News Corp.’s board unanimously approved a plan to split the media conglomerate in two pieces, separating its lucrative entertainment operations from its publishing business, said a person familiar with the situation.
The board made the decision after a meeting in New York Wednesday evening that lasted roughly an hour and a half, the person said. News Corp. Chairman and Chief Executive Rupert Murdoch spoke at the meeting and financial advisers made presentations to the board. The person said many details such as who will run the publishing business have yet to be resolved. The split is expected to be formally announced early Thursday morning.
The entire process is expected to take about a year, and the board must give final approval to the detailed plan.
One company will house entertainment businesses like 20th Century Fox, Fox broadcast network and Fox News Channel while another houses the publishing assets, which include The Wall Street Journal and the Times of London along with HarperCollins book publishing and News Corp.’s education business.
News Corp. shares have jumped 11% since Tuesday when the media company confirmed it was contemplating splitting in two, as investors applauded the idea of the company’s less profitable newspaper assets being carved off.
Publishing generates much lower profit margins than the company’s TV and film operations, and faces stiff competition from online news outlets. Industrywide newspaper advertising has fallen about 50% in the past five years, estimates the Newspaper Association of America. While the Journal has added subscribers, and has protected its content behind a paywall, the new standalone publishing company will confront deep challenges.
“Without deeper cost-cutting, given print advertising’s continuing spiral downward, the new company’s thin 7% profit margin would disappear quickly,” wrote Ken Doctor, an analyst of the news industry at Outsell.
For the entertainment company, its overall profit margin will be higher without publishing. Its stock market valuation is expected to rise above that of News Corp.’s current valuation, analysts say, as the publishing assets are seen as a drag on the stock
Moreover, without the taint of the phone-hacking scandal at News Corp.’s British newspapers, the entertainment company may have an easier time doing certain acquisitions, say people familiar with the situation.
That is important because the entertainment company could eventually have to confront the disruption posed by the Internet that has already affected newspapers. Film and television is already threatened by competition from online outlets, such as Netflix Inc. and Google Inc.’s YouTube.
In recent years profit growth at News Corp.’s entertainment businesses have been driven entirely by its cable channels, such as Fox News and FX. While entertainment profits grew 13% over the period from 2008 to 2011, all of that has come from the cable segment, whose operating income more than doubled between 2008 and 2011 to $2.76 billion.
The broadcast TV, satellite TV and film businesses each saw operating profit fall over the same period. With broadcast TV, operating profit fell almost in half in that period, from $1.1 billion in ’08 to $681 million in 2011 (partly due to sales of some TV stations in 2008). The publishing businesses expected to be spun off saw operating profit fall 26% in that period, estimates Nomura Securities analyst Michael Nathanson.
Film, broadcast TV and satellite TV saw improvements in the first nine months of the current fiscal year, while publishing continued to decline. Mr. Nathanson expects the three divisions to finish this fiscal year with lower earnings than in 2008.
“I am perplexed about why so much value is created overnight in the entertainment company,” says Todd Juenger of Sanford C. Bernstein. “A lot of investors are thinking they’re spinning off the wonderful high growth assets into the entertainment company but…it will also include businesses that aren’t high growth.”
News Corp. declined comment on valuation.
The film division is the second-largest entertainment business by revenue and profits, and it has enjoyed blockbuster hits including “Avatar” in recent years. But it also has been slammed by a plunge in DVD sales, a key source of profits in the film industry over the past decade. Consumers have increasingly turned to services such as Netflix and Redbox vending machines to rent DVDs rather than buy them. PricewaterhouseCoopers estimates global DVD and VHS revenues fell 19% between 2007 and 2011. It is expected to keep falling, only partly offset by rising streaming and other electronic rental revenue.
Broadcast television, including News Corp.’s Fox network and TV stations, was hit hard during the 2008-09 recession because it is heavily dependent on advertising. SNL Kagan says gross advertising revenue at U.S. broadcast networks fell to $17.2 billion in 2011 from a peak of $19.4 billion in 2006 and little growth is expected in coming years. Broadcasters have begun extracting payments from cable companies to transmit their channels but those fees remain relatively small, particularly relative at advertising revenue.
Fox’s cable networks have been the standout, driven both by rising ad revenues and increases in subscription fees. Mr. Nathanson of Nomura Securities expects the cable networks to have annual revenue growth of 11.1% from 2011 to 2014 and even faster rises in operating income.
News Corp.’s revenues from cable and satellite operators could grow more slowly however if consumers start cutting the TV subscription cord in significant numbers, or if they choose cheaper TV packages without sports channels, says RBC Capital Markets analyst David Bank. He says that along with Walt Disney Co., majority owner of ESPN, News Corp. has the largest exposure of any media conglomerate to sports networks. He estimates News Corp. could lose $240 million of operating income annually if 5% of pay-TV customers switched to the cheapest-available package.
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