EUR 850.00 For Business Accounts Only

Morningstar | Fox Posts a Strong Initial Quarter in Its New Form; Investor Day Focused on Unique Position in Media

Fox Corp held its first investor day as a newly reconstituted firm on May 9 in conjunction with its first earnings release. While the fiscal third-quarter results beat top- and bottom-line consensus expectations, the focus of the investor day was on the unique position that Fox holds in the media in the eyes of management. We agree the firm has one of the simplest models among the major media firm in the U.S. but believe that management may be slightly over exaggerating the specialness of Fox’s positioning in the media landscape. Despite our skepticism, we continue to think that Fox represents a large albeit well-placed bet on the viability of live sports and news. We are maintaining our narrow moat rating and $42 fair value estimate.

Total revenue for third quarter increased by 12% year over year to $2.75 billion, driven by growth at the broadcast segment. Cable revenue improved to $1.38 billion, up 4% versus a year ago. Affiliate revenue grew by 4% as the escalator price increases outweighed the subscriber declines. Ad revenue for the cable networks improved by 4% as the firm continues to benefit from the digital expansion of Fox News. EBITDA margin for the segment expanded to 53.6% from 52.2% a year ago as the revenue gains and lower sports rights costs more than offset the additional Fox News investment in digital delivery.

Television segment revenue grew by 20% to $1.37 billion as the firm continues to catch up to its peers in term of retransmission and reverse compensation revenue. Affiliate revenue improved by 29% year over year to $452 million due to reverse comp growth. The category has improved by more than 20% each quarter in fiscal 2019. Ad revenue for the segment expanded by 10% to $812 million as the firm benefited from an additional NFL playoff game and improved ratings on the network. Television EBITDA margin improved slightly by 10 basis points to 7.2% as the revenue growth was mostly offset by higher programming costs including sports rights.

As a result, overall adjusted EBITDA margin actually declined to 27.8% from 28.7% year over year as the EBITDA expansion at the segments was more than offset by the growth in corporate and eliminations. The EBITDA generation at the cable segment continues to dominate the television group at $741 million to $99 million, respectively, in the quarter.

While much of the investor day presentations were simply promos for the company’s segments, we did see a few interesting nuggets. One such nugget was the announcement of Fox Bet, a joint venture with The Stars Group focused on sports gambling in the U.S. The firms want to take advantage of the wave of states that are legalizing sports gambling. Fox Bet will launch a wagering platform by the end of 2019 with free games for all players and cash betting for players in states that have already legalized gambling. Fox estimates that the sport gambling market in the U.S. will approach $7 billion by 2025.

Fox Bet is a replication of Sky Bet in the U.K. which had been owned by Sky plc and CVC Capital prior to its sale to Stars in 2018. Fox took a 4.99% stake in The Stars Group for $236 million and has the option to buy up 50% of the firm’s entire U.S. gambling business (including online casino and poker) over the next 10 years. As arguably the number two sports network behind ABC/ESPN, Fox Sports is well positioned to capitalize on the legalization of sport gambling, particularly since Disney will be largely staying on the sidelines with respect to direct involvement with wagering.

During the investor day, Fox disclosed that the cable network segment has 38% of its forecast 2019 affiliate revenue up for renewal in fiscal 2020 with an additional 26% in fiscal 2021 and 8% in fiscal 2022. While we project that Fox News and Fox Sports 1 get affiliate fee increases along with annual escalators clauses, we do not expect that the networks will be able to push through the double-digit increases in first-year fees that many cable networks, including Fox News, received in previous renewal negotiations. The television segment is even more frontloaded with 50% of its forecast 2019 affiliate revenue up for renewal in fiscal 2020 with an additional 30% in fiscal 2021 and only 1% in fiscal 2022. Given this profile and the fact that Fox has lagged its peers in capturing retrans and reverse comp revenue, we expect that the television segment will significantly outpace the cable segment in terms of affiliate fee growth over the three-year period from fiscal 2020 to fiscal 2022.