While there has never been much love lost between Disney and Comcast, their ongoing battles over Fox and Sky will undoubtedly leave the two companies mortal enemies. Tensions are rising as evidenced by Disney Chairman and CEO, Bob Iger’s attack on Comcast’s potential for regulatory approval of a Fox acquisition, as we detailed in our June 26th blog (
link).
The source of rising tensions is clear as Comcast has already forced Disney to pay 35% more for Fox than it had originally agreed upon and caused Disney to stop its share repurchase program, given the increased leverage resulting from a 50%/50% cash/stock bid vs. the original all-stock acquisition plan. In addition, with Comcast’s £12.50/share bid for Sky and the implied increase in value for Sky embedded within Disney’s Fox bid, we believe Fox will meaningfully increase its bid for Sky in the days ahead (
increasing Disney’s overall debt load from the two planned acquisitions).
We continue to believe there are no obvious acquisition alternatives for either Disney or Comcast. In turn, we expect bidding for the Fox assets being pursued to move higher, with an ultimate acquisition price of $45-$50 likely (
with a New Fox stub adding $8-$12 of value). Disney is trying to scare Comcast away from bidding and to make Fox investors believe a Comcast bid is not approvable. However, the template laid out by the DoJ in Disney’s recent Fox approval (sale of the RSNs) creates a framework that can work for Comcast to achieve quick DoJ approval as well (
excluding the RSNs, the only wholly-owned domestic assets being acquired are two non-sports, non-must-have cable networks in FX and Nat Geo and a Film/TV studio – none of which impact Comcast’s marketplace leverage).
We believe Disney has failed to scare off Comcast and we continue to believe Fox investors want the highest possible acquisition price.
Why Comcast Should Bid $47 for Fox and £15 for Sky
The most obvious reason is to win.
Disney has already bid far higher than they expected for Fox and as a disciplined company they may be nearing their breaking point. Remember, Disney is heading into a major investment cycle for
Disneyflix, one that we believe investors are severely underestimating as it tries to build a global SVOD platform to compete with Netflix. Disney will need to invest billions of incremental dollars in content annually, ramp technology spending dramatically and forgo revenues/profits from the syndication of content to legacy distribution platforms. In turn, this is a less than ideal time for Disney to dramatically increase leverage.
Disney’s ESPN division also has a critical renewal coming up in 2021 for Monday Night Football. The MNF contract, along with the other major Sunday packages, is likely to be put out for bid in late 2019/early 2020. With ESPN already paying nearly $2 billion/year while subscribers fall and ratings drop, ESPN is an precarious position to hold onto MNF (
we expect digital bidders such as Amazon to be aggressive as well as newly deep-pocketed bidders such as AT&T’s WarnerMedia). With the NFL likely to keep all Sunday packages on broadcast, ESPN’s only option to maintain NFL programming is MNF. In turn, a more levered balance sheet could be problematic.
On top of those issues, Disney is going into a major renewal cycle for its cable networks assets, most notably ESPN. As the most overpriced component of the bloated, legacy MVPD bundle, we wonder if Disney really wants to be significantly more levered as it enters into negotiations. With MVPD’s video business facing increasing pressure from cord-cutting and cord-shaving, the cost of Disney/ESPN networks and distribution (penetration) requirements have become a real problem for distributors. Carriage negotiations are likely to be significantly more contentious than in the past, with Disney’s increased leverage occurring just as the next wave of negotiations kicks off in late 2019 into 2020.
If we were in Comcast’s shoes, we would literally push Disney to their breaking point to see if we could make them blink and give up. At all-cash $47 for Fox and £15 for Sky, Comcast’s leverage would be about 5x initially, but would end 2019e at just under 4.5x, with organic growth and synergies taking leverage to the mid-3x’s by the end of 2020e. Given the stability of Comcast’s broadband business, we believe this leverage is more than manageable, especially when you factor in Comcast’s expertise in large-scale acquisitions (such as NBC) and running a distribution business (Comcast Cable).
We suspect a $47 bid from Comcast would force Disney to match (
with regulatory approval ahead of Comcast, simply matching should be enough for Fox’s board to declare Disney the winner). At the same time, if Comcast goes to £15, Disney through Fox, will be forced to match Comcast’s bid. If Disney pays $47 and £15, current leverage would move to above 3.6x and 2019e would be around 3.1x, well above Disney’s historical comfort zone. While organic growth and synergies would bring that leverage down meaningfully in 2020 and beyond, we wonder if Disney would really go that far knowing they have to build a global SVOD platform, maintain sports rights and renegotiate most of their major MVPD contracts over the next 24 months.
Transform Disney Winning into Losing
Even if Disney does not blink and proceeds to match Comcast at $47 and £15, the resulting leverage on Disney will benefit Comcast. As the second largest MVPD (
only smaller than AT&T/DirecTV), Comcast would benefit from Disney becoming more levered during those negotiations. We have to imagine Comcast also does not want to see Disneyflix be successful, as it hastens the decline of the legacy MVPD business, which Comcast still generates meaningful value from. In addition, Comcast’s NBC may have greater aspirations for sports programming (well beyond NFL rights), which would be easier to acquire if Disney’s leverage is above their comfort zone.
No Downside to Comcast
Putting it all together, we simply see no meaningful downside to an aggressive Comcast counter-bid to Disney’s current $38 offer. If Comcast wins, they take control of unique assets that rapidly transform Comcast into a vertically-integrated global media company and stop Disney from acquiring assets that Disney’s management has deemed critical to their global, direct-to-consumer ambitions (
albeit we believe they could do it faster/better without an acquisition). They also leave Disney with a management transition problem, as Iger retires in mid-2019 without a Fox deal, with no obvious successor. If Comcast loses, they leave Disney in a leverage position that Disney has never found itself in, while facing major content and distribution renewals and the need to ramp investment spending in content and technology to enable direct-to-consumer offerings. The downside in losing for Comcast is that they are left underlevered with growth slowing, with no obvious other place to invest the type of dollars they wanted to buy Fox and Sky with. Not such a terrible thing, but investors may worry what would Comcast buy instead.
