You’ve heard of good banks, bad banks, and toxic assets.
What about a good, bad and a toxic News Corporation?
Nomura has a note on Monday that splits News Corp into three companies with distinct revenue and earnings profiles.
The good is comprised of the cable networks (including News Corp’s current share of BSkyB), television and Sky Italia businesses. Nomura also includes line losses from News Corp’s “other” businesses and all the firm’s debt and cash.
It assumes a go-forward tax rate of 32 per cent. The result:
Based on these assumptions, we estimate that Good NWS will generate EPS of $0.92 in FY12E and $1.15 in FY13E. From FY10 to FY13E, we estimate that EPS will grow by a CAGR of 30%, which we believe to be fairly impressive growth.
If this company actually existed, what would investors pay for this solid structural media play? Looking at public comps, the market appears willing to be pay somewhere in the 14x to 15x earnings for pure-play cable network assets. Looking at News Corp’s cable network portfolio vs. its peers, it is at or near the top in terms of both revenue and EBIT 2010-13E CAGR at 10.6% and 15.7%, respectively.
Assuming a 14.0x multiple on calendar 2012E earnings of $1.04, we estimate that Good NWS would be valued at $14.54 per share. We believe this is another indication of what the downside risk or floor price for NWSA shares should be.
At pixel time News Corp was trading at $14.88 (down 0.76 cents, 4.86 per cent on the day) only a few cents above this valuation for the “good” portion. This suggests some bold assumptions from Nomura or that headline risk continues to undervalue the core business. (Or that investors are worried about another dodgy acquisition spree — or something else entirely.)
The “bad” portion isn’t actually bad in a toxic assets sense. It’s more of a cute way of classifying the part of News Corp that Nomura suggests investors would be less bothered about losing. These are the book publishing, magazine and film businesses. MySpace losses are also included in this portion. The result:
In FY12E, we estimate Bad NWS income before tax of just under $1.4 billion. As the company will have no debt and no below-the-line assets, and using a tax rate of 32% tax rate, we estimate EPS of $0.38 in FY12E and $0.41 in FY13E. From FY10 to FY13E, we estimate that EPS will decline by a CAGR of 1.5%, which includes the MySpace losses through FY11.
Looking at it another way, we estimate that Bad NWS would have EBITDA of about $1.6 billion. After backing out capital expenditure of $80mn and taxes of $440mn, free cash flow could total about $1 billion for FY12E or about $0.42 per share.
… the implied value of Bad NWS is $1.10
Now for the toxic portion: all of News Corp.’s newspapers. And the valuation assumption: zero, sort of.
We now estimate UK newspapers will generate $1.5 billion in revenue in FY12 (or 4.5%of total revenue) and EBIT of $65 million, implying margins of 4%. Our total Newspapersegment revenue forecast is now $6.2 billion, with $499 million of EBIT for FY12E. Weproject that Toxic NWS will generate EPS of $0.12 in FY12E and $0.13 in FY13E. FromFY10 to FY13E, we estimate that EPS will decline by a CAGR of 2.5%.
Given the unknown of what could still come out from any additional investigations (although for now we believe the risk is limited to just the UK), we will take an overly conservative approach and assign a zero multiple valuation to the Newspaper segment. However, we are not saying that if News Corp decided to sell or spin these assets off that they are worthless, but rather believe that under News Corp ownership they will be given little value.
Spin-offs are all the rage these days and there’s long been a clamour for Rupert Murdoch to rein in his indulgence for newspapers. Although some investors smell blood, Rupert Murdoch describes further newspaper sales as “pure rubbish”. But the speed and spread of this scandal to date suggests that nothing should be completely counted out. At the very least it’s a reminder of the irony that the problem for News Corp is — to borrow a phrase — one in the periphery and the real danger, from the firm’s perspective, lies in any spread to the core.
On that topic, Nomura’s note ends by looking at some of the regulatory and legal risks News Corp may face in the US. Senators have called for the DoJ to investigate whether the company broke the Foreign Corrupt Practices Act, while the FBI said on Thursday it was looking into allegations of hacking by News Corp employees into the phones of 9/11 victims. In theory, the FCC could also get involved, though this seems unlikely.
Nomura thinks that a full-blown FCPA investigations is unlikely but does float the possibility that the SEC will want to take a look at News Corp’s books. (The SEC and DoJ jointly enforce the Foreign Corrupt Practices Act.)
More imaginable is an SEC investigation into the FCPA’s Books and Records and Internal Control provisions at News Corp. The company could be in direct violation of these provisions, as bribes would have been hidden as miscellaneous or false expenses. However, we note that bribes would likely represent an immaterial expense at News International and much less at the parent company.
It adds that the least worst option for News Corporation may be to a conduct an internal companywide review before reporting the results to the SEC. There’s a precedent for this, writes Nomura:
We note the recent SEC agreement with Tenaris SA regarding its bribing of Uzbekistan government officials during an oil pipeline bid. The company by conducting a worldwide internal review was able to self-report FCPA violations to the SEC. Under a Deferred Prosecution Agreement (DPA), the company agreed to pay $5.4mn in disgorgement of profits (off of $5mn in alleged profits) and $3.5mn in a non-prosecution agreement to the DOJ. The SEC, in return, refrained from pursuing civil prosecution.
A dismal precedent.
Full note in the usual place.