Wall Street Divided Over Fox's Sky Bid as Stock Drops, Draws Downgrades
Reactions range from "underwhelming" and "where's the strategic fit?" to "a combined Fox/Sky would be both a content and a distribution powerhouse."
Wall Street had the weekend to digest Friday's surprise news that 21st Century Fox has made a preliminary offer to buy full control of European pay TV giant Sky in a deal that values the latter at roughly $23.2 billion, but reactions have differed sharply.
And Fox's stock dropped 6.6 percent to $26.35 on Monday after a 1.5 percent decline on Friday as a couple of analysts kicked off the new week downgrading their rating, citing the U.K. regulatory review that could take around a year and other concerns. Sky's stock closed down 2.8 percent on Monday.
Fox currently owns a 39.1 percent stake in Sky, which operates in the U.K., Ireland, Germany, Austria and Italy and for which the entertainment conglomerate offered $13.52 (£10.75) per share in cash. The possible combination would bring together content and distribution assets, similar to telecom giant AT&T's recent $85.4 billion deal for Time Warner.
Several analysts covering Fox and its stock on Monday agreed that the regulatory review of the proposed deal, or a lack of excitement for the takeover, would be an overhang for the stock, leading them to cut their stock rating. But otherwise, analysts at times came to very different conclusions about the potential deal and its benefits.
MoffettNathanson analyst Michael Nathanson was outright critical in his report, downgrading his rating on Fox's stock from "buy" to "neutral." "We were psyched when Fox sold Sky Italia and Sky Deutschland to BSkyB for $9 billion in July 2014," he wrote. "We viewed those assets as perennially disappointing and poorly positioned for a world moving towards greater internet protocol delivery and consumption. As such, Friday’s announcement of a possible Fox/Sky deal, while accretive and not utterly shocking, is underwhelming from a strategic and timing perspective."
Warned Nathanson: "Due to this deal, we believe that U.S. investors will reduce Fox's forward multiple as they see satellite as a less valuable asset."
Wells Fargo analyst Marci Ryvicker was also outright critical. "The Sky acquisition is accretive, but where's the strategic fit?" she asked in a report. "While this transaction is accretive by 10 percent – it's all tax-related."
She also took a shot at the Murdoch family, which controls Fox, saying: "We ask, where's the 'story-telling' that the Murdochs seem to love so much? Yes, this removes the perpetual M&A uncertainty, but we're not so pleased with the fact that Fox's balance sheet is now tied up – hence, no [stock] buybacks or [financial] optionality, a little scary to us given the rapidly evolving ecosystem."
Her conclusion: "We scratch our heads in terms of what a distribution company headquartered in the U.K. does for a global content company headquartered in the U.S. over the long term. We're not buyin' it, hence we reiterate our 'market perform' rating."
S&P credit analyst Naveen Sarma echoed some of her financial concerns, placing his Fox debt ratings on "CreditWatch negative" due to the Sky play, meaning the ratings could be lowered. "We believe there is a significant likelihood that a final agreement could be reached," he explained. Moody's also said it would review its Fox debt ratings for a possible downgrade.
Telsey Group analyst Thomas Eagan was among more optimistic on the deal rationale. "We like the industrial logic behind this deal," he wrote. "Fox was not receiving value for its Sky stake. Actually, it was being penalized due to the M&A risk."
But he also cautioned that "the regulatory review could be long and rancorous, and Fox could be under pressure." In conclusion, he downgraded his Fox stock rating to "market perform" and lowered his stock target price by $7 to $28.
Eagan gave the deal "better odds than in 2010" when News Corp. before its split into Fox and News Corp had offered to buy full control of Sky before withdrawing the offer amid the phone-hacking scandal. "Ultimately, we expect this deal will be approved," the analyst wrote. "Today, we expect much of the morality concern has subsided."
Guggenheim Securities analyst Michael Morris went the opposite way, raising his Fox price target by $3 to $32 and maintaining his "buy" rating. "The increase in our relative target multiple reflects optimism that the company will successfully complete an accretive consolidation of Sky, as well as our modestly more favorable view of networks as increased competition among distributors supports the need for content," he explained. "Importantly, we do not believe that Fox's current public valuation fairly reflects its 39 percent ownership in Sky as it is not consolidated in operating profit."
He said that his investor conversations "indicated concern that the proposed transaction would complicate what had become a more streamlined, primarily U.S.-based content and networks strategy," adding: "In general, fears that European video distribution is a lower-growth business weighed on early sentiment." But Morris highlighted that "Fox sees Sky as having attractive core growth potential, while also bringing distribution expertise, both linear and direct to consumer, to the company."
The analyst predicted that the deal could "represent only a step toward a strategic goal of controlling a global distribution platform," which "could indicate potential investment in the U.S. as Fox seeks to keep pace with Comcast and AT&T, which have integrated or plan to integrate significant distribution and content production capabilities."
But Morris acknowledged some doubts about this renewed strategy of merging content and distribution, saying: "We remain skeptical on the effectiveness of the vertical consolidation in the U.S., but believe major players see an increased need for robust product offerings and view content control as providing some differentiation."
Macquarie Capital analyst Tim Nollen was one of the most bullish analysts on the deal, having predicted it earlier this year. "Sky’s share price peaked at £11.40 in mid-2015, which underscores the timeliness of the Fox offer," he wrote. "Strategically, we believe a combined Fox/Sky would be both a content and a distribution powerhouse."
He continues to rate Fox's stock "neutral" though, saying: "We like this deal, but await further details to determine any estimate changes or change in view."
Sky has also gotten a mixed response to the takeover offer. The Financial Times reported that the company contacted its to 10 shareholders and found them to be "pretty sanguine" about the price Fox offered. Two smaller shareholders though raised concerns and called for a higher offer. And the investment director for a third shareholder, Standard Life Investments, told the BBC on Monday that he hoped Fox's offer was "a starting bid," adding that the companies would hopefully "appreciate that a higher bid is more appropriate."