He’s also raising his 2010 EPS forecast because of James Cameron’s movie coming out at midnight tonight. I know what you’re thinking: the fortunes of a Big Media corporation don’t rise or fall based on a single movie. Because Wall Street understands that filmed entertainment has become just a small part of a major media company’s overall portfolio of businesses. What’s more, since stocks are typically priced on multiples of the expected value of discounted cash flows, for a film to have an impact, it would have to generate wildly more profit or loss than investors expected. And yet the well known Pali Capital media analyst Rich Greenfield explains his action:
3D filmmaking has existed for a long-time, with animation increasingly utilizing the medium over the past several years. However, the “chicken and the egg” issue (quality/quantity of 3D movie content with sufficient 3D screens to exhibit on) has been permanently put to bed in our mind, having seen Avatar last night. We can gripe about the unnecessary length of the film and a typical Hollywood ending, but the honest truth is that nobody in the world has ever seen a movie like Avatar.
— Fox’s potential to generate a profit on Avatar remains unclear given its cost and whether a film so closely associated with 3D filmmaking will translate into (2D-only) DVD/Blu ray sales during 2010. That being said, we do not walk away believing Fox is in danger of losing a massive amount of money on the film.
— Avatar (best experienced on one of the US’s 178 IMAX 3D screens or at worst on the 3,000+ traditional 3D screens the film will open on Friday) will set off a new wave of 3D filmmaking in the years to come and is likely to accelerate consumer interest in in-home 3D (not as far away as you think; only 2-3 years).
So Why Give Up on the News Corp. SELL Rating Now and Upgrade to Neutral?
— Avatar is going to generate incredible excitement over the next month and will not be a disaster profit-wise with the Fox film slate set to notably outperform expectations this year.
— Earnings estimates are going higher, even without outperformance in film. Our revised estimates now assume high-teens organic operating income growth in fiscal (June) 2010, well above management guidance of high-single to low-double digit growth, albeit largely discounted in the stock. In addition, we believe EPS will be $0.86 now, versus street consensus of $0.81 (our prior estimate was also above consensus at $0.82).
— Our short thesis had been premised on the lack of growth post-FY2010 (we are still expecting flat EPS in FY11, albeit off a higher base). However, with earnings heading higher, shorting for an FY11 earnings miss simply feels pointless.
Pair-Trade to Collapse Spread Still Makes Sense, Long NWSA, Short NWS
— We continue to believe there is no fundamental reason for a 17% spread to exist between NWSA and NWS shares, with the spread averaging 12% since 1994, and only 6% since the domicile shift was approved by shareholders in 2004 (18% is the all-time high since the domicile shift).
Key Risks/Issues in Near-Term
— Not “blowing up” on Avatar profitability wise
— Ratings of American Idol – particularly given the relative outperformance of the FOX network during the first half of the 2009-2010 television season.
— Retransmission consent battle brewing with Time Warner Cable. Fox is talking a tough game, but TWC appears ready and willing to pull Fox signals.
— Acquisitions. With a strong balance sheet and no interest in share repurchase, we continue to believe News Corp. is interested in pursuing strategic acquisitions (including expanding their distribution network, such as buying in BSkyB).