Seeking Alpha • Jul 06
News Corp: High-Quality Assets Suffering Conglomerate Discount
News Corp is a conglomerate with high-quality assets in property listings portals, professional information products and marquee newspapers.
A stake in REA alone is worth 71% of its market capitalization, so the rest of the business is valued at a 19% Free Cash Flow Yield.
News Corp has some high-quality businesses, while others are mostly at least stable; group EBIT should grow at mid-to-high single-digits.
The current P/E is 15.7x. We believe this includes a conglomerate discount, and the stock deserves a blended P/E of 20x.
Investors can gain a 20-30% upside from either a long News Corp / short REA pair trade, or by owning News Corp shares outright.
Introduction
We are initiating our coverage of News Corp (NWSA) with a Buy rating and an expectation of a 20-30% upside.
News Corp. is a NASDAQ-listed media conglomerate with a market capitalization of $9.2bn. Shares have fallen more than 40% since their peak in March 2021, and are now at their lowest since November 2020:
News Corp Class A Share Price (Last 5 Years)
Source: Google Finance (05-Jul-22).
(News Corp has two classes of shares, Class A and Class B (NWS), with both having the same economic rights but only Class B having voting rights in most situations. We prefer Class A for being slightly cheaper.)
The best risk/reward is available from going long News Corp and short REA Group (RPGRY), a listed Australian company in which News Corp holds a 61.4% stake. The stake is worth $6.6bn, equivalent to 71% of News Corp’s current market capitalization, which means the rest of News Corp is too cheap at a double-digit Free Cash Flow Yield.
Long-only investors can also profit by holding News Corp shares outright. News Corp has a number of high-quality assets and should be able to grow its EPS at mid-to-high single-digits over time. Shares are trading at a P/E of 15.7x, which we believe is 20-30% too low. Share buybacks should help generate a high-single-digit EPS growth and the Dividend Yield is 2.6%, generating a low-teens annualized return even if valuation changes do not materialize.
Company Overview
News Corp. is a media conglomerate with interests in property listings, print and television. The company operates primarily in the U.S., Australia and the U.K., and reports in five main segments:
News Corp Revenues & EBITDA by Segment (FY21)
Source: News Corp company filings.
Digital Real Estate Services – property listings websites in Australia, the U.S. and parts of Southeast Asia
Subscription Video Services – pay TV and video streaming in Australia, including the Foxtel Group
Dow Jones – consumer publications and professional information products, including The Wall Street Journal
Book Publishing – primarily the consumer publisher HarperCollins, with more than 120 branded imprints
News Media – newspapers in Australia, the U.K. and the U.S., as well as a U.K. radio network business
Advertising was as much as 27% of group revenues before COVID-19. Because of this, as well as currency and acquisitions/disposals, News Corp’s EBITDA can be volatile, though it has been rebounding strong since FY21:
News Corp EBITDA by Segment (Since FY15)
Source: News Corp company filings.
NB. FY ends 30 Jun. Figures include impact of currency and acquisitions/disposals.
Many of News Corp’s segments are in entirely separate sectors and have little synergies with each other. This has likely created a conglomerate discount in its valuation and also a pair trade opportunity.
Long News Corp, Short REA
The pair trade opportunity is to go long News Corp and short REA.
The main asset in the Digital Real Estate Services segment is a 61.4% stake in listed Australian property listings company REA Group. REA currently has a market capitalization of $10.7bn, larger than that of News Corp, and the implied value of the stake is equivalent to 71% of News Corp’s current market capitalization:
Valuation – News Corp vs. REA
Source: Company filings.
Excluding REA’s implied value and contribution, News Corp has a market capitalization of just $2.6bn and a Last-Twelve-Month (“LTM”) (ending March 31, 2022) Free Cash Flow (“FCF”) of $500m, which implies a FCF Yield of 19%:
FCF & FCF Yield – News Corp vs. REA
Source: Company filings.
NB. Figures are LTM as of 31-Mar-22.
This “News Corp ex. REA” FCF Yield is far too high and should eventually shrink. If the FCF Yield were to shrink by 50% to 9.4%, then the value of “News Corp ex. REA” even if FCF remains unchanged.
Investors can benefit from this by going long News Corp and short REA. The actual ratio to be used depends on subjective judgment, but each News Corp share owns 0.1385 REA shares indirectly, which implies a dollar ratio of 100:71. We look at an example where we buy $100 of News Corp and sell short $71 of REA below:
Example Long News Corp / Short REA Trade
Source: Librarian Capital estimates.
In this example, suppose REA’s share price were to fall by 30% while the theoretical value of the non-REA part of News Corp were to increase by 50%. These should translate into a 7% decline in the theoretical value of each News Corp share, which means we would lose $7 on the long side but gain $21 on the short side, resulting in a net profit of $14 from the trade. This would represent an upside of 49% from the original $29 net exposure.
Upside of 20-30% can be achieved with smaller changes in the “News Corp ex. REA” FCF Yield.
Owning News Corp Shares Outright
Long-only investors can also profit by holding News Corp shares outright
News Corp has a mix of assets, some of which are high-quality while others are more mediocre. We believe overall EBIT can grow at mid-to-high single-digits annually on average, based on:
Digital Real Estate Services – EBIT growth at 10%+
Subscription Video Services – EBIT decline of 2-3%
Dow Jones – EBIT growth at 10%+
Book Publishing – EBIT growth at 3-4%
News Media – EBIT growth at 4-6%
Our assumptions are based on each segment’s track record, outlined below.
Digital Real Estate Services Segment
Digital Real Estate Services is a strong business capable of growing EBITDA at 10%+ annually in our view.
The segment’s main asset is a 61.4% stake in REA Group, a listed property listings company in Australia; it also owns an 80% stake in Move, a similar business in the U.S. that competes with Zillow. (REA owns the other 20% of Move, as well as stakes in certain property listing businesses in Southeast Asia.)
The segment generates revenues from listings, advertising, referrals and related financial products such as mortgages. Segment revenues and EBITDA have been growing strongly, helped by acquisitions, though they did fall significantly in FY20 due to the impact of COVID-19 on listing and project volumes, currency as well as a transition to a referral model in the U.S.; REA-only revenues (in AUD) show a similar pattern:
Segment Revenues & EBIT – Digital Real Estate Services
Source: News Corp & REA company filings.
We expect strong revenue and EBITDA growth to continue in this segment, though a downturn in the Australian property market may create some temporary negative headwinds.
Subscription Video Services Segment
Subscription Video Services is structurally challenged, but EBITDA declines are likely limited to 2-3% annually.
The segment includes News Corp’s 65% stake in Foxtel Group (the other 35% is held by Telstra (TLSYY)) and the wholly-owned Australia News Channel. It is mostly a traditional pay TV business, more recently augmented several new streaming services. Revenues and EBITDA have been falling for several years, as the traditional pay TV subscriber base continues to shrink. The decline decelerated in FY19-21 but picked up again in FY22 year-to-date:
Segment Revenues & EBIT – Subscription Video Services
Source: News Corp company filings.
We expect further subscriber and revenue declines, mitigated by continuing cost control, resulting in small EBITDA declines.
Dow Jones Segment
Dow Jones is a strong business capable of growing EBITDA at 10%+ annually in our view.
The segment includes both consumer publications such as The Wall Street Journal and Barron’s and professional information products such as Dow Jones Risk & Compliance and Factiva. In 2022, the segment entered the commodities information market by acquiring OPIS for $1.15bn and Base Chemicals for $295m from S&P Global (SPGI).
The segment has been growing its Circulation & Other and Professional Information Business revenues steadily, helped by acquisitions. Circulation revenue growth has been driven by an expanding subscriber base, with a 48% increase in total subscribers between Q4 FY19 and Q3 FY22. Advertising was 21% of segment revenues in FY21, having declined during the pandemic. EBITDA will likely have doubled from its FY18 level by the end of FY22:
Segment Revenues & EBIT – Dow Jones
Source: News Corp company filings.
We expect strong growth in circulation and professional information revenues to continue to drive EBITDA growth.
Book Publishing Segment
Book Publishing is a mediocre business likely to see EBITDA growth limited to 3-4% annually in our view.
The segment consists primarily of HarperCollins, the #2 consumer publisher globally. In FY21, it generated 96% of its revenues from consumers, and only 22% of these revenues are digital sales. Consumer print publishing faces poor secular demand trends and Amazon’s pricing power.
EBITDA has been range-bound through FY18-20; FY21 was helped by a boost in demand from COVID lockdowns, hits including the Bridgerton series as well as two acquisitions; FY22 year-to-date saw EBITDA decline again, as rising costs more than offset slightly higher revenues:
Segment Revenues & EBIT – Book Publishing
Source: News Corp company filings.
The segment is likely stable due to its scale advantage, with earnings growing slightly faster than inflation.
News Media Segment
News Media is a solid business capable of growing EBITDA at 4-6% annually in our view.
The segment consists of newspapers in Australia (including The Australian), the U.K. (including The Sun and The Times) and the U.S. (primarily New York Post). Advertising was 59% of segment revenues in FY19, but had shrunk substantially in FY20-21 due to the disposal of News American Marketing (a newspaper ad and in-store coupon business) and COVID-19. These led to a collapse in EBITDA from $204m in FY18 to $52m in FY21:
Segment Revenues & EBIT – News Media
Source: News Corp company filings.
