Should Fox Buy Full Control of Sky Now?

Is it time for 21st Century Fox to buy full control of pan-European pay TV operator Sky, in which it already owns a 39 percent stake?

Macquarie Capital analyst Tim Nollen believes so. “We think the time is right for Fox to buy in the rest of Sky, he wrote in a recent report on Aug. 25. “We have long believed 21st Century Fox may look again at buying in the 61 percent of Sky that it doesn’t own, if the timing and circumstances were right. We think that moment has come, with Sky shares down 32 percent year-to-date in U.S. dollar terms.”

The analyst suggested a 20 percent deal premium to Sky’s stock price, which would cost Fox about $22.3 billion to buy the rest of the company, including debt and cash, according to his calculations. He mentioned an enterprise value of $27.48 billion (£20.7 billion) for Sky.

“Sky shares are down 23 percent this year, and in U.S. dollar terms post the Brexit vote, Sky is a further 9 percent cheaper,” Nollen wrote. “Sky has underperformed the U.K. market by 31 percent year-to-date.”

Argued Nollen: “The logic is simple when you put the pieces together.” From Sky’s perspective, he said: “Sky’s acquisition from Fox of Sky Deutschland and Sky Italia has allowed it to achieve scale on content (sports rights, general entertainment programming incl. new cross-border licenses like Showtime) and technology (set top boxes, OTT platform and AdSmart addressable advertising). A Fox/Sky combination would give Sky stronger financial backing for more content acquisition on a wider footprint.”

Nollen also highlighted the rationale from Fox’s end as it would give it full ownership of a premium distribution service. “We think the structure of the European pay TV market is good for strong incumbents like Sky and should look attractive to Fox, which faces a more difficult market environment in the U.S.,” the analyst said. “European pay TV markets are more concentrated, more vertically integrated, less penetrated into households, more flexible in terms of network packages offered and generally cheaper than U.S. pay TV bundles.”

Possible regulatory changes in Europe could also support a deal, the analyst argued. “Changes could come that would make [networks’] online transmissions more easily available across borders,” he said. “This would reward scale and reach.”

Plus, deal financials are also “compelling,” said Nollen. “Our merger model assumes an all-cash deal with a modest 20 percent price premium,” he wrote. The company’s market value stood at $19.39 billion (14.62 billion pounds) as of Friday morning. “Cost synergies of 3 percent generate year 3 earnings per share accretion of 12 percent and year 10 of 25 percent.” But he added: “Sky investors may well demand a higher premium, which we think Fox might be willing to pay for the long-term strategic logic of this deal.”

Nollen also highlighted that not everyone would be on board with a deal. “We think Fox investors may prefer Fox to divest its 39 percent Sky stake for a cash return, but we believe diversification and scale will become increasingly important, and Sky offers a sound business that could help mitigate concerns over the U.S. pay TV business and offer stable subscriber growth, whether in satellite or OTT, in Europe and Asia.”

Others on Wall Street have different takes on the Sky stake and its future. Some analysts said that Sky’s recent post-Brexit vote stock drop wasn’t steep enough to make a difference. They also argued that Fox top executives have consistently signaled they have no immediate plans to buy full control or sell the Sky stake.

“At the moment, there is no urgency for us to do anything other than harvest value out of Sky,” Fox CFO John Nallen said before the Brexit vote. “There is no catalyst for us to say we need to change that.”

And a banker recently told THR: “I’d expect nothing has changed about [Fox’s] approach. But the Brexit referendum has affected stocks and put M&A back in focus.”

Fox and Sky representatives didn’t comment.

“Possibly with [the pound] so weak against the dollar, it would be opportunistic for Fox to exploit this and pick the company on the cheap,” said Peel Hunt analyst Alex DeGroote. “Sky is at an interesting stage, trying to consolidate three regions as well as drive through further innovation.”

Talk about the Sky-Fox relationship has flared up repeatedly since 2011 when the company then known as News Corp., before the split into Fox and News Corp, offered to buy full control of BSkyB. It abandoning the plan amid the phone-hacking scandal. In late 2014, BSkyB agreed to acquire Fox’s Sky Deutschland and Sky Italia to create the enlarged Sky, which operates in five European countries, namely the U.K., Ireland, Italy, Germany and Austria.

Said one Wall Street watcher: “I think this question if the time is now will continue to be raised once or twice a year until Fox actually makes a move.” When could that be? “Who says,” that person said. “Maybe next year.”