Friday, July 13, 2007

News Corp. as an acquirer is limited by family ownership

While the outcome of News Corporation’s audacious bid to acquire Dows Jones continues to percolate, it might also be timely to look at News Corp. as an acquirer of media companies over time. Despite the image perpetrated by the company’s vocal detractors, News Corp is actually one of the few large media companies that has been much more of a creator and builder of media outlets than an acquirer. I’ll explain why.

Of the 20 largest media deals between 1981 and 2002, News Corporation was involved in exactly---one. That was its purchase of Gemstar-TV Guide for $6.5 billion, number 14 on that list. It also bought a controlling interest in DirecTV. In that period, however, the company started the broadcast Fox Network, with some smaller purchases of 20th Century Fox and some local TV stations; it started a satellite TV system for the UK (now BSkyB) and invested in a very early stage another for Asia (Star); it started from scratch the cable Fox News Network.

News Corporation’s recent high profile acquisition of MySpace for $580 million was impressive only because it was for a company less than three years old with maybe $20 million in revenue and no profit. But that price is small in media terms. When compared to McClatchy's acquisition of the Knight Ridder newspaper and broadcast group for $4.5 billion, the $5 billion offered for Dow Jones is modest. And it doesn't come within shouting distance of the $36 billion value of Viacom’s merger with CBS in 1999 (and since divested) or the Time Warner-AOL merger debacle.
News Corporation’s penchant for growing organically—as the strategic planners put it—is partly a reflection of its leader, Rupert Murdoch. It is also an outcome of the corporate structure and priorities that Mr. Murdoch has maintained throughout his career. News Corporation is a public company, which means that its ownership is shared among thousands of individuals, mutual funds and trust funds. The Murdoch family, however, controls about 30% of the voting stock, which gives it effective control over the company. This is essential to understanding its growth strategy.

But first some background. (MBAs can skip the next few paragraphs). There are two basic models for one firm to acquire another. One is by using cash. The other is by providing stock of an equivalent value.

A cash acquisition is easy to understand. The owners of the acquired company get a check when they send in their stock. The value of the deal rarely changes between the time it was announced and when it is completed.

However, the most common structure that acquisitions take with large public companies is through stock swap. That is, the acquiring company issues shares of its stock in exchange for the stock in the company being acquired. So, if the acquiring firm, Company A, has stock currently trading for about $10 per share and has agreed to acquire Company D for $500 million, it would need to issue 50 million of its shares and parcel those out to the stockholders of Company D, who would trade them for their own shares in Company D. Thus, Company A now has all the stock – hence ownership--of Company D.

The stock swap has some advantages and disadvantages, but the former tend to win out. The advantage for many stockholders of the acquired company is that the transaction does not typically involve any capital gains tax liability. The sellers are simply swapping ownership shares. They have not realized any gain (or loss) until and if they sell that stock. In a cash transaction, owners are simply selling their shares, so there are immediate tax consequences.

One disadvantage of a stock acquisition is that the values of the transaction can change if the value of the stock of the acquiring company fluctuates substantially before the deal is completed. For example, in the above example the parties had agreed on a $500 million value. Should the stock market in its collective opinion feel that this is not a good deal for Company A, the price of the stock may be driven down, let’s say to $9 per share. If the stockholders of Company D still get 50 million shares, then the value of that stock is down to $450 million. Depending on what was negotiated, the acquiring company may have to pony up more shares, in this example 5.5 million more shares, to keep the value the same.

What does all this have to do with News Corporation? It’s crucial. When a company issues stock, it may dilute the ownership of current stockholders. For example, say there are 100 million shares outstanding and one stockholder owns 30 million of those. It then has 30% control. If the company issues 50 million shares to make an acquisition, that stockholder still has 30 million shares, but now only 20% of the total.

Why would such a stockholder approve a deal that would dilute their ownership interest? In making the acquisition, the company becomes larger, hopefully more profitable. So 20% (or .02% or whatever for a smaller stockholder) ) of a bigger pie may be better in the long term than 30% (or .03%) of a smaller company.

But if maintaining control is paramount, then dilution by issuing stock is off the table. This has been the case with News Corporation, where the Murdoch family places a high priority on maintaining control. The result is that it must make the bulk of its acquisition by cash or grow by reinvesting profits in organic development. When it makes an acquisition for cash, it may need to offer a higher price than a stock alternative, as it must accommodate the tax liability of those stockholders who had not planned on selling. This is a problem in the Dow Jones offer that has not received much attention. The tax consequences could be substantial, especially for long term owners, such as the Bancroft and Ottaway families that have had their Dow Jones stock for many years.

This self imposed constraint on News Corporation has kept the company out of the major acquisition business. When it does make a large acquisition, such as the bid for Dow Jones, it must pick its spots. If it succeeds with this bid, it will likely be out of the major acquisition business for awhile, especially given its cash-gobbling plan for starting a financial news network for cable. At the end of March, News Corporation had about $7 billion in cash, more than enough to cover its $5 billion bid for Dow Jones, but not much left over when working capital needs are considered. And, given its near death experience in the early 1990s when it took on too much debt to finance its growth into television and satellite, it is not likely to want to load up much further on its current $15 billion in debt.

Although News Corporation has made media acquisitions over the years, they have tended to be relatively small by big media standards. They have been made with the intent on growing them by further investment and good management. To a far greater extent than most of its major media company competitors, it has added to media competition by its new ventures and added resources provided for smaller acquired ventures. And it has pursued this strategy in large measure due to its priority to maintain the company as a family run enterprise.

(Full disclosure: As a result of some divestitures and spins offs I find myself with ownership of some News Corporation shares with current value of under $400.)