2023-11-16 05:53:51 ET
Summary
- News Corp’s 1Q24 update was reasonably positive, but weakness in Move and continued structural challenges for advertising revenue highlight near-term and longer-term challenges.
- News Corp is a difficult company for investors to understand and a conglomerate discount appears to be justified.
- With a full valuation and a number of downside risks to be mindful of, the stock warrants a Hold rating at best.
Introduction
News Corporation (NWS) reported 1Q24 results on 03 November 2023. In this note I'll review the 1Q24 materials and discuss notable positive and negative factors that are relevant to the NWS investment case. The 1Q24 result appears to have initially been taken quite well by the market, with the stock's price firming slightly in the days after the release, however those gains quickly faded. Taking a longer-term perspective, the NWS share price is now ~40% above lows hit in March 2023. After this solid run since March, and with the NWS price chart showing the stock to be trading quite close to all-time highs, I'll review the NWS valuation and consider whether the company fits in with my value-driven investment approach.
Companies such as NWS that have a conglomerate-style structure, with activities spread across a wide range of unrelated or loosely related segments, can often trade at a discount relative to a notional portfolio consisting of investments in companies operating in those same segments. A 'conglomerate discount' might be justified if corporate center holding costs are high, or if the allocation of capital between the disparate operating segments is done poorly, but I think that the conglomerates space can be an interesting hunting ground for value investors.
1Q24 Positives
Key positives reported in the 1Q24 materials are summarized and discussed below:
- Book Publishing: 1Q24 revenue was 8% higher than the 1Q23 print. It should be noted that 1Q23 Book Publishing revenue was weak due to logistical changes at Amazon (inventory levels reset, rightsizing of warehouse footprint), so the reported growth rate probably does not reflect the underlying trends in the segment. I think it is fair to say that most analysts would consider Book Publishing to be a relatively low growth component of the NWS portfolio. That said, at $525m, 1Q24 revenue recovered nicely after a disappointing 4Q23 revenue of $446m. As a share of consumer revenue, digital sales came in at 22%, lower than both 1Q23 (23%) and 4Q23 (25%).
- Digital Real Estate Services: Following a lengthy period of softness that lasted throughout most of FY23, Australian real estate market listings firmed in 1Q24. A strong bounce in listing activity in the key markets of Sydney and Melbourne is particularly beneficial as that these regions tend to be higher margin. Trends in the Australian real estate market are important for NWS given the group's 61.42% ownership of ASX-listed REA Group Ltd . REA management now expect FY24E buy listings to be 3% to 5% higher than FY23; improved market activity levels, combined with the effect of recent price increases point to a solid contribution from REA for NWS in FY24E.
Source: REA 1Q24 Market Update, page 2.
- Subscription Video Services: I am quite bearish regarding the medium-term outlook for the Subscription Video Services segment. The demise of traditional pay TV services appears inevitable and I lack conviction that NWS will be able to offset the associated earnings decline via growth in its streaming offerings. It was therefore an unexpected positive to see adjusted revenues in this segment actually increase by ~1% relative to 1Q23. Broadcast subscriber churn has also slowed from the ~14% level observed in 1Q23, stabilizing at ~11% for each of the last two quarters.
- Dow Jones: Average subscriber numbers reported impressive growth relative to 1Q23 and were also slightly up on 4Q23 levels. Strong digital-only subscriber growth has allowed NWS to manage through the continued decline of print subscriptions and still report a 1% increase in total subscription revenue relative to 1Q23. Digital-only circulation revenue now makes up ~70% of the total Dow Jones segment subscription revenue. Digital-only subscriptions to The Wall Street Journal came in at 87% of total Wall Street Journal subscriptions. NWS appears to be well-advanced on the transition to digital within the Dow Jones segment.
Source: NWS 1Q24 Release, page 4.
1Q24 Negatives
Key negatives reported in the 1Q24 materials are summarized and discussed below:
- Digital Real Estate Services: In contrast to improvements coming through from REA, conditions for the group's USA real-estate listings play, Move (which operates realtor.com® | Homes for Sale, Apartments & Houses for Rent ), remain rather soggy. 1Q24 Move revenue was ~16% lower than the 1Q23 print, and ~3% down on 4Q23 levels. Higher mortgage rates seem likely to keep US housing transaction volumes under pressure, so I do not feel optimistic about the near-term outlook for Move.
- Subscription Video Services: 1Q24 subscriber numbers increased relative to 1Q23, but came in ~1.6% lower than 4Q23. The continued decline in residential subscriber numbers is not at all surprising given industry dynamics, but it was disappointing to see both BINGE and Foxtel Now streaming subscriber numbers fall below 1Q24 levels. Successful navigation of the complicated transition from the legacy broadcast model to a streaming model is vital for the Subscription Video Services segment.
Source: NWS 1Q24 Release, page 3.
- News Media: 1Q24 advertising revenues for the News Media segment were 5% lower than 1Q23 levels. Advertising is a key revenue line item for News Media, typically making up ~40% of the segment total revenue. Print advertising revenue fell in both News Corp Australia and News UK, with Australia also delivering weaker digital advertising revenue relative to 1Q23.
Risk Factors
In this section, I will briefly highlight several upside and downside risk factors that I consider investors in NWS should be mindful of.
- The Australian dollar ('AUD'): Although AUDUSD has recovered from lows of around 0.63 to sit at ~0.65 at the time of writing, I would expect AUD to strengthen further against USD in the medium-term. Given that ~41% of group revenue is exposed to AUD (FY23 Form 10-K, page 58), I consider AUD to be an upside risk factor for NWS.
- Take-over potential: This is less of a negative risk factor than an absence of a potential upside risk. The Murdoch family controls ~40% of the NWS voting stock (Class B shares). This concentration of voting power is likely to deter potential acquirers from making a bid for NWS.
- Digital advertising trends: With the likes of Amazon, Facebook and Google continuing to drive the shift of advertising away from traditional print and TV towards digital platforms, I consider the changing nature of advertising markets as a downside risk factor for NWS. Even if NWS is able to keep pace with leaders in the digital advertising space, the lower price rates for digital advertising will create revenue pressure due to the loss of the group's higher price rated traditional advertising.
- Economic cyclicality: Advertising revenue is highly sensitive to economic conditions. Advertising represents around 17% of NWS group revenue. I see economic cyclicality as more of a downside risk factor for NWS than an upside risk factor, as businesses are more likely to cut back on advertising spend in recessions than they are to boost advertising spend when economic conditions are healthy.
- Generative AI: Whilst NWS is currently investigating the use of AI as a tool to distribute content, on balance I see generative AI as a downside risk factor for the company. As a producer of media content, NWS may be able to use generative AI to lower content production costs, but the competitive threat from players with better access (including via direct ownership) to cutting edge generative AI seems likely to more than outweigh content cost reduction benefits.
We are actively working to make the most of our premium content for AI and are engaged in advanced discussions that we expect to bring significant revenue to the company in return for the authorized use of our peerless content. Our quest is to maximize value for all investors, so we are assiduously reviewing our structure.
Source: NWS 1Q24 Release , page 1.
- Corporate governance: The influence of the Murdoch family on NWS is well-understood. The company has historically attracted a fair amount of criticism regarding poor corporate governance and my expectation is that this trend will continue. Corporate governance is therefore a downside risk factor for NWS.
What About Value?
NWS has a market cap of ~ $12.15bn. REA Group, which is listed on the Australian Securities Exchange ('ASX') under the code REA , has a market cap of ~AUD$20.8bn (based on the ASX 15 November 2023 closing price of AUD$157.45), implying that NWS's 61.42% ownership of REA Group is currently valued at ~$8.3bn (using AUDUSD at 0.65). Since an observable market value for the NWS holding in REA is readily available and simple to calculate, I decided to make use of this data point in my initial valuation assessment. In applying this approach, I am implicitly assuming that the market value of REA is a fair reflection of the company's underlying value.
In Exhibit 1 below, I set out an Adjusted Enterprise Value ('Adjusted EV') analysis for NWS that captures the market value of the group's stake in REA. Since REA is fully consolidated by NWS, the Adjusted EV calculation adjusts NWS balance sheet values for cash and debt to account for the group's 61.42% economic exposure to REA (rather than the 'raw' balance sheet 100% exposure before non-controlling interests).
Exhibit 1:
Source: author calculations based on NWS and REA quarterly reports.
In Exhibit 2, I set out an Adjusted EBIT calculation for NWS. Adjusted EBIT shown here starts from the reported NWS FY23 EBIT and makes the following adjustments:
- add back non-cash intangible amortization and impairment
- deduct REA's reported AUD FY23 EBIT after translation to USD
- adjust for an assumed normalized annual restructure charge of -$75m (note that FY23 EBIT included a restructure charge of -$125m)
- reverse the FY23 -$10m of one-time costs related to the professional fees incurred in connection with evaluating the proposal from the Murdoch Family Trust for NWS to merge with FOX (this -$10m cost is a good example of corporate governance risk referenced above)
- reverse FY23 equity losses of affiliates relating to Australian sports wagering (estimated to be -$55m)
- allow for 1/3 of the $160m pa cost-out program announced in February 2023 to be retained
Exhibit 2:
Source: author calculations based on NWS and REA quarterly reports.
Having calculated Adjusted EBIT as discussed above, I then assume 1-year forward EBIT growth of +5% to arrive at Valuation EBIT. Bringing together Valuation EBIT and Adjusted EV, we arrive at a valuation metric for NWS excluding REA. Exhibit 2 shows that Adjusted EV/Valuation EBIT drops out at ~11.6x.
Looking at NWS this way, on an 'excluding REA basis', the material challenges faced by the Subscription Video Services and News Media segments relating to the transition from a legacy broadcasting/advertising world to the future streaming/digital advertising world are particularly salient. Add in to the equation concerns regarding corporate governance, and I find myself concluding that a fair value EV/EBIT multiple for 'NWS excluding REA' is around 10x to 11x. On that basis, I am struggling to see much value appeal in NWS.
Note that the analysis described above assumes that REA is fairly priced. For a value investor such as myself, REA's P/E multiple of around 50x is uncomfortably high. If I were to assume that REA's market cap overstates REA's underlying value by 10%, then the 'NWS excluding REA' EV/EBIT multiple would increase to ~13.5x.
Conclusion & Rating
NWS owns a wide range of assets and operates across multiple market segments and geographies. It is therefore not an easy company to understand. The bulk of the group's revenue streams are sensitive to economic cyclicality. Several of the markets in which NWS operates face highly uncertain futures and the increasing importance of AI seems likely to weaken the group's competitive standing relative to entities with better technology experience and resources. There are parts of the group that will appeal to growth-focused investors (the Digital Real Estate Services segment in particular). The company owns some quality assets that are perhaps deserving of higher than peer-average earnings multiples (mostly within the Dow Jones segment - The Wall Street Journal, Barron's, Dow Jones Risk & Compliance), but looking across the group as a whole, I do not get a sense that NWS is a conglomerate of 'best-in-class' holdings.
For further details see:
News Corporation: Uncompelling Complex Conglomerate