Are News Corp, REA Making The Right Move?

This story features NEWS CORPORATION, and other companies. For more info SHARE ANALYSIS: NWS

-Compelling for News Corp
-Risks in REA's exposure
-NWS capital return less likely
 

By Eva Brocklehurst

News Corp ((NWS)) and REA Group ((REA)) will partner to acquire US online real estate classifieds business, Move Inc, for US$950m. This is the largest investment News Corp has made since it split from Fox. The deal is cash funded and split 80:20 between News Corp and REA. Move is considered the number three real estate portal in the US market in terms of traffic but has delivered the slowest revenue growth of the three. Citi observes the 3-year compound growth rate of just 6% compares with Zillow's 44% and Trulia's 57%. Zillow and Trulia are planning to merge and Citi also notes other real estate markets are also trending towards two major digital players, e.g. Rightmove/Zoopla in the UK and REA/Domain in Australia.

Citi believes the deal is a compelling opportunity for News Corp to deliver increased value to shareholders, despite the relatively high price being paid for the asset. Execution risk is material, as Move is facing well funded and established competitors. Nevertheless, Citi considers the risk/return is skewed to the upside and welcomes the transaction from News Corp's perspective.

It is a smart move, in Credit Suisse's opinion, as while News Corp has paid a sizeable premium and the transaction is likely to be dilutive, it has the potential to deploy cash in an area where its associate, REA, already has expertise. Move also has tax losses that may ultimately lower the effective purchase price. News Corp could also help Move become more competitive, having the financial capacity for greater marketing spending and the ability to leverage existing US media assets and drive traffic to Move's websites.

CIMB is less impressed, questioning the logic behind REA's 20% stake. There is a large US real estate online opportunity, with relatively less penetration than the Australian marketplace which already has 50% online penetration, but the broker is not sure if Move is best placed to capture this opportunity. Valuation metrics signal US investors are willing to pay a 100% premium for the number one and two players – Zillow and Trulia – over Move. The investment is relatively small for REA but, if the rationale was so compelling, the broker asks: why not acquire a larger stake? The benefits to News Corp are obvious, given REA's involvement, but CIMB envisages limited upside for REA over the medium term. CIMB also considers Australian online valuations are stretched and the risk of a property correction, while not assumed, puts the spotlight on REA's exposure given its shift to a listing model.

The market structure in the US differs from Australia and Deutsche Bank warns that any read through regarding the online growth path is limited. The US real estate market is almost 20 times larger in terms of transactions and agents. The broker does not have a problem with REA's 20% stake, as it effectively puts the company in a position to benefit from any upside while limiting the downside. Deutsche Bank also expects Move would be well placed to increase its share of the addressable US market, but News Corp will need to work hard – if Zillow and Trulia merge – to make the most of the opportunity. Without any additional investment in sales and marketing, the transaction appears broadly neutral to Deutsche Bank's forecasts.

The transaction makes strategic sense to JP Morgan, from a News Corp perspective. Management can leverage REA's expertise. Still a need to reinvest in marketing is likely to hold down earnings growth in the near term. The investment should help propel News Corp's business mix towards a potentially higher growth digital segment but JP Morgan also observes this transaction further decreases the likelihood of capital returns to shareholders, which may disappoint some investors attracted to the hefty cash balance. From a REA perspective, JP Morgan notes the net cash balance is almost eliminated, for now, although the business does generate strong cash flow. JP Morgan acknowledges the early stage market opportunity in the US but was surprised by REA choosing a developed market partnering with News Corp.

News Corp has three Buy, two Hold and one Sell rating on the FNArena database. The consensus target price is $20.86, suggesting 15.1% upside to the last share price. REA has three Buy, three Hold and one Sell rating with a $46.98 consensus target, suggesting 10.4% upside to the last share price.
 

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