Karen Bradley, the UK Culture Secretary, has referred 21st Century Fox’s bid for the 61% of Sky (SKY) that it doesn’t already own to competition regulators. We are not surprised with her decision and have actually been expecting it for quite some time. The concerns relate to whether the Murdoch family will have too much control over the UK’s broadcasting industry.
In our view, there is minimal difference between the family’s influence with 100% control and its influence with 39% control. We don’t think the legal separation of the television operations, such as Sky, into 21st Century Fox from the newspaper businesses within News Corp will significantly influence the regulator's position, as the Murdochs ultimately control both.
However, the reach of the Murdochs' newspaper empire has shrunk dramatically since Fox’s previous attempt to buy Sky in 2010, with the majority of British people now receiving news from the internet or other non-Murdoch media companies. Thus, we see limited legal grounds to stop the merger.
That said, it is a hot potato politically, as there are some powerful politicians and interest groups that oppose the deal. It is much easier to kick the can down the road and let someone else make the decision, and so we are not surprised by Bradley’s decision. However, we still expect the deal to close, though this delay likely adds another six months to the review process.
There is no change to our Sky fair value estimates of £10.10 for the UK-listed shares, which we had raised prior to the bid, based on improving fundamentals. Our narrow moat rating – which suggests a slim competitive advantage - is also intact.
Competitive Advantages
Sky has succeeded in aggregating some of the best content available and marketing its services. More than a decade ago, the firm began to enter exclusive deals to carry major sporting events in the United Kingdom. In addition, it acquired rights to many first-run movies and US-produced television series, which are becoming increasingly popular in the UK.
While it resells the majority of its purchased content to other television carriers, it also produces its own shows to distinguish its product. The completion of a new production facility in 2011 enhanced the company's content-creation capability.
The firm also offers broadband and phone service. These businesses have grown rapidly and are now similar in size to Virgin Media and TalkTalk, though they are still smaller than those of BT Group, the incumbent telephone operator.
While BT's new-subscriber growth in the UK has been increasing since it began offering BT Sport for free to its broadband customers, Sky continues to increase its broadband subscriber base. While the firm doesn't have the scale in broadband and telephony that it has in pay-TV services, the incremental business is improving the firm's margins and free cash flow.
The Italian and German markets are far behind in their development of pay-television services versus the UK. By acquiring the firm's sister companies in these countries, management hopes to replicate its British success in Italy and Germany. In December 2016, 21st Century Fox agreed to acquire the 61% of Sky it doesn't already own for £10.75 per share. We expect the deal will eventually be approved by shareholders and regulators.
