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The Science of Hitting
The Science of Hitting
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Fox: Reason for Optimism in the Back Half of Fiscal 2020

A look at the company's first-quarter financial results

November 08, 2019 | About:

Fox Corp. (NASDAQ:FOX), which was formed in March 2018 following The Walt Disney Co.’s (NYSE:DIS) acquisition of the majority of the assets owned by 21st Century Fox, recently reported results for the first quarter of fiscal 2020. For the quarter, revenues increased 5% to $2.67 billion. The gains in the period were largely driven by a 4% increase in affiliate fees, offset by a 2% reduction in ad revenues (reflective of year-over-year headwinds from the FIFA World Cup, the UFC and political advertising revenues at the local stations related to the 2018 mid-term elections).

As shown below, the pace of affiliate fee growth has slowed materially over the past two years.

While the overall trend has been discouraging, with some headwinds from an acceleration in cord cutting, the short-term results are also being impacted by the timing of some key contract renewals. The company will renew agreements covering more than 40% of their affiliate fee revenues this fiscal year and another 25% in fiscal 2021. For that reason, CFO Steve Tomsic made this important statement during the question and answer portion of the conference call:

"I think that's around the mark [roughly 7% total affiliate fee growth for the year]… You should expect December this year to be similar kind of performance for us [to the first quarter]. But then with the renegotiations that we've just done, the rate resets that we get out of those renegotiations really begin to kick in at the start of the calendar year. So, when you look at our first half, second half growth rate, the growth rate will absolutely be skewed to that second half, and in particular, our third quarter, where you'll see the benefit of those rate resets really kicking in."

The company’s ability to command material rate increases will be dependent on the strength of their brands. As I discussed in an article outlining the new company’s strategy, Fox is primarily focused on live news and live sports, which account for roughly 80% of the company’s revenues from affiliate fees or live event advertising.

While it’s still early days for "New Fox", there are some encouraging signs on this front. Here’s what CEO Lachlan Murdoch had to say about the company’s primary objectives around programming:

"Our strategy to build Fox around live sports, news and event programming is producing results and delivering audience growth and engagement. For example, we are now six weeks into the fall season and Fox has established itself as both the number one rated broadcast network and the only big four network to deliver year-on-year audience growth in the key 18 to 49 demographic (+5%) and in total viewers (+10%). This leadership position stems from the investments we are making across our network, beginning with FOX Sports, which has accounted for 22 of the 50 most-watched telecast in the country since the NFL Kickoff. Our ratings are up 11% across our entire portfolio of college and pro football, led by Thursday Night (viewership +22%) and our Sunday broadcast (+8% to a three-year high)."

Moving down the income statement, the 5% increase in revenues and flat year-over-year expenses led to a 12% increase in segment operating income to $806 million. Below the line, Fox is digesting the costs associated with being a standalone public company. As a result, they only reported a 3% increase in diluted earnings per share (EPS) for the period.

In terms of capital allocation, Fox has already made a handful of bets, most notably the Credible Labs acquisition and the investment in The Stars Group, as well as the recently announced television station deal with Nexstar. In addition, the board of directors has now approved a $2 billion repurchase authorization, with $500 million worth of stock to be repurchased in the near future (enough to reduce the diluted share count by roughly 2.5%).

Conclusion

The success of Fox continues to be heavily weighted towards Fox News, which accounts for roughly 70% of the company’s overall profitability. While the business is currently suffering from some “news fatigue” with the news ad market softer than what they're seeing in entertainment and sports, the company's dominant position as the number one cable channel for the past four years and the number one cable news channel for the past 18 years speaks to the durability of the brand. That brand relevance is a key factor in securing broad distribution and rate increases for Fox.

In terms of the valuation, Fox should earn roughly $2.4 per share this year. At a current price of $34, the stock trades at roughly 14 times forward earnings (and an even lower multiple on free cash flow).

While I have confidence in their ability to continue commanding outsized rate increases, they are also facing some material pressure from both cord cutting and the cost of acquiring key sports rights. Personally, I do not see either of those factors becoming much less of a headwind in the coming years than they are today. For that reason, while I am comfortable holding the shares that I currently own, I think it’s unlikely that I’ll be adding further to this position.

Disclosure: Long Fox and Disney.

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About the author:

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

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