Finally, the global wave of media mega-mergers has washed up on Australia’s shores, following Malcolm Turnbull’s removal of the ‘two out of three’ and ’75% coverage’ rules in October 2017. But will Nine’s bid for Fairfax make any difference to either organisation or will it be a case of a princess vainly kissing a toad in the hope of finding a prince? Or is it more like two toads kissing?
Media's changing landscape
Overseas, the US-based Comcast bid US$66 billion for the Fox Inc. entertainment assets which includes franchises like the X-Men and The Simpsons. That bid was pipped by Disney’s US$77 billion rival offer, leaving Fox and Comcast to fight it out for the 61% of European broadcaster Sky plc that Fox doesn’t already own.
Meanwhile rumours of further mega-mergers and acquisitions circle media companies such as CBS and Viacom by the likes of Apple and Amazon.
Closer to home, Nine Entertainment (Nine) executives appear to be equally enamored with their childhood reading of the Russian fairytale about the frog-kissing princess. They expect their corporate kiss will transform Fairfax. Nine is offering Fairfax shareholders 0.3627 Nine shares (equivalent to 82 cents currently) plus 2.5 cents cash for each Fairfax share. That’s 84 cents per share for Fairfax, or about $1.17 if the value of Domain’s in-specie distribution is included.
With 2.3 billion shares on issue, Nine’s offer values Fairfax at about $2 billion, or more than two times its book equity (which itself was written down aggressively in 2012 as a result of persistent returns on equity of less than 4%pa).
Fairfax has responded approvingly by stating:
"The structure of the proposed transaction provides an exciting opportunity for our shareholders to maintain their exposure to Fairfax's growing businesses whilst also participating in the combination benefits with Nine."
Takeovers often promise and are frequently justified on the basis of ‘combination benefits’, also known as synergies. But synergy benefits invariably fail to materialise, or if they do, they take much longer to arrive than expected, forcing the bidder to write down the goodwill in its offer. Recently, Japan Post was forced to write off $4.7 billion, several years after buying Toll Holdings with the company’s President, Masatsugu Nagato, stating: "The price we paid for Toll was high … the writedown is intended to wipe the slate clean." Wiping the slate clean is easy for CEOs when its billions of dollars of other people’s money are used as the mop.
Consumption of media has changed completely
Newspaper audiences have been gutted and diced by the emergence of digital media alternatives. The era of newspapers monetising their markets through advertising and classifieds is long gone.
Free-to-air television has likewise seen its audiences decimated not only by Facebook and Google taking eyeballs away from television, but by streaming alternatives such as Netflix, Apple TV and Amazon.
TV content has changed over the last decade. The age of binge-watching has been sparked by series such as Game of Thrones, Homeland, Ozark, Breaking Bad and House of Cards. Consumers will always be attracted to the next hit forcing media companies to keep increasing their spend on ever-higher production, casting quality and writing values.
How can Nine compete when it spends $2 billion on Fairfax, while Netflix and Time Warner (which owns HBO) and CBS (which owns Showtime) spend US$6 billion annually on developing their own content? Meanwhile, Disney and NBC Universal are spending around US$12 billion annually on TV programming.
I once likened the Australian TV competitive landscape to four card players (four networks – Nine, Ten, Seven and the ABC) locked in a room with no windows or doors. The Australian viewing audience is represented by the pile of chips that each player tries to win. Each year one of the players secures a winning hand (the most popular TV drama or reality TV concept) but the next year its mantle is lost to another network. The pile of chips never grows, it is merely passed around. Today, thanks to the likes of Facebook, Google, Amazon, Netflix and others, that card-playing room has a drain in it and chips are constantly falling down the drain making the pile of chips smaller.
Merging with Fairfax will not change that dynamic for Nine. The Fairfax audience already knows Nine exists and the Nine viewers are all familiar with Fairfax’s titles. At best, Nine will win a few chips this year or next, but lose them again the year after, or the year after that.
What motivates managers of public companies to make acquisitions?
The drivers of acquisitions include:
1. The desire to be bigger, which is the yardstick by which salaries are often measured.
2. The pressure from institutional shareholders to ‘grow’ revenues and profits.
3. The aspiration to increase the share price.
4. The need to grow faster.
5. The push from lenders and corporate advisers to take advantage of other factors such as low interest rates, a buoyant stock price or investors flush with cash and a rapidly closing window for deal-making.
6. The belief the buyer can do a better job than the target.
Rarely do the above motivations result in better long-term returns to shareholders.
Would I give my money to Nine?
There is only one compelling reason to make an acquisition and that is to receive more than is being given away. Nine's shareholders will effectively pay two times book equity for Fairfax ensuring that Fairfax’s forecast 14% return on equity will be halved in the hands of Nine's shareholders. Why would I give my money to Nine to pay more for Fairfax than I could have paid for Fairfax myself on-market?
If a princess kissing a toad does not produce a prince, then two toads kissing each other certainly won’t. The economics of newspapers and free-to-air TV are not improved by a change in ownership, and the market has already spoken. The Fairfax share price is cheering the news, while the Nine share price fell.
When viewing mergers and acquisitions, look through the lens of the industry’s economics and the return on equity of the target. When I do that, I don’t see anything to get excited about on behalf of long-term Nine shareholders or Fairfax shareholders, who may soon be Nine shareholders too.
Roger Montgomery is Chairman and Chief Investment Officer at Montgomery Investment Management. This article is general information and does not consider the circumstances of any individual.