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The Science of Hitting
The Science of Hitting
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Fox: Searching For a Path Forward

Some thoughts on the company's first-half 2020 results

February 09, 2020 | About:

Fox Corp. (NASDAQ:FOX)(FOXA), which was formed in March 2019 following The Walt Disney Co.’s (NYSE:DIS) acquisition of the majority of the assets owned by 21st Century Fox, recently reported results for the second quarter of fiscal 2020. For the quarter, revenue increased 5% to $3.8 billion. The gains in the period were largely driven by a 7% increase in affiliate fees, along with a 1% increase in advertising revenue despite tough comparisons in the year-ago period.

As shown below, the pace of affiliate fee growth accelerated sequentially from the 4% growth rate reported in the first quarter (in addition, as noted on the conference call, management expects high-single-digit growth for affiliate revenues in the back half of 2020).

The acceleration in the quarter reflects the positive contribution from some recent distribution deals, as well as a higher mix of vMVPD subscribers in the pay TV universe from providers like YouTube TV and DirecTV Now (the pricing is better with those providers given more recent deal vintages).

The company’s ability to command material rate increases will be dependent on the strength of its brands. As I’ve discussed previously, Fox is primarily focused on live news and live sports (in total, roughly 80% of the company’s revenue is from affiliate fees or live event advertising).

Recent results have shown that this strategy is working. As noted on the conference call, Fox is now the home of both the top-rated broadcast network and the most-viewed cable network.

Much of the company’s live sports programming consists of college and professional football, with strong results in 2019: for the year, total regular season football viewership was up 14% over 2018 – well ahead of the company’s closest peer (streaming grew nicely as well, up 57% year over year).

At Fox News, the company continues to maintain a sizable lead over its competitors. In 2019, it averaged 2.9 million viewers in primetime (+33% over 2019), compared to 1.7 million for MSNBC (-13%) and 1.2 million for CNN (-2%). The network remains a go to source for important political events, with ratings for the recent State of the Union broadcast doubling the combined result of its two competitors. As we move into the back half of the year and prepare for what will likely be another contentious another U.S. presidential election, the strength of Fox News should be on full display.

In addition to its legacy businesses, Fox is making investments in hopes of diversifying its revenue base. While I have my doubts about the long-term effectiveness of this strategy (in terms of ROI), the reality is shareholders are along for the ride. So far, these investments include the Credible deal, the investment in The Stars Group and the launch of an over-the-top offering (Fox Nation), to name a few. It’s still early days on all of these fronts, so we’ll see how these develop in the coming quarters.

Despite the 5% increase in revenue, earnings before interest, taxes, depreciation and amortization declined significantly in the quarter, reflecting a combination of tough comparisons and incremental costs at the Television segment for programming rights (such as the NFL and the WWE). A big question in my mind is how much of the affiliate fee rate increases that Fox has been able to negotiate will ultimately end up in the pockets of shareholders as opposed to flowing through to the leagues (especially as the cost of these marquee rights may come under pressure due to the presence of some new bidders). Time will tell. For now, all I can say is that I’m much more optimistic in the long-term earnings power of a business like Fox News than I am for the broadcast network.

Conclusion

By my math, Fox should earn somewhere around $2.5 per share this year. That should move north of $3 per share in the next year or two. At a current price of $36 per share, the stock trades at low double-digit multiple of 2021 earnings - a significant discount to the S&P 500.

While I have confidence in its ability to continue commanding outsized rate increases, the company is also facing some material pressure from both cord cutting and the cost of sports rights. In addition, as I hinted at above, I do have some questions about the long-term capital allocation decisions (the recent completion of $500 million in share repurchases partly alleviates those concerns, but I remain skeptical that management is truly committed to this approach in the years to come).

For those reason, while I am comfortable holding the shares that I currently own, I think it’s unlikely that I’ll be adding further to this position. In addition, if the stock moved meaningfully higher from current levels, it’s a position that I would be comfortable letting go of.

Disclosure: Long Fox and Disney.

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About the author:

The Science of Hitting
I'm a value investor with a long-term focus. My goal is to make a small number of meaningful decisions a year. In the words of Charlie Munger, my preferred approach is "patience followed by pretty aggressive conduct." I run a concentrated portfolio - a handful of equities account for the majority of its value. In the eyes of a businessman, I believe this is sufficient diversification.

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