21st Century Fox (FOX) shareholders have had a brilliant seven months or so. It started back in December when Disney agreed to buy a whole bunch of the firm’s assets for over $50b. These included the TV and movie studios, as well as certain cable channels like FX and the regional Fox Sports Networks. In total, said assets make up around two-thirds of Fox’s total earnings. The rest of Fox – which includes assets like the Fox News Channel, Fox Business Network, Big Ten Network, and Fox Sports 1 and 2 – was to be spun off to shareholders as a new company. I shall call that company ‘SpinCo‘ for the purposes of this article.
Now, Disney’s original offer was an all-stock one. It agreed to exchange 0.2745 shares of Disney stock for every share of 21st Century Fox. If my numbers are correct, then that offer was worth roughly $30 per Fox share. In addition, Fox shareholders would also receive new shares of SpinCo stock worth around $10 per share. That was the situation until last week’s big news that Comcast was entering the mix. It turned up and offered $65b in cash for the same assets that Disney had agreed to purchase. Let’s call it $35 per Fox share in cash, with SpinCo still in play too. Unsurprisingly, this latest twist sent Fox shares soaring.
This leads us up to yesterday’s news: Disney has come back and bumped up its previously accepted offer. The new deal terms are worth roughly $38 per Fox share. In addition to the revised offer price, the funding mix has also changed. Rather than being an all stock deal, shareholders get to choose whether to receive cash or Disney stock (subject to 50/50 proration). The assets in question haven’t changed either, so SpinCo is still on the table for current Fox shareholders. That took Fox to its current price of around $48 per share.
This kind of goes without saying, but if you have held Fox shares these past seven months then you have done great. They have returned nearly 50% since Disney’s first offer back in December. Despite the run-up, I think the shares are a strong hold for a couple of reasons. The first, and most obvious, is that the bidding war may not be over. Some analysts think Comcast will come back with an offer in the low-$40s per Fox share. With SpinCo on the side, that would take the total value to the low-$50s, around 10% higher than yesterday’s closing price.
Even if no further bids are forthcoming, there is another very good reason to hold on: the prospect of picking up paper in a better company. The enlarged Disney would be an absolute mammoth in terms of quality content. Star Wars, The Avengers, Avatar, X-Men and Marvel Entertainment would all fall under its banner. That is on top of the parks & resorts, plus the consumer products division, which between them pump out billions of dollars in annual profit. I like 21st Century Fox and think it has a decent business, but Disney paper is more valuable. That is probably why the Murdochs were originally very happy with an all-stock offer.
The way I see it, this portion of the deal is win-win for Fox shareholders. You either get a higher all cash offer from Comcast, or you get to walk away with some portion of Disney stock. The latter gives you an underlying business that generates significantly higher returns on capital than the business you currently own.
That leaves us with SpinCo. With all the hype surrounding the other parts of the equation, I think SpinCo has largely been left out. As mentioned above, it will generate around $2.75b in annual EBITDA as a standalone company. Of that, the company expects to convert over 70% into free cash flow – call it $2b per annum. Net-debt is slated to come in at $7.5b, so the balance sheet will be in good condition to start with.
The thing I like most about SpinCo? It comes with low expectations. With that $2b in annual free cash flow, we are looking at a free cash flow yield of around 10%. The market isn’t expecting too much from it. The stodgy assets (live sports and news) throw off so much cash that they give the parent company plenty of options to grow earnings. That could come via rapid debt reduction, bolt-on acquisitions of televisions assets, stock buybacks, and so on. All-in-all, I don’t see any reason why folks would want to relinquish their Fox shares at this moment. Just sit back and enjoy the culmination of the bidding war.
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