Rupert Murdoch counts the $3 billion cost of waiting for Sky

Rupert Murdoch and his son James may have to pay considerably more in 21st Century Fox's pursuit of Sky Plc as a result of the phone hacking scandal of 2011. AP

by Neil Chenoweth

Rupert Murdoch's latest bold tilt to win British satellite broadcaster Sky Plc is a $US32 billion ($42 billion) deal looking for a narrative – beyond the obvious historical obsession with Sky, why is Murdoch doing this deal?

The takeover bid that Murdoch's 21st Century Fox foreshadowed on Friday at £10.75 a share is all about how you tell the story.

Few expressed surprise about the bid, which values Sky's shares and options at £18.9 billion ($US23.8 billion). If you add in the net debt the bid puts a total enterprise value on Sky of £24.7 billion ($US31.6 billion). This puts the transaction well into the major leagues.
Analysts have ascribed various rationales for the deal. Murdoch is exploiting the weaker British pound after Brexit; he is building a stronger vertically integrated business in Europe to counter weakness in the US economy; even that it ensures European distribution of Fox content (as if having management control of Sky could not ensure this).

The pound is down 14.5 per cent since Brexit but more notably Sky shares had dropped 18 per cent in British currency since October before the bid lifted the price on Friday.

There are other ways to parse this deal. It was phone hacking that torpedoed Murdoch's original bid for Sky in 2011.

Five years later it's essentially the same deal that 21st Fox is putting up under new chief executive James Murdoch, to acquire the 60.9 per cent of Sky that Fox does not already own.

It's just that he has to pay $US3.1 billion more. You could call it the opportunity cost of the hacking scandal.

Failure saves billions

Chase Carey, who as president and chief operating officer of News Corporation (later 21st Century Fox) launched the 2010 bid for Sky and planned a bid for Time Warner.

That's not the only possible narrative. On another reading, the Murdochs have saved billions of dollars as a result of the failed 2010 bid.

Rupert Murdoch launched the original Sky in 1989 before he was forced in the middle of the great News Corp debt crisis of 1990-91 to merge it with rival broadcaster BDB to form British Sky Broadcasting (the name went back to Sky in late 2014).

James Murdoch's stint from 2003 to 2007 as CEO of BSkyB, and then his role until 2011 as head of News International, was a critical period when BSkyB successfully negotiated the transition from a purely satellite broadcast service into an internet and satellite based offering.

These changes would have a big impact on BSkyB's earnings, so it was a canny move by News Corp CEO Chase Carey in June 2010 to launch a £7 a share bid for BSkyB before the rising earnings lifted the share price.

Buying out the other shareholders would cost News £7.8 billion, or $US11.5 billion. (All conversions from pounds to US dollars have been done using the exchange rates at the time.)

The hacking scandal not only forced News to drop its bid for BSkyB, but also led to the Murdoch family empire being split into 21st Century Fox and the new News Corporation. This was Carey's moment, with James Murdoch effectively sidelined by the scandal.

James' management duties extended to little more than the satellite operations: Star TV, Sky Italia and Sky Deutschland.

Carey proceeded to sell Sky Italia and the Sky Deutschland stake to BSkyB in November 2014. After a Sky share issue the $US8.8 billion sale generated $US7.3 billion cash for 21st Fox, which Carey proposed to use to help fund a bid for Time Warner.

Walking away from deal

It would have made 21st Fox the biggest traditional media company in the world. But when Time Warner haggled over price, Rupert Murdoch walked away.

Either Murdoch had become risk averse, or he feared the deal would leave Carey with too much power. Carey left the company on June 30 this year, leaving James and his brother Lachlan, who is co-executive chairman of 21st Fox, with a need to establish their business smarts with a big deal.
Bidding for Sky was the obvious move.

Last Friday's bid values Sky shares and options at £18.9 billion, and the cost of the bid for 21st Fox at £11.7 billion, or $US14.7 billion. As noted, that is $US3.1 billion more than the $US11.5 billion that News Corp was prepared to pay in 2010.

But 21st Fox is still flush with the $US7.2 billion cash it extracted from Sky two years ago for Sky Italia and Sky Deutschland. If you include that in the total net outlays, then 21st Fox's cash requirements for this Sky deal are actually $US4 billion less than they were in 2011 when the hacking scandal came along.

21st Fox actually ends up with more money, thanks to the hacking scandal, an implausible $US4 billion silver lining.
But today Sky is geared up with the debt that it took to buy Sky Italia and Sky Deutschland from 21st Fox. In 2010, News Corp's bid plus net debt valued Sky at £14 billion ($US20.7 billion). Now it's £25.1 billion ($US31.6 billion).

So the real cost of buying Sky has jumped 80 per cent, measured in British currency, and 52 per cent in US dollars.

Trying to maintain growth
What do these numbers mean?

First, Sky's earnings did leap, just as Carey and Murdoch had expected. In 2011 Sky reported operating profit of £1.07 billion. By 2016, that had jumped to £1.5 billion.
But can Sky maintain that growth, or have the Murdochs missed the boat? It's a worry.

Meanwhile the old Sky Italia and Sky Deutschland racked up £3.6 billion of sales last year, providing 43 per cent of Sky's UK revenue. But operating profit (before the interest bill) was just £54 million. Right now it's a money pit.
Sky paid £7 billion for these two operations, and they are years away from justifying the price tag that Sky paid 21st Fox for them. In taking over Sky, is 21st Fox now buying them back at a new premium?

What's the plan?

Last year Rupert Murdoch reappointed the controversial Rebekah Brooks to head News UK, seemingly in part to show that he could. He needs to find a better rationale to buy Sky now than to say five years ago they said he couldn't.
If anyone can get this deal to work it must be the Murdochs. But first they need to explain why it's necessary.

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