A Sly Move: Bet on Fox

04/25/2003 12:00 am EST


Tobin Smith

Founder and Chief Research Analyst, Transformity Research LLC

"Recent developments at Fox Entertainment make this is a rather complex situation, and we note that the fundamentals are subject to change. Nevertheless, Tobin Smith, editor of ChangeWave Investing attempts to update his readers on the current situation. According to Tobin, here's a "quick-and-dirty" update...

Fox Entertainment Group (FOX NYSE) is getting dinged in the markets related to the news that Rupert Murdoch's News Corp. (the parent company of FOX) had won the battle to purchase control over Hughes Electronics and the DirecTV satellite unit for $6.6 billion. News Corp. will pay $14 per share for the Hughes stake. The concerns with the deal come from the way it will be executed. When News Corp. completes the purchase, ownership of Hughes will be transferred to the Fox group and will add a significant debt load (some say as much as $4.5 billion) to the one already being carried by the unit. After the deal's completion, News Corp. will transfer its 34% ownership stake in Hughes to Fox for 74.2 million shares and a $4.5 billion promissory note.

“The big question: ‘Does owning a controlling interest in DirecTV add to FOX's value and cash flow or does it destroy value?’ It's too early to definitively tell. But I can tell you two things for sure. One, DirecTV has been in limbo for three years and has not done a thing to build on its superior-to-cable TV experience. That will change BIG time under Fox. Two, video-on-demand, very-high-speed broadband, a better user experience, AND exclusive sports access will be coming as soon as possible. FOX received a number of downgrades from analysts today, and the stock has lost about 17% in the day's trading. A note from a Merrill Lynch analyst noted that even though the sale might be positive for Fox strategically, the deal raises concerns that the unit is being used as a financing vehicle for News Corp. instead of an independent operating entity.

“Well, not quite. FOX has a very clean balance sheet and can absorb the additional debt easily. In essence the question is can FOX add enough new DirecTV viewers and/or raise the monthly take from subscribers to significantly add to the $2 billion annual gross of the company. It does not pay to bet against Fox when it comes to programming or marketing. In addition, the deal would make News Corp. the only global distributor of satellite programming when combined with the company's holdings in the United Kingdom, Italy, Latin America, and Asia. This satellite TV experience could prove beneficial to the transaction and the operation of DirecTV, along with giving News Corp. and Fox the operating leverage over channels that can be valuable in negotiations with firms that own cable systems and networks like AOL Time Warner.

“I'll give the benefit of the doubt to FOX and lower the buy under to $24, but don't be surprised if the stock continues to sell off a little over the next few days. FOX will sell about $1 billion of other assets (The L.A. Dodgers, et al) to remove any balance sheet issues. Post-war ratings will be 20% higher than pre-war and that will add significant cash flow as well. Not to mention the pay-per-view fees for the movie studio and TV programming. I will report any new news on the deal from Fox officials to you as soon as I get it. Further, for full disclosure: I'm a regular panelist on Fox News Channel's Bulls & Bears during the cable network's weekend business block. I don't own any stock in the company, but I am a paid contributing market analyst for the network.”

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