Fox News Corp. Reports Mediocre: Margin Contraction Overwhelms Revenue Growth

| About: Twenty-First Century (FOXA)

Summary

FOXA reported a 6% drop in Operating Income Before Depreciation and Amortization (OIBDA).

Lower profitability reflects significant margin contraction within its cable and film segments.

All three segments reported revenue growth.

Film segment's recent releases did not meet management's expectations, but there is reasonable hope for a quick turnaround.

Valuation appears to offer only a limited reward for investors who believe FOXA's margins will rebound.

21st Century Fox, Inc. (NASDAQ:FOXA)'s results for its fiscal fourth quarter 2016 (4FQ16) left investors with a lot of uncertainty. Overall financial results for 4FQ16 look moderately unfavorable. Solid revenue growth of 7% was more than offset by significant contraction in operating income before depreciation and amortization (OBIDA). While FOXA has some attractive assets, brands and opportunities, its valuation suggests the reward is limited for investors expecting near term improvement.

Revenue

4FQ16

4FQ15

Change

Change %

Television

1,041

987

54

5.5

Cable

3,921

3,568

353

9.9

Film

2,038

1,907

131

6.9

Elimination

(354)

(257)

(97)

N/A

Total

6,646

6,205

441

7.1

OIBDA

4FQ16

4FQ15

4Q16 Margin

4Q15 Margin

Television

144

113

13.8

11.4

Cable

1,214

1,218

31.0

34.1

Film

164

269

8.0

14.1

Elimination

(71)

(56)

Total

1,451

1,544

21.8

24.9

Click to enlarge

Source: SEC.gov 8-k filing for FOXA

Television was FOXA's best performing business segment in 4FQ16. It was the only segment that expanded OIBDA margin expansion which increased 238 basis points (bps) to 13.8%. The improvement reflected revenue growth of 5% partially offset by higher costs for programming and marketing. Television's results for 4FQ15 were not an aberration.

FOXA Television Revenue Growth and OIBDA Margin

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Source: Sec.gov 8-k and 10-k filings for FOXA

Television is poised for a rebound. The chart above shows its margin has been contracting since FY2013, and revenue has been volatile. However, there are some reasons to be optimistic about FOXA's television segment's future.

  • The network owned three of the top four broadcast series.
  • Fox programs received 144 Emmy nominations.
  • Super Bowl LI and the presidential election should facilitate a nice bounce for FY 2017.

Cable reported mixed results for 4FQ16. Revenue increased almost 10% which exceeded the segment's growth rate for the first nine months of F2016. Domestic advertising was the main driver of the near double digit increase in revenue. Fees from domestic and international affiliates increased 6% and 9%, respectively. International advertising declined 6% and a stronger U.S. more than offset strong growth measured in long currency.

Although the whole cable industry faces pressure from cord cutters, FOXA's segment is well positioned. Its assets include Fox News Channel, which the firm said was the highest rated cable network in the past year, and an emphasis on sports. Cable alternatives, such as Netflix (NASDAQ:NFLX), have focused on movies and television series instead of live entertainment. Furthermore, FOXA's management, unlike Walt Disney Co. (NYSE:DIS), is showing flexibility in delivering its content instead of trying to leverage a couple critical channels, such as ESPN to force cable customers to buy channels they seldom watch. FOXA's strategy seems more prudent.

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Management highlighted five drivers of cable segment's 318 bp contraction in OIBDA margin.

  • Higher sports programming costs
  • Expenses for expanded political coverage at Fox News Channel
  • Spending on initiatives to expand FOXA's international presence
  • Negative EBITDA of $25 million in 4FQ16 from National Geographic which was not consolidated within FOXA in 4FQ1
  • Unfavorable currency movements

Film was FOXA's worst performing segment. Management acknowledged the underperformance and blamed the 39% drop in EBITDA on release costs for the sequels for X-Men, Independence Day and Ice Age for the 39% drop in EBITDA. 4FQ16 capped a tough year for the film segment. Its full year OIBDA margin of 12.8% was the lowest in at least eight years.

Click to enlarge

Film is capable of quickly turning around its revenue growth and margin. FOXA's studio demonstrated its ability to produce fresh hits with Deadpool. The film garnered a cult following, developed mass appeal, received solid critical reviews, and generated global revenues of $783 million on a $58 million budget according to boxofficemojo.com. Deadpool did not help 4FQ16 because it was released in mid 3FQ16.

FOXA begins fiscal 2017 with decent tailwinds. The studio plans to release the following movies:

  • War of the Planet of the Apes
  • Birth of a Nation
  • Kingsman 2
  • Miss Peregrine's School for Peculiar Children
  • Assassin's Creed
4FQ16 4FQ15 Change Change %
OIBDA 1,451 1,544 (93) -6.0
Equity Earnings in Affiliates (72) (55) (17) 30.9
Depreciation and Amortization 161 154 7 4.5
Interest Expense, Net 286 283 3 1.1
Other Expense, Net 386 812 (426) -52.5
Pre-Tax Income 546 240 306 127.5
Tax Expense (Benefit) (60) 93 (153) N/A
Net Income 606 147 459 312.2
Click to enlarge

Source: SEC.gov 8-k filing for FOXA

Despite a $93 million unfavorable variance in OIBDA, FOXA reported significantly greater net income in 4FQ16 than 4FQ15 due to other expenses and taxes. FOXA reported negative other income of $396 million in 4Q16 compared with $812 million in 4Q15. FOXA did not provide details of this line item in its press release or earnings call, but its most recent 10-k shows that other, net includes charges for pension liabilities, restructuring expenses, severance costs, and losses on strategic transactions. FOXA recorded an income tax benefit of $60 million in 4FQ16 compared with income tax expense of $93 million in the same period of the prior fiscal year. A favorable tax ruling was the chief driver of the difference. While a lower level of one time charges and a favorable tax ruling are good, most investors focus on OIBDA.

Conclusion

FOXA's most recent results confirm that is more appropriate for speculative investors than those focused on companies with strong fundamentals and reasonable valuation ratios. FOXA reported moderate deterioration in its primary benchmark, OIBDA. Its film segment's most recent productions did not meet management's expectations. The firm does have some compelling brands and assets, such as Fox News Channel, a strong lineup of sports content and a cable business that generates solid margins. However, the following table suggests that investors' reward for improvement in OIBDA is likely to be limited because FOXA's valuation is already slightly aggressive relative to its peers and analysts anticipate stronger earnings growth.

Trailing P/E Earnings Growth (%)
FOXA 18.0 14
DIS 17.8 6
CBS 15.3 8
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Source: Yahoo Finance and CBS Marketwatch

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I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.