Fox Corp. (FOX)(FOXA), which was formed in early 2019 following The Walt Disney Company’s (DIS) acquisition of the majority of the assets of 21st Century Fox, recently reported results for its fourth quarter of fiscal 2020. For the quarter, revenues declined 4% year-over-year to $2.4 billion, with an 8% increase in affiliate revenues offset by a 22% decline in advertising. As shown below, the pace of affiliate fee growth decelerated sequentially from the +10% reported in the third quarter.
The deceleration in the fourth quarter’s affiliate fee growth rate reflects the impact of cord cutting. The number of pay-TV subscribers across Fox’s slate of channels declined by more than 6% year-over-year in the fourth quarter, compared to a low-single digit decline earlier in the year. If this pace of subscriber declines is sustained – or worsens – that will put a lot of pressure on media companies that depend upon the pay-TV business. It will also likely have an impact on how they spend money on things like bidding for sports rights.
The fact that Fox still delivered an 8% increase in affiliate fees in the face of an unprecedented level of subscriber declines is noteworthy. The math implies that the company has negotiated mid-teens per sub affiliate fee annualized rate increases in its recent renewals. And as management noted on the call, they renewed contracts that covered roughly 70% of their affiliate business in fiscal 2020. Said differently, as long as the pace of subscriber declines doesn’t accelerate meaningfully from here, I think Fox should continue to deliver mid-to-high single digit annual growth in affiliate fees.
At Fox News, the company’s most important channel, it was another banner year. Here are some of the highlights that CEO Lachlan Murdoch mentioned on the conference call:
“Another business that's had an extraordinary year is Fox News, which ended fiscal year 2020 with record-breaking viewership. In June 2020, Fox News was the leading primetime network in all of television among total viewers, making it the first cable network to ever lead all broadcast networks in ratings for an entire month. For the fiscal year, we were again the number one channel in all of cable for total viewers across prime and total day… Fox News has been the number one channel in all cable for four years running and the number one channel in cable news for 18 years. We have a long track record of succeeding through multiple economic and political cycles and during administrations of both political parties. We are pacing calendar 2020 to have our highest-rated primetime year in network history with total viewers up 39% over 2019. Our primetime programs are now routinely notching around 4 million viewers a night. Though not a head-to-head comparison, the Fox News channel is eclipsing broadcast news stalwarts like Good Morning America, CBS This Morning and Meet the Press in viewership.”
The results at News are a big reason why Fox has been able to extract those large rate increases.
On the other hand, the company’s other channels are facing short-term pressure from the pandemic. Local advertising revenues have fallen precipitously, the temporary shutdown of the major sports leagues has left Fox without much of its marquee programming (albeit less than others due to Fox’s exposure to college and pro football) and social distancing has impacted their ability to produce entertainment programming for the broadcast network (shows like The Masked Singer). While it will take time for these issues to be resolved, I think the company is in a position to weather the storm.
A big question in my mind continues to be how much of the affiliate fee rate increases discussed above will ultimately end up in the pockets of Fox shareholders as opposed to flowing through to the leagues and players. Time will tell. For now, all I can say is that I’m more optimistic in the long-term earnings power of a business like Fox News than I am for the broadcast network.
But even if affiliate fees outpace programming expenses, that still does not mean the company's growing cash flows will be returned to shareholders. As I’ve discussed in the past, Fox has made a number of investments in the past 12-18 months in hopes of diversifying its revenue base, including Credible, The Stars Group and the acquisition of Tubi. It’s still the early days for each of these deals, with management sharing some encouraging commentary on the call, but I remain skeptical about the long-term value that can be created for shareholders through these decisions – and if management keeps pursuing additional deals, which sounds likely, that’s a problem for shareholders like myself who would prefer outsized capital returns over M&A (for context, Fox allocated $1.1 billion to investments in fiscal 2020, compared to $600 million for share repurchases).
For the year, revenues increased 8% to $12.3 billion, with adjusted EBITDA climbing 4% to $2.8 billion. Adjusted earnings per share (EPS) declined by 6% to $2.50 per share.
Conclusion
With the stock at $25 per share, Fox trades at roughly 10 times fiscal 2020 earnings. I previously expected the company to earn closer to $3 per share in fiscal 2021, but guidance on the call suggests that the impact from the pandemic, particularly in the first half of the year, will likely result in a material headwind to earnings at Fox (and possibly result in a year-over-year decline).
In addition, I continue to be concerned that shareholders will be forced to live with questionable capital allocation over the coming years. Consider some of Lachlan’s commentary on the call:
“Our goal remains to expand the ways our audiences interact with and connect to our brands, while simultaneously diversifying each brand sources of revenues.”
Simply put, I do not see how Credible or Tubi will expand the core customers' connection to Fox News. In addition, I think efforts to diversify the company's main revenue sources through efforts like Fox Nation will prove difficult. To be fair, management is in somewhat of a tough spot; to do nothing in the face of high-single digit subscriber declines feels misguided. My issue is that I don’t think their proposed solutions actually address the problem. For those reasons, while I continue to hold shares in Fox, I’m honestly uninterested in adding to my position, even if the stock became 10% or 20% cheaper. And as that might suggest, there's also a possibly that I may head for the exits in hopes of finding greener pastures elsewhere.
Disclosure: Long FOX and DIS
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