From an August low of $14.67 to a February 29th high of $20.30, the company's shares have soared. We believe that the company on a discounted cash flow valuation is worth between $23 and $25 after $2.20 per share in debt. We have not factored in the potential cost of the liability involved in phone hacking. While earnings are showing good moment as the entertainment businesses are performing well, we believe the shares are vulnerable to a sell off rather than ready to start a new up move.
There are four reasons why we believe that investor hopes of a restructuring are ill founded.
First, a spin-off into a separate company may not protect the company and its shareholders from any legal liability arising from phone hacking and other illegal acts or their cover up at the Sun, the News of the World or other newspapers. This liability is not confined to the U.K. properties and could possibly taint the company's U.S. holdings and/or ensnare its executives.
Secondly, besides not shielding the company from liability, the sale or spin-off of the papers would not generate much in the way of proceeds. We estimate that profitability at the papers has declined from a recent level of around $230 million (This is far lower than prior historical peaks). Valuing these before the impact of the liability associated with the investigation should, as a rough rule of thumb, be about four to six times operating income. This would mean that a cash sale of the assets before taxes would be about $1 to $1.3 billion in proceeds before taxes. There will very likely be some damages due the victims of the hacks -- let's just pick a number of $100,000 to $500,000 per hack. Assuming the papers are correct that there were 4,000 people hacked, that would suggest a half billion to $2 billion liability overhang. That liability will not go away even if the papers are sold. There is also little likelihood the shares would have any value at all in a spin-off without immunizing the company from liability.
Thirdly , the notion that anybody other than Rupert Murdoch is the chief executive of News (which is still a family business) is dead wrong. Investors who crown Chase Carey with the official powers of chief executive before Mr. Murdoch has exited the company as controlling shareholder, could well scuttle what they wish for. Mr. Carey deserves full credit for enhancing the profitability of the company's electronic media businesses, but Mr. Murdoch was the visionary who drove the acquisition and or creation of Fox, Sky and Star. He, also, remains the dominant shareholder through his ownership of Class B shares.
Fourthly, Mr. Murdoch's acquisition of the Sun and the News of the World, the Sunday Times and the Times, were turning points in the growth of News. In the extraordinarily competitive U.K. newspaper world, he has been a tremendously disruptive force and by consolidating printing in Wapping East London, he changed the industry's landscape forever. Further, by leveraging the cash flow from his U.K. newspaper holdings, he was also able to launch a major attack on the U.S. broadcasting industry. Even further back historically, he and his family have been in the newspaper business in the U.K. since the First World War and he is profoundly committed to it.
While it is possible that the damage from the phone hacking scandal -- involving alleged criminal acts could ultimately lead him to decide to dispose of the newspapers, he has been through difficult challenges before and has come through. In the mid 1980s, he took on the Fleet Street unions -- one of the most entrenched and intransigent in the world and defeated them resoundingly despite enormous public outcry. True at that time, Margaret Thatcher's government provided strong regulatory backing. Again. in the early 90s, the company's brush with insolvency was a greater threat to the company and to shareholders than today's difficulties. But the company and Mr. Murdoch made changes to its financial structure and governance without selling, disposing or spinning off assets.
Finally, Mr. Murdoch is at heart a builder and is, we believe, loath to undo any part of what he has built without a compelling commercial reason, or unless his hand is forced. The phone hacking scandal as it mushrooms may be that compelling reason, but we think investors see too much "good news" in it. The scandal is not good news. Nobody knows where it will lead and it may not be possible to contain with financial legerdemain. It is a significant challenge to a man who has faced many before. We are not saying therefore that he will not decide to split the company into NewsCorp or News Int'l -- it's just unlikely and goes against every grain of who Mr. Murdoch has been these last sixty years.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.