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Morningstar | Nine Makes a Ninja Move on Fairfax

We are ambivalent about Nine Entertainment's pursuit of Fairfax. The rationale for the AUD 2.3 billion acquisition may be strategically sound at this juncture, with the impressive combined scale across all media platforms likely to enhance no-moat-rated Nine's positioning with audience and advertisers. Furthermore, management should be commended for doing so by crystallising the strong recent gains in Nine's shares which have surged more than 60% in 2018 to-date, and are trading at a substantial premium to our AUD 1.50 fair value estimate. Indeed, it is no small coincidence Nine approached Fairfax in early July when Nine stock price was around all-time highs, buoyed by the resurgent TV ratings and revenue momentum.

However, Nine shareholders' enthusiasm for this transaction needs to be tempered to a degree. First, we calculate the EPS accretion on a fiscal 2018 pro forma basis to be 2%, incorporating AUD 50 million in cost synergy. This is higher than management's "EPS-neutral" estimate but is still marginal.

Second, longer-term value accretion remains hostage to how the merged entity competes against the relentless onslaught of digital disruptors such as Google, Facebook, and Netflix. It would be a real-time test case of how a cross-media giant still predominantly rooted in traditional media fares against digital media whose share of the Australian advertising pie has grown to over 50%, from 27% just five years ago.

Third, while management trumpeted various potential revenue synergies from the merger (addressable TV advertising, enhanced data capability, greater share of marketers' budgets, digital growth), the absence of any quantifiable targets underscores the uncertainties in realising the benefits. As such, we are left with the prima facie case of Nine acquiring no-moat-rated Fairfax whose EBIT (excluding Domain) we forecast to decline by an average of 6% per year over the next five years.

Completion of the proposed merger has some way to go, with management projecting consummation by the end of calendar-year 2018, assuming receipt of all necessary approvals. We do not see any impediment to the deal. The October 2017 passing of the media reform package has removed the legislative hurdle to this proposed merger, while the competition regulator's views are likely to be enlightened by the current digital inquiry showing the challenges facing traditional media from proliferating digital onslaught.

What could, however, derail the deal is an interloper, either for Fairfax or perhaps even for Nine itself. The latter scenario is not as outlandish as it may sound, especially if a giant traditional media operator (say, News Corporation) decides to diversify away from the challenging print and pay TV environment in Australia. A free-to-air TV network with a 50% interest in a popular subscription video on demand, or SVOD, service called Stan may just fit the bill.

In terms of the details of the proposed scheme of arrangement, Fairfax shareholders will receive 0.3627 Nine shares for each Fairfax share, along with AUD 0.025 in cash per share. Using Nine's previous closing share price, this implies an offer price of AUD 0.94 for Fairfax shares, a 22% premium to Fairfax's pre-deal closing price.

Nine shareholders will hold a 51.1% majority interest in the new company, while Fairfax shareholders will make up the remaining 48.9%. Nine's current CEO Hugh Marks, will lead the new company and the six-person board will have equal representation from current Fairfax and Nine directors, although both the chairman and the managing director will be from Nine. The ACCC will conduct a review of the merger, with the public review scheduled to take 12 weeks--after receipt of all submissions and relevant information. This deal would have been unthinkable this time last year owing to the "2 out of 3" rule, which prevented one company from owning a TV station, radio station, and newspaper in the same area. This and the "75% audience reach" rule were abolished in October 2017, clearing the path for a deal like this.