The Economics of New Media Investing: The Rise of Fox News

Includes: NWS, NYT
by: Nadav Manham

I'm starting a new category, which I'm going to call "BMMT Capital Partners: the Economics of New Media Investing."

1) My New Year's resolution is to spend more time thinking about great investments than great investors. I feel like I'm running out of things to say about what makes a great investor in terms of psychology and how he sets up his fund and the incentives he faces, etc. I'm now at the point where I simply think "a great investor is someone who makes great investments." Therefore I think my job is really to find and study great investments and then work backwards to the people who make them.

2) Part of knowing what makes a great investment is knowing what the market tends to misprice. It's not enough simply to understand what makes a great business, because often what makes a great business great is well-known to the market and therefore not mispriced. To get from a great business to a great investment you have to figure out what about it is mispriced.

3) I believe what the market tends to misprice is the long-term earnings power of a company two to five years out from the time of investment, especially for younger companies, companies in changing industries, and/or companies entering new business lines. The market was pretty good at pricing Coca-Cola's (NYSE:KO) Q3 2009 earnings back June in 2009. It was less good at pricing its 1991-2000 earnings back in 1988, when Buffett made his big bet (I'll deal with this in a future post) after correctly forecasting a fundamental change in the economics of Coke's business.

4) Those investors (whether they are stockpickers, PE investors, venture capital investors, or operating within businesses) who develop an edge in this area can make a lot of money. You could have made a little money correctly predicting Coke's Q3 09 earnings a few months in advance, but you would have made a lot of money correctly predicting Coke's 1991-2000 earnings power back in the fall of 1988.

5) What most determines the long-term earnings power of a company two to five years out AND is undervalued by the market is the quality and durability of its moat. When Buffett bought Coke in 1988 he did not have any unique insights about the general growth of the soft drink industry in the coming two decades--his estimate was probably as good as the market's. Where he did have an insight was in forecasting correctly the percentage of the future growth of the soft drink industry that would be captured by Coke rather than its competitors, which was a function of its moat. He also had an insight in correctly forecasting the percentage of that future growth that would be captured by Coke's shareholders rather than its employees, suppliers, construction contractors, distribution partners, etc. That too was a function of its moat.

6) Those investors who can correctly forecast the quality and durability of a company's moat two to five years ahead of time can make a lot of money.

So I want to study moats and how to forecast them. I've decided to focus my efforts on moats in the media industry, for several reasons:

a) It's a fun industry.

b) It's undergoing a lot of change.

c) Many investors have made a lot of money investing in media in the past few decades. Many investors have lost a lot of money investing in media in the past few years. So you'll get a lot of mileage out of studying media if your goal is to judge investors.

What does the name "BMMT Capital Partners" mean? I imagine assembling a Dream Team of the greatest media investors of the modern era, those who've made money in the last decades and who have managed to keep it or even grow it in the upheavals of the past few years, and asking them to form an investment partnership to invest in new media companies in the next decade. They can make investments in existing companies, private equity, venture capital, whatever. The goal is to forecast the future of moats, which is where the real money is. My Dream Team is:

Buffett, Warren

Malone, John

Murdoch, Rupert

Thomson Family.

So please stay tuned. In this category I plan to look at the media industry and its moats, and underlying everything will be the question "What would the Dream Team do?"

First up: check out this article about the rise of Fox News. Forget about the politics and focus on the fact that the channel went from nothing in 1996 to current run-rate operating profit of $700 million, which if you capitalize at 10x comprises about a fifth of the equity value of its parent company News Corporation (NASDAQ:NWS), and which is more than the combined earnings of CNN, MSNBC, and the evening newscasts of NBC, ABC, and CBS. Rupert Murdoch's allocation of corporate capital to start Fox News has to rank among the best media investments of the past two decades, especially considering how poor the competition is. Compare it to, say, the New York Times Company's (NYSE:NYT) decision to buy the Boston Globe, or to buy back its shares in the early years of the decade, and you'll see what I mean. Now the New York Times can only write slightly snarky articles about media companies that make money, rather than being one itself.

What was Dream Team Member Murdoch thinking when he made that bet back in the mid-1990s? How to reverse engineer that great investment? Here are my thoughts on what he did right:

1) Murdoch is famous for ranting about how liberal the news media is. I don't care about politics but in economics terms he happens to be right: In deciding to start a news operation with a conservative slant Murdoch was entering a field with almost no competition from traditional media conglomerates. About half the company votes Republican and in aggregate they spend the same money on cars, clothes, detergent, etc. as Democrats do. Advertisers don't care about politics either, they care about eyeballs and wallets. So the decision to create a channel to connect advertisers to an underserved population of eyeballs and wallets was a great contrarian move.

2) Murdoch correctly forecast that cable channels would have the most durable and lucrative economics of all the various platforms for delivering news. He did not start a newspaper with a conservative slant, or a magazine. He did not start a broadcasting network with a conservative slant. He did not start a website with a conservative slant. He started a cable channel. Another great move. Interestingly, around this same time fellow Dream Team Member John Malone was reallocating his fortune away from cable systems and towards cable channels.

3) Murdoch did the right thing by putting Roger Ailes in charge. Ailes was the perfect person to execute Murdoch's strategy.

4) Murdoch was patient. Fox News did not make much money until 2003, but Murdoch had the ability and the willingness to continue to invest in it until it hit the tipping point of size and popularity that cable channels need to extract high carrying fees from cable systems.