News Corp: From headlines to bottom line

An ever-changing empire

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Rupert Murdoch is generating some of the biggest returns on shareholders’ capital in his 58 years running News Corp, but finding it harder than ever to excite the market about the fact.

The phone-hacking scandal at the News of the World, the UK Sunday tabloid that made Mr Murdoch a multinational mogul 42 years ago, has focused attention on the culture of the global media group he oversees.

Yet as investors debate whether it is time for the 80-year-old chairman and chief executive to cede more power, less attention has been paid to his recent business record. On that score, the numbers show a fast-changing empire, whose newer businesses in cable programming and broadcast television are throwing off cash, but are being held back by the older assets.

Getting to a full picture of News Corp’s performance over time is almost impossible. Extraordinary items such as an $8.9bn impairment charge in 2009 cloud the picture, assets such as Star TV in Asia have been reclassified and “intersegment revenues” – group businesses spending money with each other – amount to almost $1bn a year. A vast division called “Other”, with revenues of $1.53bn and a $575m operating loss last year, has hidden embarrassments such as MySpace and oddities such as Russian billboards. Currency swings and a domicile switch from Australia to the US in 2004 complicate matters while revenues and profits have been skewed by acquisitions and disposals.

Using a Credit Suisse tool called Holt to look instead at cash flow returns on invested capital, or how assets are used to generate returns, it is clear that News Corp’s cash flows have risen strongly in the past decade and are comfortably exceeding its cost of capital. It generates more than $2bn in cash a year, and having almost lost his company to the banks 21 years ago, Mr Murdoch has hoarded this cash since the financial crisis began.

Yet investors have punished it for how it uses its cash. Instead of the buy-backs some wanted, it has made controversial acquisitions such as 2007’s $5.7bn Dow Jones purchase (since written down by $2.8bn), and more recent moves to buy Shine, his daughter Elisabeth’s TV production company, and expand into education.

Investors had hoped that a bid for British Sky Broadcasting would soak up the remaining cash, but now fear that its enforced abandonment will encourage Mr Murdoch to spend it on less promising assets. If some is spent on buy-backs that may increase the Murdochs’ voting control. (Against that the cash hoard should cover any financial penalties stemming from phone hacking, investors add.)

Today’s News Corp is a mixed bag, with margins of just 6 per cent in satellite TV, 11 in newspapers and 36 in cable networks. Nomura’s Michael Nathanson talks of “good News” (cable networks, TV, Sky Italia), “bad News” (film, mag­a­zines, books) and “toxic News” (the newspapers).

Cable programming’s prospects, higher “retransmission” fees transforming the Fox broadcast network’s finances and the industry-leading mid-teens margins of 20th Century Fox film studios, prompt analysts to say the share price should be almost $21, rather than below $17. Not one of the 22 analysts following News Corp rates it a “sell”, according to Bloomberg.

But a “Murdoch discount” has long weighed on the stock, reflecting investor anxiety about unpredictable uses of their capital. After the MySpace and Dow Jones deals, the gap between News Corp’s theoretical worth and its market valuation was widening even before the phone hacking scandal.

A different chairman and chief executive might decide break-up was the best way to enhance shareholder value. But as long as the man who built News Corp from a small newspaper business in Adelaide is there, few are betting on such an outcome.

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News Corp has an impressive record of generating economic value. Credit Suisse-Holt analysis measures real after-tax cash flows from all depreciating and non-depreciating assets – akin to calculating the internal rate of return for any investment. News Corp has consistently generated returns exceeding its cost of capital. In other words, it makes more money from its assets than it costs to acquire them. This is a good thing, but investors must remember that excess returns eventually normalise.

One reason News Corp’s cash flow returns on invested capital started to accelerate at the turn of the millennium is that the company became disciplined about asset growth – especially once the dotcom frenzy ended. From 2002 to 2006, the company was actually a net disposer of assets. What is more, News Corp generated more revenues from its shrinking balance sheet. This discipline came to an abrupt halt with the purchase of Dow Jones in 2007, but overall the company cannot be accused of profligacy.

Although News Corp creates value for shareholders and has been disciplined about asset growth, there is room for improvement. Compared with its rivals, margins are low. The main reason is that some divisions – including newspapers and book publishing – have chronically low returns. Others, such as television, are cyclical; and box office hits and flops sway film margins. This is a big criticism of News Corp. But it also means the company has a lot of potential upside if underperformers can eventually be cut adrift.