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Morningstar | Good News on Digital Transition not yet Evident on the Bottom Line. See Updated Analyst Note from 10 May 2019

News Corporation is making good progress on transitioning to a more digital-centric model. Digital subscribers to its various mastheads grew around 20% year on year on average in the third quarter of fiscal 2019, subscribers to the group's video streaming products (Foxtel Now, Kayo) jumped 80% since the start of 2019, average monthly unique users of Move's realtor.com site grew 7%, and the books division continues to enjoy a digital-led renaissance with digital sales now at 21% of the unit's revenue base, up from 17% in the second quarter.

The solid growth in these metrics was unfortunately not reflected in the financial result, as normalised EBITDA (excluding recently consolidated Foxtel) in the three months ended March 2019 fell 16% year on year to USD 153 million. Granted, unfavourable currency movement contributed USD 9 million to the USD 29 million decline. But there is no hiding the fact underlying earnings were under pressure across most units, with news and information down 16%, digital real estate 16%, and Foxtel suffering a 4% fall in pro forma EBITDA to USD 96 million, weighed down by higher sports costs and marketing investment to support the streaming initiatives. Books division was the lone highlight, with EBITDA up an impressive 29% to USD 53 million—the seventh consecutive quarter of growth.

This has led to an average cut of 7% to our group EBITDA forecasts. The downgrade reflects the more challenging trading conditions especially facing the print media and digital real estate units, compounded by the cost of Foxtel's evolution to a multifaceted video distribution model. As a result, our fair value estimate has eased 5% to USD 14.50 (AUD 20.70).

Shares in no-moat-rated News remain undervalued, trading at a 20% discount to our revised intrinsic assessment. While near-term earnings may show otherwise and investor frustration is palpable, the stock price is not reflecting the inroads News is making towards being a more digital-centric group.

The books division is an example of what could go right with management's digitisation strategy. EBITDA from this unit has grown from USD 197 million in fiscal 2014 to our forecast USD 270 million in fiscal 2019. This translates to a CAGR of 6%, an impressive feat for what is commonly regarded as an old media business. Digitisation has contributed significantly to this growth, with e-books and downloadable audio books not only expanding the readership universe, but also driving monetisation of News' significant existing (and growing) back-catalogues titles.

In terms of result details, third-quarter reported net profit after tax, or NPAT, USD 10 million was a substantial reversal from an impairment riddled USD 1.1 billion loss from a year ago. Adjusted for one-offs, normalised NPAT was down 24% to USD 26 million. At the operating level, normalised EBITDA was up 35% to USD 249 million, primarily boosted by Foxtel's result which began being consolidated from fourth quarter of fiscal 2018.

Finally, it is worthwhile highlighting the progress Foxtel has made in the streaming space. Since the start of 2019, Kayo has grown its subscribers to 239,000 now from 115,000, with actual paying customers increasing to 209,000 from 100,000. Similarly, Foxtel Now has grown its Foxtel Now subscribers to 567,000 of whom 505,000 are paying customers. The growth shows management's (perhaps belated) commitment to an increasing streaming-centric video entertainment world. This may have cannibalised some of Foxtel's traditional set-top-box customer base, leading to its higher third-quarter churn of 17.7% (from 15.3% a year ago). Marketing expenses to support these initiatives are also substantial, increasing the cost by USD 10 million in the quarter. However, the potential consequence of doing nothing and hoping traditional pay TV will win back customers would be dire.