News Corp… Sufficiently Digital? Sufficiently Sustainable?

In an investment era that feels likely to be defined by the rise and rise of cloud software platforms and iterations of the ‘as-a-service’ recurring revenue model, News Corporation (NWS) remains in many ways a throw-back investment.

With a name synonymous with newspapers and traditional media formats, and a multi-national operating model borne out of extensive corporate activity over its four plus decades since incorporation, NWS is a truly unique investment proposition on the ASX (Chart 1).

Chart 1. (For News Corp ownership (%) of above assets see Chester AM valuation – Table 4)

Listed in both Australia and the US (Nasdaq) and carrying a legacy dual-class share structure that is unique on the ASX (but less so in the US), it can be hard to escape the feeling that NWS remains something of a share market misfit locally.

Despite its strong presence in Australia via its majority ownership in REA Group (REA.ASX), its Foxtel stake (65%), its minority equity investments (HT1.ASX / HPG.ASX) and ownership of several leading newspaper titles, NWS remains an immaterial (<0.5%) constituent of any of the major ASX indices owing to its relatively small domestic float via the Chess Depository Interests (CDI) listing mechanism.

Additionally, with Founder/Chairman Rupert Murdoch and family interests owning close to 40% of the group’s voting Class B shares, the investment proposition for local fund managers has rarely felt compelling since its split from the larger 21^st Century Fox entertainment business in 2013. And to be fair, highlighted in Chart 2 (black line), not owning NWS has for a long time been a sound strategy.

Chart 2. Source: UBS, October 2021

For Chester, the decision to invest in NWS during 2020 reflected a belief that the risk/reward profile of the stock had become extremely favourable, a key tenet of the Chester investment process.

In the months following the onset of the Covid-19 pandemic, the implied value of NWS’ assets excluding its 61.4% ownership of the issued shares in REA Group (captured as the blue line above) had fallen to historically low levels.

The comparison offered in chart 2 is simplistic and doesn’t necessarily consider the realities of being able to realise perceived or indicated (ie; mark to market) value from assets such as the group’s REA stake. It does however lead to two clear conclusions:

1. Over the years, any investment in NWS has represented an increasingly large bet on the fortunes of REA Group and its share price.
   
2. The implied value of NWS’ assets aside from its REA ownership has been one of almost continual decline since 2013.
   

For Chester, NWS’ majority ownership of REA represents an investment in one of the highest quality companies on the ASX.

As part of our assessment of quality, Chester consider seven specific questions about a company and their industry position including an assessment of barriers to entry, pricing power, threat of regulatory intervention and organic growth prospects.

REA continues to compare very favourably with other listed companies and has a track record of success matched by few others.

The fact that REA was able to achieve record EBITDA (earnings before interest, taxes, depreciation and amortisation) in 2020-21, more than 10% above the pre-pandemic levels of 2018-19, talks to a business that is highly predictable with a customer base highly dependent of its services – principally, online property listings.

Accordingly, at a time when more and more digital businesses are being afforded premium valuations on the potential that they might achieve market leadership and strong profitability, REA continues to stand out as amongst the most deserving.

With regards to the value of the ex-REA assets owned by NWS, commonly referred to as the News Corp stub, Chester remains confident that these assets continue to be under-appreciated by the market, despite the stronger NWS share price over the past 12 months.

“We are acutely focused on simplifying the structure of the company and making clear the full value of the sum of our parts,” News Corp CEO Robert Thomson said in August 2019.

Consistent with those ambitions, NWS has accelerated a digital transformation program in its business in the last two years.

Faced with a decline in cyclical advertising revenues in 2020-21 in its News Media business, along with no contribution from the divested News America Marketing business (sold in May 2020), it’s notable that NWS was still able to achieve revenue growth in 2020-21 as other segments of the business more than compensated for these declines (Table 1).

These trends toward a greater proportion of revenues from digital subscriptions across the Dow Jones, News Media and Subscription Video Services segments, together with the group’s resilient Book Publishing business, support the prospect of higher valuations being ascribed to these businesses in future.

Table 1. Source: News Corporation Annual Results, 2020-21

Improving corporate governance

The board’s decision to increase the disclosure it provided shareholders around business performance has been beneficial on multiple fronts.

By splitting out the Dow Jones business unit from the traditional UK and Australian mastheads, investors are much more aware of the strong underlying performance of the Dow Jones business in recent years, free of some of the structural challenges still faced elsewhere in the news businesses of the group.

Likewise, greater transparency about Move Inc, NWS’ US digital real estate portal, has also allowed for easier comparison with competitors and by extension improved insight as to the potential value of this businesses outside the NWS corporate model.

By committing to greater transparency with shareholders, the board have proactively addressed one the most common criticisms of News Corp in the past. Namely, a lack of disclosure and shareholder engagement has seen NWS viewed as a quasi-private company with limited regard for minority shareholders.

While Chester aren’t suggesting NWS don’t still have a lot of work to do on this front, recent gestures such as the board’s decision to terminate a legacy (2013) shareholder rights agreement, thereby preventing the Murdoch Family Trust increasing its voting rights as a result of the group’s approved US$1 billion share buy-back, do point to a board committed to improving company governance practices.

Growing digital businesses with strong momentum

Looking ahead, Chester is particularly optimistic about the possibility of the market ascribing greater value to the Dow Jones and Move businesses in the near term. Operating in the huge US market, both businesses have come through the pandemic-challenged 2020-21 very strongly and enter 2021-22 with considerable operating momentum.

Purchased jointly with REA Group in 2014 (Ownership: NWS 80%/REA 20%) for US$950 million, Move has largely operated in the shadows of the highly profitable Australian real estate classifieds business since acquisition.

Consistent investment has been a feature of the business largely offsetting strong growth that had seen revenues double to close to US$490 million by the end of 2018-19 since acquisition.

After a tough final quarter of the 2019-20, when the pandemic severely impacted the US real estate sector, Move has emerged with considerable momentum and capped off 2020-21 in June with a record fourth-quarter result that saw US$186 million of revenue achieved at record margins (2020-21 revenue was US$641 million).

With average monthly unique audiences consistently averaging over 100 million across its flagship realtor.com website recently, management are seeing record levels of agent adoption across their lead-generation and referral products.

The ongoing transition of revenues away from branded site advertising toward packaged agent services talks to a higher quality revenue that should be less cyclical moving forward.

With US-listed competitor Zillow (NASDAQ: Z) continuing to lead in the US real estate classifieds segment, it is notable that Zillow’s core IMT segment (internet, media, technology) generates EBITDA margins well above 40% currently, lead by its Premier Agent product.

This compares to the low teens EBITDA margins delivered by Move in 2020-21. For Chester, ongoing revenue momentum in 2021-22 would strongly support the contention that Move has passed a tipping point in its development and is now ready to deliver material operating leverage.

Overvalued or undervalued?

Comparing the US-listed New York Times (NYSE: NYT) business to the Dow Jones business operating inside the NWS corporate structure is instructive (Table 2 below).

Across numerous financial and operating metrics, the two businesses are very similar, having both achieved material EBITDA improvement in 2020-21 as costs were well managed through the pandemic and digital subscriber growth was strong.

While the difference in total subscribers they each have is noteworthy, this discrepancy is wholly offset when you consider the large discrepancy in pricing strategies between the two companies, especially their respective flagship newspapers.

In 2021-22, Chester expects that the integration of the recent OPIS (Oil Price Information Service) acquisition will shine further light on the higher margin Professional Business Information (PIB) unit that operates within Dow Jones.

Led by Dow Jones’ Risk and Compliance business that has delivered revenue growth greater than 20% for the last six years (US$195 million revenue in 2020-21) Chester anticipate increased disclosure around the PIB unit in coming periods will lead to greater appreciation of the quality of this largely enterprise business.

Table 2. Sources: as noted

With an enterprise value currently exceeding US$9 billion, it’s notable that The New York Times valuation is more than double the current residual stub value of NWS at REA’s current share price (Table 3).

So too this valuation comfortably exceeds the consensus valuation for the Dow Jones business, which appears to be around 50% of the current NYT valuation based on a recent sample of sell-side analyst estimates post the NWS 2021 annual result.

With an increasingly digital customer base, Chester certainly sees upside to the consensus Dow Jones valuation if management can consolidate the operating gains achieved in 2020-21 and continue to grow digital subscribers at a healthy rate in the years ahead.

Chester recognises that the stub value argument of valuing the conglomerate NWS structure appropriately has been around for a long time.

That doesn’t make it wrong. What it may take is a catalyst to see this valuation gap close. Is that Rupert Murdoch’s passing I hear you ask? Perhaps something sooner?

Table 3. Based on market prices at 20 October 2021

Resilient earnings, increasingly sustainable business models

With regards to the remainder of the NWS assets, these businesses have by and large come through the last 18 months in very good health and made strong progress in their efforts to transition themselves for a more sustainable future.

NWS’ book publishing business, HarperCollins, continues to defy those who forecast a slow death for the humble book and delivered EBITDA more than 20% higher than the business had achieved in any year since the separation in 2013.

While it is unlikely to ever be considered a digital business for obvious reasons, 22% of the consumer revenues achieved by the HarperCollins business were sourced digitally in 2020-21, demonstrating the group’s ability to provide literature to consumers in their preferred format these days.

HarperCollins will look to consolidate its strong recent performance in 2021-22 by integrating the recent Houghton Mifflin Harcourt (HMH) acquisition and will explore additional licencing/content partnerships to capitalise on the huge demand for audio streaming services currently.

For Foxtel (Subscription Video Services), NWS is now making strong progress in its efforts to transition what was a challenged pay-TV business into a leading player in the highly competitive content streaming market.

The launch of pure-play streaming services Kayo and Binge in recent years have contributed to the group achieving record paying subscribers of more than 4 million early in 2021-22.

While the market will likely remain cautious on the outlook for Foxtel as long as a large proportion of the segment’s revenue continues to be drawn from traditional Foxtel residential customers paying significantly more (ie, 4-5 times) for their services than newer streaming subscribers, recent commentary from management was quite optimistic.

Should management’s ambitions for 5 million subscribers together with revenue and profit growth be achieved over the next three years, it’s very likely the mid-single digit EBITDA multiples used to value the business currently would be revised higher.

Despite being arguably the most impacted of NWS’ businesses by the global pandemic, the News Media segment of the group remained resilient and faces the prospect of a cyclical recovery in advertising in the periods ahead with an enlarged digital customer base.

Excluding divested businesses, the News Media segment in 2020-21 saw underlying revenue declines of only -4% when adjusted for foreign exchange movements.

Year on year digital subscriber growth of 25% and 9% across the key Australian and UK mastheads respectively underpin the ongoing revenue transition being achieved in the business.

With digital revenues representing 32% of segment revenues in the final quarter of 2020-21, it’s clear the News Media segment is making good progress in its digital journey.

“The past year has seen the revaluing of our content through landmark news payment agreements with the major tech platforms," Robert Thomson said in August. "These deals, the financial terms of which are confidential, will add significant revenue annually, clearly into nine figures and are a profoundly important part of the ongoing transformation of the content landscape.”

While the true significance of NWS’ agreements signed with Google and Facebook in 2021 will take some time to become fully apparent, these agreements are supportive of a couple of Chester’s long held views.

Specifically, News Corp’s businesses continue to generate content that resonates with large audiences under a portfolio of valuable brands.

Additionally, as technology increasingly commoditises media content, a proportion of consumers will continue to pay a premium for original material from trusted sources.

Chester expects the aggregate value of NWS’ assets to remain a topic of debate as the business cycles a record year of profits in 2020-21 and management look to maintain a strong digital transformation agenda.

At a time when many listed companies enjoy premium valuations off the back of business models built around subscriptions and the potential to generate high levels of recurring revenue, Chester believes there is upside to the value the market is ascribing to several NWS businesses.

With a portfolio of resilient, profitable and for the most part, strongly cash-generative businesses, Chester is confident News Corp remains an under-appreciated and undervalued investment opportunity.

Table 4. Source: Chester Asset Management, 20 October 2021

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