Fox Corp. (FOX, Financial)(FOXA, Financial), which was formed in early 2018 following The Walt Disney Co.'s (DIS, Financial) acquisition of the majority of the assets owned by 21st Century Fox, reported results for the first quarter of fiscal 2021 on Tuesday. Revenue increased 2% to $2.72 billion, with 10% growth in affiliate fees offset by mid-single-digit declines in advertising and other revenue (primarily due to the absence of sports sub-licensing revenue). This led to a 36% increase in adjusted Ebitda to $1.17 billion as well as a 42% increase in adjusted earnings per share (but as I'll explain shortly, the outsized growth in profits in the quarter reflects a one-time item). As shown below, the 10% growth in affiliate fees in the quarter, which was delivered in spite of a 6% decline in net pay-TV subscribers, matches the best growth rate that Fox has delivered in the past six quarters.
As that math suggests, Fox has been able to secure strong double digit rate increases from distributors, which has proven incredibly important in the face of accelerated pay-TV sub declines (with help from renewals covering about 70% of their affiliate business in fiscal 2020, with a notable recent example being the Comcast renewal announced in April). This outsized growth in per sub rates reflects the fact that Fox's brands are in high demand by customers – and as a result are "must have" programming for any multichannel video programming distribuort or virtual MVPD. As CEO Lachlan Murdoch noted on the conference call, Fox News has been a particular standout as of late:
"The news teams at the Fox television stations and FOX News have done a superb job throughout this election season, and viewers from across the political spectrum have been turning to us in record numbers as a result. FOX News finished September as the first cable network to lead all broadcast networks in weekday primetime with total viewers for the full quarter. In fact, FOX News has been the most watched network in all of television, from Memorial Day through Election Day. We achieved ratings growth in total day and primetime throughout the first quarter. FOX News total day ratings were up 28% in total viewers, and 31% among adults 25 to 54 years old. Primetime ratings increased even more substantially, up 43% in total viewers, and up 54% among adults 25 to 54 years old. This demo is sought out by advertisers, making these gains particularly impactful. Already in the second quarter, the rate of growth in both total viewers and in the 25 to 54 demo has accelerated from last quarter."
On a segment basis, Cable Network Programming revenue increased 3% to $1.33 billion, with segment Ebitda up 14% year over year to $781 million. In the Television segment, revenue was flat at $1.35 billion, with segment Ebitda up 82% year over year to $457 million. In both segments, profitability was meaningfully helped by the postponement of live sporting events, which led to a temporary reduction in programming rights amortization and production costs. As Chief Financial Officer Steve Tomsic noted on the conference call, this was a benefit of roughly $275 million in the quarter, with those costs shifted into the remainder of fiscal 2021 (primarily in the second quarter). If we remove this amount from the bottom line, which may actually overstate the net cost (due to the fact that the company would've brought in additional ad revenues had they aired the sporting events as expected), adjusted Ebitda in the first quarter would've been roughly flat year over year.
In the first quarter, cash from operations totaled $267 million, with $150 million in free cash flow. In addition, Fox received $462 million from Disney as a reimbursement from prepayment of the estimated share of tax liabilities from the divestiture of the regional sports networks (sold to Disney in 2018, and then divested by Disney shortly thereafter as a condition of receiving governement approval for the deal). At quarter-end, Fox held $5.1 billion in cash and equivalents; after accounting for $8 billion in debt, the company has $2.9 billion in net debt on its books.
In terms of capital allocation, Fox has leaned more aggressively into share repurchases. As noted on the call, the company has repurchased $305 million worth of stock since the start of the fiscal year and has repurchased $900 million worth of stock since the repurchase authorization was announced a year ago (diluted shares outstanding in the quarter were down 3% year over year).
Conclusion
The good news is that Fox's strong slate of brands puts them in a strong negotiating position with distributors, enabling them to command continued outsized rate increases. The bad news is that a major portion of their business is reliant upon the continued acquisition of sports rights (like the NFL), where the cost may be rising as quickly as – and potentially even faster than - revenues. In addition, it remains unclear how well brands like Fox News would fare in a world where the pay-TV bundle ultimately implodes – an outcome that I think is increasingly likely given the actions and incentives (drive DTC subs) of companies like AT&T (T, Financial), Comcast (CMCSA, Financial) and Disney.
Management believes that the growth of some of the digital-native businesses, which include Tubi, Credible and FoxBet (along with the Flutter equity stake the TSG / FanDuel options), may help it to diversify the business and offset the continued decline in pay-TV subs. As I've discussed in the past, I have my doubts about some of these assets (in the sense that they're a good fit for Fox and will ultimately create meaningful long-term value for shareholders). That said, some of the data shared on the call suggests these businesses are performing well and can be benefit from the impressions generated by Fox's portfolio of owned and operated assets, so maybe I'm wrong.
In terms of the valuation, Fox should earn $2.50 to $3 per share in fiscal 2021. At a current price of $26 per share, the stock trades at roughly 10 times forward earnings. Despite the seemingly cheap valuation, the concerns that I discussed in May remain top of mind. For those reasons, and because I found an idea that struck me as a more attractive long-term investment, I sold half of my position in September. It is now an immaterial position in my portfolio (less than a 2% weighting).
Disclosure: Long Fox, Comcast and The Walt Disney Co.
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