Advantage: Murdoch

The pre-emptive News Corp. bid for Dow Jones is so compelling that it is hard to conjure a reasonable scenario in which the Bancroft family, New York Times Co., Washington Post Co., a private equity investor or anyone else can stop it.

In an overture first reported today by CNBC, News Corp. surprised everyone – including the Wall Street Journal, which was half an hour late on the story – with an offer to pay $5.5 billion (or $60 a share) for the outstanding shares of DJ, a 65% premium over Monday’s close of $36.33.

The all-cash offer values the company at 19 times its operating cash flow over the last 12 months, as compared with the prior day’s value of 12x earnings before interest, taxes, depreciation and amortization (EBITDA). By contrast, the average enterprise value for the publicly held newspaper stocks was just 10x EBITDA as of Friday.

The magnitude of the offer from media magnate Rupert Murdoch was designed not only to get the attention the controlling Bancroft family but also to send a message to potential alternative acquirers that News Corp. will pay whatever it takes to capture control of a brand that will enhance the business-news channel it is launching this fall to 30 million homes (including subscribers of its own DirecTV).

When the Fox Business Channel was announced, Merrill Lynch predicted it could generate $360 million in annual subscription revenues from cable and satellite operators, not to mention hundreds of millions more in ad sales. As the “Wall Street Journal Channel” instead of “Fox Business Channel,” it’s fair to conclude that the number of subscribers – and the resulting fees and ad revenues – would be substantially higher.

One hurdle News Corp. would have to overcome at the new channel is a Dow Jones affiliation contract with CNBC that runs until 2012, according to Reuters. But this likely would not be an insurmountable obstacle to a determined News Corp.

Even if News Corp, were frustrated for a time in affixing the Journal name to its new channel, the Dow Jones/Wall Street Journal brand has significant value for the rest of Murdoch's global media operations. The empire runs from the Times of London to Sky TV to 110 newspapers in Australia to the Fiji Times.

Because the strategic value of the contemplated transaction to News Corp. far outweighs its intrinsic economic value, it is difficult to imagine how any alternative acquirer could outFox Mr. Murdoch.

Of course, the transaction could be rebuffed by the Bancroft family, whose members hold voting control under a two-tier stock structure similar to those at the NYT and WaPo. The Wall Street Journal reports that a “slight majority” of the family votes are against selling to News Corp., but concedes “it is not clear if the family is opposed to an offer...or if it's simply trying to get Mr. Murdoch – and other bidders – to sweeten their offer."

DJ's stock took a hopeful leap in August, 2005, when Murdoch's own New York Post reported that certain restive members of the extended clan wanted to see the paper sold. Although that kafuffle blew over and it is possible the family will unite again to block the current News Corp. overture, history shows these sorts of things eventually tend to go in the other direction.

Similar situations over the years in places like Louisville and Los Angeles demonstrated that a large number of newspaper heirs spread over multiple generations eventually will take the money and run. I wound up quitting my job and moving to San Francisco in 1984, when the family that owned the Chicago Sun-Times decided to sell the paper to News Corp. – after assuring us this would never happen.

Though the Bancrofts ultimately control the fate of the company, they can't be entirely oblivious to the concerns of the common stockholders. "I think investors who own the shares will be almost unanimous in saying this is a price they cannot refuse," said Jean-Marie Eveillard of First Eagle Global Fund, who is one such shareholder.

If you accept the proposition that DJ is likely to be sold, News Corp. appears to have a clear advantage over NYT, WaPo and any of the other conceivable contenders, because its financial capacity to fund the transaction is far superior to that of anyone else.

News Corp. had $5.7 billion in cash on its books as of the end of 2006, as compared with $348 million for WaPo and $72 million for NYT, according to their respective annual reports. Cash matters because it would be required to make up the difference between the price paid for DJ and the amount of debt that can be secured to fund the transaction.

As you will recall from our previous discussions about newspaper finance, an acquirer can borrow a certain amount of money against the company’s operating earnings but has to make up the rest with equity. If DJ were purchased for $5.5 billion and the buyer could borrow an aggressive 9x Dow’s trailing EBITDA, then the buyer would have to come up with $1.45 billion.

Although NYT and WaPo don’t have that sort of cash lying around, they each could borrow against the profits of their existing operations to raise enough money to compete with News Corp. This would turn both companies into highly leveraged enterprises at a time that the outlook for the newspaper business is less than rosy.

Assuming the other publishers could raise the necessary money to compete with Murdoch, would they, should they?

With WaPo deriving 43% of its revenues last year from its Kaplan education properties instead of the media business, the company is in a stronger position than NYT to borrow the money necessary to compete with News Corp. But the company’s assiduous efforts to diversify away from publishing suggests it may not want to mortgage its future to acquire DJ. Even Warren Buffet, the company’s ordinarily supportive outside director, has soured on the newspaper business.

When the NYT completes the pending sale of its broadcast division, it will be almost a pure-play newspaper publisher producing some of the weakest profits in a beleaguered industry. As if that weren’t enough of a challenge, the company is under increasing pressure from disenchanted shareholders who want it to abandon the stock structure that gives the family control of a company whose shares have fallen by nearly half in recent years. Given all that, NYT looks like more of a candidate for going private (or the target of a hostile take-over) than a white knight for DJ.

If the big-name media companies don’t shape up as likely candidates to buy DJ, what about some of the private equity players that have billions to spend?

Although DJ is a trophy acquisition worth stretching for, the economics of a publishing deal at more than 19x cash flow are daunting. A private equity investor determined to own DJ likely would have to invest more equity than customary, potentially impairing the return on the deal when the property is sold after the typical three- to five-year holding period. Further, a private equity buyer paying 19x earnings for DJ would be taking a huge leap of faith in assuming that the company would attract an equally high multiple at exit.

The News Corp. offer for DJ is the opening gambit in what most likely will be a long, complicated and potentially messy game. But the strategic imperative, financial power and sheer determination of Rupert Murdoch gives him the clear advantage. I wouldn't bet against him.