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The Science of Hitting
The Science of Hitting
Articles (456) 

Why I'm Buying Twenty-First Century Fox

After following the stock for awhile, this is my rationale for taking the plunge

August 18, 2016 | About:

I recently added shares of Twenty-First Century Fox (FOXA), a global media and entertainment company, to my portfolio. I’ve been following Twenty-First Century Fox for some time but have not previously owned the stock. I thought it would be worthwhile to broadly outline my thesis.

Cable network programming

The company’s most important segment, which is where I’ll focus my attention, is cable network programming. Twenty-First Century Fox owns and operates numerous TV channels, including Fox News, Fox Business Network, Fox Sports 1 (FS1), FX / FXX and regional sports networks (RSN). Importantly, these channels are in high demand by a diverse collection of consumers, which enables the company to command relatively large affiliate fee rate increases from the pay-TV providers (primarily cable, satellite and telecom companies).

Consider this example: In late 2014, Fox and Dish Network (DISH) were unable to come to terms on a new carriage agreement. The spat was resolved a few weeks later. According to the Wall Street Journal (source), the multiyear carriage agreement negotiated between the two companies included monthly affiliate fees for Fox News of $1.50 per subscriber – a 50% increase from the prior deal. A decade earlier, Fox News commanded affiliate fees of just 25 cents per sub (source).

Affiliate fees are big business for Twenty-First Century Fox: In fiscal 2016, the company reported $11.2 billion in affiliate fees – more than 40% of its revenues. That compares to $5.4 billion in fiscal 2011, or a five-year CAGR of nearly 16% (despite material currency headwinds). As noted in the most recent 10-K, domestic affiliate fee increases were broad based in fiscal 2016, led by FS1, FX, Fox News and the RSNs.

As the company renegotiates 15% to 20% of its pay-TV subscriber base in each of the next three years (based on management's guidance), I expect this trend to continue.

In addition to affiliate fees, the Cable Network Programming business has continued to report solid advertising revenue growth. Importantly, sports and news programming are both somewhat immune to the impact of time-shifted viewing, which is a huge draw for advertising dollars.

While cable network programming revenues have risen sharply, profits have not kept pace. Over the past four years, segment margins have contracted by roughly 400 basis points. Without going into too much detail, my research suggests that the near-term pressure from FOXA's investments in new channels and programming is a price worth paying; long-term, I think these investments will generate value for shareholders. In the years ahead, these investments will drive outsized revenue growth. In addition, we’re nearing the tail end of the investment cycle (in both the U.S. and abroad). If my assumptions are correct, this could potentially unlock ~$1 billion in pretax earnings over the next few years.

Cord cutting

Concerns about cord cutting have battered media stocks (that's the only reason why Twenty-First Century Fox reached my target price). It might be helpful to consider some relevant data.

  • The average American spends a tremendous amount of time watching TV (more than four hours a day, according to Nielsen). These numbers have not changed meaningfully in the past few years. Relative to other entertainment options, pay-TV is quite inexpensive.
  • The subscriber declines reported to date have not been very large. In 2015, total pay-TV net subs in the U.S. declined roughly 1% (the trend was flat to slightly positive in the previous five years). While I wouldn’t be surprised to see this trend continue or slightly worsen (essentially what we've seen to date in 2016), it seems unlikely that it will meaningfully accelerate.
  • I don’t think companies like Comcast (CMCSA) will sit still as video subs depart in large numbers. Comcast has a strong incentive to push customers into bundles – and prices its services accordingly (that’s partly why ~70% of its customers have a double or triple play bundle). In addition, it's working with companies like Fox and Disney (DIS) to improve on-demand offerings (unrestricted access to current and prior programs).

This combination (competitive pricing through bundled services and widespread access to content) will make it difficult for the cord shaving / skinny bundle OTT offerings like Sling and Vue to offer material differentiated value to consumers.

Equity investments

In addition to its core businesses, Twenty-First Century Fox has a number of investments (primarily Sky PLC [SKY] and Hulu). Without going into detail, my research leads me to the conclusion that, in aggregate, the company's investments are worth more than $5 per Twenty-First Century Fox share (pretax). Valuing Twenty-First Century Fox solely based on its reported earnings in fiscal year 2016 incorrectly accounts for the value of these interests.

Conclusion

In its recently completed year, Twenty-First Century Fox reported adjusted EPS of ~$1.70 per share. At a recent price of ~$25 per share, the stock is trading at less than 15x trailing earnings. My model, which is built upon the arguments I’ve laid out in this article, suggests that earnings can grow at a mid- to high single-digit rate in the coming years. If the company continues to use free cash flow to aggressively repurchase its own stock, EPS may advance at a double digit clip.

Overall, the current valuation is appealing enough to justify an investment in Twenty-First Century Fox. If the stock price continues to decline, I plan on adding additional shares.

Disclosure: Long Twenty-First Century Fox.

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About the author:

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

Rating: 4.6/5 (11 votes)

Voters:

Comments

DLV
DLV premium member - 1 year ago

a concern I have for Fox is the same as Disney in that all the money they rake in from subscriber fees could plummet in the near future with more people cutting the cord and more push towards greater a la carte pricing. Everybody with cable or satellite dish is currently sending them $1.50 a month for Fox News alone. Would everybody individually pay that? Probably not. Same for a bunch of their other channels. FS1 and FS2 pull in $1.29 a month per subscriber.

I think they could find a way to keep growing the revenue from those channels, but I'm not certain of it and there is significant risk that the revenue could greatly drop in the next few years.

The Science of Hitting
The Science of Hitting - 1 year ago    Report SPAM

DLV,

I'm not sure that a la carte pricing - if it's even offered - makes a ton of sense for most people. Consider that the average households watches ~300 hours of TV each month across ~17 different channels (Nielsen and Redef data). Now look at the cost for OTT offerings - either packages (Sling, Vue, etc) or single channels (HBO, CBS, etc). Even if you really only care about ~5 of the ~17 channels watched in your household, it's difficult to save money relative to the average Comcast "Double Play" bundle, at least based on what I've seen (I'm happy to look at the math if you have an example that suggests otherwise). This assumes people care about and are willing to pay for the channels that consistently have strong ratings - Fox News, ESPN, etc.

I'd encourage you to read the three-part series referenced below, which I think does a good job addressing the cord shaving argument:

https://stratechery.com/2013/the-cord-cutting-fantasy/

Cord cutting, on the other hand, is a problem: if you cut TV all together, you'll save a lot of money (hundreds of dollars per year). As noted above, I question how many people are truly willing / able to completely cut the cord. If I'm incorrect on this assumption, it would not be good for FOXA.

Thanks for the comment!

Douglas Eugene
Douglas Eugene - 1 year ago    Report SPAM

Hi Science: In addition to the fine comments you make here, the company's own history suggests shares are fairly or undervalued, too. FOXA's average PE multiple over the past 6 years has been 16.8X earnings; both the trailing PE (as you mention) is below that average, as well as the forward PE. If we apply the average PE to 2016 estimated earnings, this suggests a price target over the next year of $32+. Not bad on shares currently priced around $25-especially if they grow EPS as you suggest. My two cents - thanks for your article.

The Science of Hitting
The Science of Hitting - 1 year ago    Report SPAM

Douglas,

Agreed, FOXA seems reasonable to me at ~$25 per share. I think there's a fair amount of pessimism built into the current valuation. Thanks for the comment!

omarandemad
Omarandemad - 1 year ago    Report SPAM

such a wonderful atricle. thanks.

The Science of Hitting
The Science of Hitting - 1 year ago    Report SPAM

Thanks for the kind words Omarandemad!

chesko182
Chesko182 - 1 year ago    Report SPAM

Hi Science,

Have you looked at the current spread that the AT&T/TWX merger is offering? It seems to be attractive and I'd love to hear your thoughts.

I wrote anarticle on this recently. http://seekingalpha.com/article/4018314-time-warner-attractive-mispriced-bet

Thanks,

Francisco

The Science of Hitting
The Science of Hitting - 1 year ago    Report SPAM

Francisco,

Here's my first takeaway from the AT&T / TWX deal announcement: when an investor / businessman that you respect (in this case, Murdoch) attempts to buy a business at "X", and then the target falls to a price that's 25% - 30% below "X", you should take a close look. I should've spent more time on TWX in the months following the failed attempt by 21CF, especially when it plummeted in early 2016.

As it relates to your article specifically, it sounds reasonable to me. Take this for what it's worth, by Andrew Ross Sorkin said recently (at the DealBook conference) that sources familiar with AT&T's position said they're more bullish on the transaction being approved with Trump in office.

Are you hedging out the AT&T exposure?

And if you are, does that materially change the math?

Please leave your comment:


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