Twenty-First Century Fox
July 28, 2014
- Murdoch’s reported price/leverage discipline creates material deal risk – assume $95 final bid versus TWX’s $105 ask.
- A likely 3-months-to-agreement/12-months-to-close timeline creates lopsided risk/reward:
- FOXA returns 42% annualized if deal falls through within 3 months, 8.1% annualized if deal closes within 15
- TWX returns -34.6% annualized if deal fall through within 3 months, 13.9% annualized if deal closes within 15
- Deal or no deal, FOXA at 18.53 times 2015 EPS (June FYE) qualifies as a wonderful business at a fair price.
One of my biggest errors over the past 5.5 years was NOT buying FOXA (previously News Corp) during the 2011 phone hacking scandal at its News of the World unit. It was a lay-up that I dribbled out of bounds due to my lack of familiarity and comfort with media assets. Moving on…while FOXA up over 100% since the scandal is not nearly as attractive at current levels, I believe its recent bid for Time Warner Inc (TWX) has created an interesting two-pronged investment opportunity: 1) a reverse-arbitrage special situation that 2) turns into a wonderful business at a fair price.
Special Situation. At a recent $32.58, FOXA is down over 9% from its pre-bid high of around $36. FOXA confirmed reports that it had offered $85 in cash and stock for Time Warner Inc (TWX), which TWX promptly rejected due to price and the would-be receipt of non-voting stock. Since the negotiations went public, it has been reported that TWX is looking for $105, preferably in all cash, and that FOXA is looking to raise its offer to $95, at most, in cash & stock with a seat on the new board.
From a merger arbitrage perspective, naturally you would first look at TWX, which I did in this tweet on July 16th. My first thought was a raise in offer by FOXA to around 20 times earnings, or $91 per TWX share, for an expected gross return of 4.5% (at an 80% probability). I thought perhaps 3 months to a formal agreement, which would have been a 13.5% annualized return. This was poor thinking, as it likely will take upwards of 12 months to close after a formal agreement.
While press reports are inherently dubious, it has been widely reported that Murdoch is not in the over-paying mood. Due to the wide bid-ask ($85-$105) and the leverage required to get to $105, I started to look at the situation from a FOXA perspective. In a no-deal scenario, FOXA likely returns to its pre-bid price of $36, for a 10.5% gross return, or 42% annualized if the deal falls apart within three months. If the deal goes through at $95, I estimate FOXA is worth $35.90 – assuming 15 months to closing (3 months to agreement, 12 months to closing), the annualized return would be 8.1%.
In a no-deal scenario, if TWX returned to halfway between its current price and its pre-bid price of $71, the annualized return would be -35% assuming three months to an agreement. If the deal goes through at $95 (effective offer of $100.47 with a $35.90 FOXA FVPS), the annualized return for TWX is 10.4% over a 15-month period. Assuming my analysis is roughly correct, it appears the market has TWX priced for a final offer of $95 and a 12 month closing process, since the 15-month annualized projected return is approximately 13.9% per annum at current levels.
75% Probability – At a 75% probability of the deal going through at $95, FOXA’s weighted-average projected annualized return is 16.6% per annum versus 1.8% for TWX.
50% Probability – At a 50% probability, FOXA’s WAPAR is 25% while TWX’s is -10.3%.
This lopsided opportunity is created by the (likely) short time to deal agreement. Even though TWX returns more in a deal scenario, because it will take upwards of 12 months to close, the annualized return fails to materially outshine the negative annualized return in the quicker three-month no-deal scenario.
Wonderful Business. Upon resolution of the TWX deal, I would transfer (if purchased) a FOXA position from the Special Situations bucket into the Generals bucket. Though not a pure-play market-neutral merger arb play, I believe FOXA is arb-like enough to qualify for the Special Situations category (I define a Special Situation to be market-neutral opportunities such as merger arbitrage, liquidations, distressed debt, etc…).
At $32.58, FOXA trades for 18.53 times Factset consensus 2015 (June FYE) net income estimates, down from 20.5 times pre-bid. This appears to be a very reasonable price for some of the best media properties on the planet. In a cable world undergoing rapid change due to the rise of the internet, content is king, and FOXA is in wonderful position to continue growing revenue and cash flows over the next five to ten years. With distributable free cash flow nearly equal to annual earnings ($3.4B projected for FY15 versus $3.8B of net income), FOXA is in position to grow the business while return significant amounts of cash to shareholders, the hallmark of a wonderful business.
Attached is my very messy spreadsheet detailing my valuation work: