News Corp Could Be A $31 Stock If Margin Improvement Continues

Our price estimate for News Corp stands at $28, implying a premium of more than 15% to the market price. However, there is potential to unlock more value if the company can sustain margin growth it has seen in recent years. In fact, we believe News Corp could be a $31 stock if its cable networks’ margins continue to increase to a point where they can rival those of its competitor Disney (NYSE:DIS). We estimate that cable networks constitute 60% to News Corp’s value.

News Corp has demonstrated strength in its cable networks business driven by an improvement in advertising and subscription fee. This segment saw 16% growth in revenues in the recent quarter thanks to 16% and 25% growth in affiliate revenues for domestic and international operations, respectively. ^[1] This growth has resulted from News Corp’s focus on its sports network and original content for other networks such as FX, which has allowed the company to negotiate price increases. As a result, margins have grown too.

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EBITDA margins for News Corp’s cable networks have increased from 29.3% in 2008 to 37.5% in 2011, and are trending toward 39% for the calendar year 2012. In comparison, Disney’s cable networks’ margins stand at around 45%. We believe that Disney has the advantage of ESPN, which garners high pricing due to strong demand for its sports programming and thus higher margins. In addition to this, Disney Channel has gained a lot of popularity among kids, even surpassing Viacom’s (NASDAQ:VIA) Nickelodeon. We believe that Disney has a superior pricing power to News Corp and therefore our margin forecast for News Corp stands at a lower value of around 40%. Given the pressure from pay-TV companies and increasing programming expenses, we see limited room for profit growth.

However, continued growth in digital licensing, investments in sports programming and expansion in international markets can provide some operating leverage to News Corp. If the company is able to increase its cable networks’ EBITDA margins to 46% by the end of our forecast period, there could be 10% upside to our current price estimate, thus making it a $31 stock.

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1. News Corp’s SEC Filings [↩]