The price action in BSkyB on Tuesday morning following confirmation a highly conditional proposal from its biggest shareholder News Corporation.
As you can see, Sky was trading above 700p at pixel time.
That’s somewhat surprising, given the risks and timeline of any of eventual offer. (And remember News Corp has not made a formal offer, just a proposal).
True — the independent directors of Sky, which include Allan Leighton and Jacques Nasser, have indicated they would only be prepared to support a proposal in excess of 800p a share. But, there are no guarantees News Corp, a 40 per cent shareholder remember, will pay that amount.
To help put those figures in context, here are some valuation metrics from Citigroup (emphasis FT Alphaville’s):
The indicative price of 700p would be pretty much bang-on 10x current year, i.e. 2010E, EV/EBITDA. Given the growth profile BSkyB, on our forecasts, would be on just 8.3x 2011E. This looks conservative, but how conservative is difficult to say. Our DCF-based fair value is 700p, which assumes an 8.8% discount rate and 1% LT growth. Simply moving the LT growth assumption to 2.5% would increase our FV estimate to >900p. A metric a lot of investors will want to use is EV/Subscriber, and 700p would value each of BSkyB’s subs at around £1,300. This is broadly in line with recent transaction levels in North/South America (e.g. DirecTV/Sky Brazil). At the same time, it is worth noting that BSkyB’s metrics, especially churn (c.10% vs. 15%+ in the Americas) potentially drive better pricing and returns, and therefore may justify a substantially higher EV/Sub
And before News Corp can make a formal offer it has to gain regulatory clearances. While the political backdrop in the UK has improved, and News Corp and Sky have agreed to work together to get the necessary approvals, it still seems unlikely that the deal will have been cleared by next year.
Note that Sky will kick off the approval process by seeking approval from EU and not UK regulators – even though BSkyB has no European interests to speak of. No doubt the new prime minister will be relieved by that. However, the Liberal Democrats (no fans of Rupert Murdoch), the Office of Fair Trading, and industry regulator Ofcom are likely to feel different, and will probably try and repatriate scrutiny of this deal.
Indeed, it’s worth pointing out that the ‘cooperation agreement’ between News Corp and BSkyB expires at the end of December 31 2011, which might provides a clue as to when News Corp thinks the deal might close. (However, News Corp believes approval could come in six months).
And it hardly needs saying that during that period a lot can happen. Murdoch could simply walk awaym and the most it would cost him is £38.5m (assuming the deal is approved).
If merger clearance is not granted or granted subject to a material remedy, then News Corporation will reimburse BSkyB for costs incurred up to a maximum of £20 million.BSkyB a fee of £38.5 million, representing 0.5% of the value of the Proposal. Further, if News Corporation either receives merger clearance unconditionally or subject to non-material remedies prior to 31 December 2011 and fails to make a firm offer within five months thereafter, or announces prior to obtaining merger clearance that it does not intend to make a firm offer, then News Corporation will pay
Of course, none of this is to say a deal won’t happen, rather that the risk reward of buying BSkyB at current levels is hardly attractive. At 715p with a close of 1 December 2011, gives an annualised return of just 11 per cent. At 775p that figure falls to just 8.57 per cent.
That said, existing Sky investors are likely to take comfort from the fact that it main shareholder believes the stock is worth 700p and its independent directors 800p. And Sky is hardly an ex-growth stock, so even without a bid it’s possible the price holds above 700p a share.
But December 2011 is a long way away.
Update: 10.49 (BST). Comment from Olivetree Securities, who reckon the new Business Secretary has the power to block this deal.
It seems to us that it is only now that the market is starting to work out how long the timeline on this deal is potentially. The stock will continue to drift (slowly) from current levels. Of course BSY stock will remain underpinned now a potential 700p bid is on the table, but working through the maths we just think they are still a touch rich.
- Given BSY management have already put an 800p max ceiling on the shares, we can reference back from this to provide a best-case value for the shares.
- Low-risk arb trades currently annualise c5%, so if we build in a best-case 800p, we end up at c750p instantly. Then modeling our timetable concerns and regulatory risks outlined below, we think the right price for BSY shares is closer to 700p (or maybe even in the 690s). This has been very much echoed by our (heavy) trading flows this morning.
- We still think this deal will take in excess of 12 months to close, indeed there is scope for it taking as long as 18 months. Even on a best-case scenario we can only model 9-10 months. It is important to note that it is only at this point that we will know the clearing price for the transaction, until then the 700-800 spread will remain.
- This is why the shareprice is slipping over the course of the morning, and will continue to do so. BSY shares are fundamentally expensive, short covering is starting to finish and long funds are taking the opportunity to sell up here.
- From a competition perspective although the overlaps are straightforward, the process re media transactions in the UK is arduous, and lengthy in timetable.
- Media deals are covered by the Enterprise Act 2002, which effects special rules. Indeed the Ofcom Medial Ownership Rules 2006 also outline key considerations. Whereas there is no language in either of these docs specifically covering NewsCorp-BSY, there are many many “Cross Media” catch all clauses, regarding the ownership of both print and broadcast media. There is a lot of protection re newspaper owners buying ITV licenses, clearly not applicable here but an insight as to how the regulator thinks. Although it is highly possible the deal ultimately gets approved, the process between now and then is lengthy.
Importantly the Secretary of State (Vince Cable) can block a deal by himself. So although overlaps minimal, this is not a regulatory process without risk, and buyers of BSY shares need to be compensated for that.
Related links:
Friday rumourtrage (updated) - FT Alphaville
BSkyB rejects News Corp approach – FT
Murdoch BSkyB move defies conventional wisdom – FT
Murdoch’s London-based global news hub – Robert Peston