in video programming and distribution.
In October 2019, Fox completed its purchase of a 67% equity interest in Credible Labs Inc., an internet consumer finance marketplace that enables consumers to compare prequalified rates on student loans, personal loans, and mortgages from multiple financial institutions. Fox paid $260 million in cash for the equity interest and will contribute another $75 million in ‘growth capital’ to Credible over a two-year period following the closing. Credible is an Australian-listed public company based in San Francisco. In the last year before acquisition, Credible’s revenue increased from $40 million to $70 million.
FINANCIAL STRENGTH & DIVIDEND
S&P and Moody’s give Fox BBB and Baa2, investment-grade ratings, respectively, and outlooks are stable. In 4Q20, the company floated $1.2 billion in incremental long-term notes. Fox also had $5.01 billion in cash.
Fox’s semiannual dividend is $0.23 per share. Fox has repurchased $305 million of its stock thus far in FY21.
MANAGEMENT & RISKS
There are many family-controlled companies in the media business, but very few have the size and scope of Fox Corp. Executive Chairman Rupert Murdoch has been a classic media mogul whose age, 89, may be of concern though he seems to have successfully managed the succession issue now that his son and Fox CEO Lachlan Murdoch appears be firmly in control of the company. The Disney merger was another step toward resolving the succession issue.
While the earlier spinoff of the publishing assets freed Fox from the secular decline in publishing, with the asset sale to Disney, Fox has become much more narrowly focused in terms of both geography and range of assets. This narrowed focus carries its own risks, as diversification may no longer offset underperformance in a particular business or geographic region. Fox also must also now spread the costs of being a public company across a smaller asset and revenue base.
Fox News stumbled into scandals in 2016-2017 with the sexual harassment charges against Fox News founder and former CEO Roger Ailes as well as Fox News star Bill O’Reilly. We think the scandals can be chalked up to some particularly bad management of Mr. Ailes and Mr. O’Reilly. Fox mostly settled claims and lawsuits related to the scandals. Fox News has long been a ratings juggernaut, and, along with other news outlets, has benefited from heightened viewer interest in political news since the 2016 presidential election. Fox Corp.Advertising spending tends to correlate with the up and downs of the macroeconomy. The company faces risks as the television and cable universe continues to shrink in the face of cord-cutting by some consumers, media fragmentation, and increased competition from the internet and social and mobile media.
COMPANY DESCRIPTION
Fox Corporation produces and distributes news, sports and entertainment programming through its U.S. domestic cable and broadcast television networks, including owned and affiliated local television stations. Fox network brands include FOX News, FOX Sports, and The FOX Network. Fox changed its name from Twenty-First Century Fox when it divested certain assets, including its film and television studios, cable entertainment networks, U.S. regional sports networks, and international sports and entertainment television distribution businesses, to Disney on March 20, 2019. Executive Chairman Rupert Murdoch and his family retain a nearly 39% controlling interest in the company.
VALUATION
The new FOXA’s limited trading history makes historical data almost meaningless. We see the peer comparison as more relevant.
On November 6 at midday, HOLD-rated FOXA traded at $25.95, down $0.66.
Source: Argus
