Fitch: FOX Asset Sales Enhance Financial Flexibility in Pursuit of Time Warner

Fitch Ratings believes Twenty-First Century Fox, Inc.'s (FOXA) decision to transfer its European direct broadcast satellite businesses to British Sky Broadcasting Group plc (BSkyB) in a transaction valued at approximately $9.3 billion improves the company's liquidity position and overall financial flexibility. Consideration for the exchange consists of $8.6 billion of cash and BSkyB's 21% interest in National Geographic Channels International and will generate approximately $7.2 billion of net cash proceeds. The transaction is in line with the company's objective to streamline its organizational structure.

FOXA also announced a renewed share repurchase authorization that will be executed during the company's fiscal year 2015. Shareholder returns that exceed FCF generation are incorporated into FOXA's current ratings provided that leverage remains below Fitch's 3.0x leverage threshold for FOXA's current 'BBB+' rating.

From Fitch's perspective FOXA has the necessary financial flexibility, primarily through monetization of non-core assets, including the transaction announced today, along with expected free cash flow (FCF) generation, to maintain strong 'BBB' ratings should the company elect to continue pursuing an acquisition of Time Warner, Inc. (TWX). Time Warner previously rejected FOXA's unsolicited bid of $85 per share consisting of 1.531 FOXA non-voting common stock and $32.42 in cash per Time Warner share.

Should a transaction between FOXA and Time Warner materialize, Fitch will have a level of tolerance within the existing rating level should the combined company initially operate outside the parameters of the 'BBB+' rating, provided a creditable de-leveraging plan is in place that reduces leverage to a level more reflective of the rating within Fitch's rating horizon (typically 12 to 18 months for M&A related activity). Fitch believes the de-leveraging plan would likely include asset sales including FOXA's DBS business in Italy and Germany in addition to asset divestures required to gain regulatory approval.

In Fitch's opinion, a potential acquisition of TWX does not address any apparent material strategic deficit within FOXA's asset and business portfolio. Fitch holds FOXA's overall strategic positioning in high regard as its businesses consist of a strong collection of cable networks, leading television and film studios, national television network with robust sports-programming rights, local television broadcast assets and international direct broadcast satellite business. Each of FOXA's businesses have the scale characteristics to operate at high margins and generate meaningful levels of free cash flow (FCF) and positions the company to address the secular threats and opportunities presented by changing media consumption patterns and continued audience fragmentation across the media and entertainment landscape.

Nonetheless, Fitch recognizes the potential scale benefits related to a Time Warner acquisition, which in turn can facilitate further investment in programming and production leading to stronger content creation and brand development. At the same time, Fitch also recognizes the potential execution, operational and regulatory risks associated with the transaction. Demand for high-quality content remains strong across all major end-markets (broadcast, cable networks and subscription video on demand). Fitch continues to believe that the entities which control the creation and production of high-quality, 'must have' video content will be better positioned to address secular issues including evolving media consumption patterns, the emergence of alternative distribution platforms, growing preference for time-shifted viewing, and growing competition from online video sources, all of which lead to continuing audience fragmentation. The potential transaction with Time Warner comes amid transforming consolidation within the telecommunications and pay-TV sector including Comcast Corporation's pending acquisition of Time Warner Cable, Inc. and AT&T, Inc.'s proposed purchase of DIRECTV creating further risk to the operating profile.

The centerpiece of any potential transaction with Time Warner would be the creation of a powerful film and television studio, including premium pay television programmer HBO, with the ability to create, produce and distribute high-quality content with a broad audience appeal across multiple distribution platforms on a global basis. The addition of Time Warner's cable network business (including an enviable sports rights portfolio associated with those networks) and the strong competitive position of Time Warner's film and television studios at Warner Bros. enhances FOX's existing asset portfolio and could enable FOX to maintain healthy pricing models for their businesses and protect their ability to attract viewing audiences.

From a credit perspective, Fitch's base case assumes a purchase price of $100 per share with consideration consisting of $50 per share in cash and the remainder in FOXA non-voting common stock. Fitch notes that its base case should not be construed as a valuation of Time Warner common stock, or a threshold or limitation for any rating category, but put forth for illustrative purpose. Fitch further assumes that there will not be any debt structure issues and bondholders will benefit from both FOX and Time Warner's businesses and cash flows. Fitch estimates FOX will issue approximately $40 billion of debt to facilitate the transaction (in the absence of proceeds from anticipated asset sales) leading to pro forma leverage of 5.6x as of the LTM period ended March 31, 2014. Pro forma leverage includes $1 billion of anticipated expense synergies. Pro forma leverage declines to 4.9x assuming $10 billion of net asset sale proceeds. Fitch case further assumes FOX adopts a conservative capital structure policy by largely eliminating share repurchases, reducing dividends and direct free cash flow generation to debt reduction. Fitch's base case estimates that the combined entity's FCF generation approximates 9% of revenues initially and grows to nearly 11% of revenues within Fitch's rating horizon. Additionally leverage trends below 3.5 within the same timeframe and drops to 3x within three years of the transaction closing likely positioning FOX's credit profile strongly within the 'BBB' category.

Conversely should the combined entity adopt a more aggressive capital allocation policy or if FOXA's accepted transaction terms are more aggressive than Fitch's base case, Fitch maintains that it would be difficult for the combined entity to maintain the current ratings. However under such a scenario Fitch would expect that negative rating action would be limited to two notches.

Additional information is available at 'www.fitchratings.com'.

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