Fox Corp. (FOX, FOXA) was created in March 2019 after The Walt Disney Company (DIS) acquired most of the film, television production, cable networks and international assets owned by 21st Century Fox (21CF). The new company’s programming strategy follows a similar path to 21CF, with a focus on live news and live sports. On a pro forma basis, revenues for Fox were $10.2 billion in fiscal 2018, with pre-tax earnings of roughly $2.0 billion.
Revenues for the business are split between the Television segment (Fox broadcast network and the company’s 28 television stations) and the Cable Networks segment (primarily FOX News, FOX Business and FOX Sports), with profitability heavily weighted towards the latter.
The most important asset at the company is Fox News, which has been the highest-rated cable news network in the U.S. for 17 consecutive years (notably, these strong ratings have not been materially impacted over the years by the loss of well-known personalities like Bill O’Reilly or Megyn Kelly). On an average night in 2018, Fox News drew roughly 2.5 million viewers in primetime. While these numbers have not been disclosed by the company, industry research firm SNL Kagan estimates Fox News generates nearly $2.00 per subscriber in affiliate fees (per sub affiliate fees for the channel have roughly doubled over the past six or seven years). With coverage in roughly 85 million households across the U.S., Fox News brings in roughly $2 billion a year in affiliate fee revenues. After roughly $1 billion in advertising revenues, Fox News brings in around $3 billion a year, or roughly 30% of Fox’s total revenues.
In addition, the channel generates outsized profitability: SNL Kagan estimates that Fox News has roughly 60% margins. At well over $1.5 billion a year, that means Fox News accounts for the majority of the company’s profits (and I expect its contribution to keep climbing over the next few years).
Fox News viewers (with an average age in the mid-60s) are in the demographic that has been least likely to cut the cord in recent years - in fact, they're watching more live TV than ever before. For distributors like Comcast (CMCSA), AT&T (T) or Charter (CHTR), that means losing carriage of Fox News would likely result in the loss of a large number of pay-TV subs. For that reason, I remain confident that Fox will be able to negotiate sizable increases in affiliate fees over time (you may remember that this was a core part of my 21st Century Fox investment thesis as well).
In addition to news, the company has significant exposure to sports through the Fox broadcast network, Fox Sports (FS1 and FS2), and a 51% interest in the Big Ten Network. The company’s portfolio includes the NFL, MLB, FIFA, NASCAR and the WWE. Notably, the company’s strategy is leading to highly sought-after live events with large audiences: In 2017, the Fox Network produced 22 of the 50 most-watched shows on broadcast TV. The company has made a significant financial commitment to secure these rights: analysts at JPMorgan estimate Fox will spend $3.0 billion to $3.5 billion next year on sports. About half of that will go to the NFL, with Fox spending $660 million for Thursday Night Football and $1.1 billion for its Sunday NFC rights (both deals expire in 2022).
I expect the cost of sports rights to continue to outpace inflation over the years. The offset for Fox will need to come through higher affiliate fees from FS1 and FS2 and higher reverse comp and retransmission fees at Fox broadcast (it’s worth noting that this balancing act will likely take some time; said differently, there will be pressure on the income statement in the near term as Fox digests the costs associated with Thursday Night Football and the WWE deal).
While there has been a lot of talk in recent years about the impact of internet players like Amazon (AMZN) or Facebook (FB) bidding for major sports rights, the evidence thus far suggests that obstacles remain. As it relates to Fox, it’s highly unlikely it will lose its Sunday NFL rights in the next round of negotiations (note that Fox owns and operates stations in 13 NFC markets).
As outlined above, the future of this business relies heavily on Fox News. The company should be able to translate strong TV ratings and leverage with distributors into outsized (mid-to-high single-digit) affiliate fee growth. That should outpace the increase in expenses, resulting in double digit growth in profitability. It’s still early, but there may also be some upside from Fox Nation, the $6-per-month over the top (OTT) offering for diehard Fox News fans (with that said, the addressable market for this product is small).
For the remainder of the company, I think low-to-mid single digit revenue growth is attainable (with outsized growth from reverse comp and retrans offset by the fact that it’s starting from a much smaller base than advertising revenues). All-in, that leaves Fox with mid-single digit revenue growth and mid-to-high single digit growth in operating profits over the next few years (for what it’s worth, pro forma revenues at Fox have increased at a 6% CAGR over the past four years).
If that plays out, the company will generate north of $2 billion of net income and free cash flow in the near future (it’s worth noting that the company has roughly $4.5 billion in net debt). With 620 million shares outstanding, that suggests earnings in excess of $3 per share. At $36 per share, the stock trades at a low double-digit multiple of forward earnings.
That valuation probably reflects the uneasiness some investors (or their clients) may have with significant exposure to Fox News. While I don’t plan to make Fox a huge position at this time, I’m comfortable owning the shares that I received as part of the 21CF / Disney deal at these levels. I’ll update my thoughts on the company following next month’s investor day.
Long FOX, FOXA, DIS, CMCSA and FB.