Fox Corp. (FOX, Financial), which was formed two years ago following The Walt Disney Co.'s (DIS, Financial) acquisition of the majority of the assets owned by 21st Century Fox, reported results for its second quarter of fiscal 2021 on Tuesday.
Revenue for the quarter increased by 8% year-over-year to $4.09 billion, with growth in advertising (+14%) and affiliate fees (+6%). The strength in advertising revenues in the quarter reflects a large tailwind from the U.S. Presidential Election in November, as well as an additional benefit from the Senate run-offs in Georgia. As noted on the conference call, management estimates that political ad revenues totaled roughly $250 million in the quarter, or more than 10% of Fox's total advertising revenues for the period.
Growth in affiliate fees reflects a roughly five point headwind from the continued decline in pay TV subscribers in the United States, which was more than offset by growth in per-sub affiliate rates. As I've noted in the past, Fox remains in a position to command outsized rate increases from distributors due to the strength of its core brands – most notably, Fox News.
As CEO Lachlan Murdoch noted on the call, the news channel had a stellar calendar 2020:
"The Fox News Channel finished the quarter with the highest average primetime ratings in the history of cable news. The Fox News channel closed the calendar year as the number one television network in weekday primetime, continuously topping all broadcast networks in total viewers since the early months of 2020. Fox News was number one in election night coverage, beating all television networks and averaging a 25% share of total viewers… We think we can continue to drive a pricing for FOX News well ahead of any volume declines in subscriber numbers. That's very clear to us looking forward."
As the affiliate fee math for the quarter suggests (6% affiliate fee growth despite 5% subscriber declines), Fox has continued to secure double digit rate increases across its portfolio with help from renewals covering about 70% of their affiliate business in fiscal 2020, including the recent Comcast (CMCSA, Financial) renewal. As the company navigates a pay-TV universe that appears to be in secular decline while simultaneously making sizable investments in potential growth avenues like Tubi, the ability to keep driving per-sub affiliate rates will be critical for Fox.
So far, they've delivered; as shown below, increases in affiliate fees have consistently been 5% to 10% over the past 18 months, all while dealing with unprecedented levels of cord cutting.
The high-single digit increase in revenues, most notably the increase in ad dollars which was delivered with minimal incremental costs, was the primary reason for strong growth in adjusted Ebitda, which increased 17% year-over-year to $305 million.
Now that the company has moved past a period of outsized cash outlays for M&A (with notable examples being Tubi and Credible), returning capital to shareholders is front of mind. In the first half of the year, Fox repurchased $415 million of stock, with the diluted share count falling by nearly 4% year-over-year as a result. This is expected to continue in the back half of the fiscal year, with chief financial officer Steve Tomsic telling shareholders that the company intends to repurchase an additional $550 million of stock over the next six months. On a current market cap of ~$18 billion, that alone is enough to reduce the number of outstanding shares by 3%.
Conclusion
The good news for Fox is that strong first half results, with a nice tailwind from U.S. political advertising, puts them in position to report a solid 2021. By my math, it appears likely that the company is on pace to earn roughly $3 per share for the year, which doesn't look too bad relative to a current stock price of less than $30 per share. In addition, if you believe that they can continue to command outsized rates increases for their portfolio of brands (channels), they are likely to continue reporting growth over the next few years (as long as the rate of pay-TV sub declines does not meaningfully accelerate from current levels).
But as is often the case when you can buy a stock at 10 times earnings, there's a catch. My concern continues to be that a major portion of the business is reliant upon the continued acquisition of sports rights (like the NFL), where the cost of securing said rights may rise as quickly as - and potentially much faster than - revenues. As we near the latest NFL renewals, everything I read leads me to believe that large rate hikes are coming, which is bad for all of the media companies that air these rights, but none so more than Fox.
At the same time, Fox needs to manage the lull that naturally follows a heightened political season and a U.S. Presidential election (quarter to date, ratings at Fox News are down double digits). It seems clear that management recognizes this reality. In my opinion, it's the reason why Lachlan spent much of his prepared remarks talking about the long-term opportunity that he believes the company has in advertising supported video on demand (AVOD) through Tubi.
The problem, as I see it, is that this business is only on pace to generate roughly $300 million in revenues in 2021 – somewhere around 2% of the company's total revenues for the year. Said differently, even if this does prove to be a saving grace for Fox, it will likely take at least five years before this business is of meaningful size, at least relative to Fox's current business.
That's a long way of saying that while Fox appears optically cheap, I'm not so sure that will prove to be the case over the long run. I previously owned shares of Fox, but decided to exit the position in the past six months as more attractive opportunities surfaced. While I can appreciate why a certain style of investor would be interested in buying the stock at today's price, it's not something I'll consider doing until I have a higher level of conviction in the other bets that management has made to ensure the long-term relevance and growth of the enterprise.
Disclosure: Long Comcast and The Walt Disney Company
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