Domain Is The Prize In Nine-Fairfax Merger

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Domain's real estate portal is the prize in Nine Entertainment's bid for Fairfax but does the merger deal provide value for Nine shareholders?

-Takes advantage of Nine's elevated valuation to acquire control of a high-growth asset
-Synergies to come from combining old media assets
-Yet main justification for the merger is the investment in new media
 

By Eva Brocklehurst

The highly-anticipated merger proposal between Nine Entertainment ((NEC)) and Fairfax Media ((FXJ)) is now on the table, which comes somewhat belatedly, brokers suggest, after the removal of regulatory restrictions last October.

Does the combination make for a bigger media company? Unequivocally yes, Morgan Stanley asserts. Whether it makes the combined business a better media company is also possible, as the broker notes scale is increasingly important and there are both cost reductions and synergies available across a number of assets.

Morgan Stanley is positive about the merger, at least for Fairfax shareholders, as it goes part way to recognising the strategic value of certain assets, in particular the 60%-owned Domain Group ((DHG)) real estate portal.

Domain is the quarry, not newspapers, Citi agrees, as it makes up 62% of its current Fairfax valuation. The transaction takes advantage of Nine's elevated valuation to acquire a controlling stake in a high-growth asset, while the rationale of combining TV and newspaper assets is secondary.

Nine appears to believe a combination with a TV network will boost Domain's growth rates. Domain will still need to pay for advertising and Citi does not expect Nine to provide a discount. Domain was spun out of Fairfax in order to realise the value of the asset and it is unclear to the broker if this same incentive exists for Nine.

The main issue for UBS is the cost synergies and how conservative the estimate of "at least" $50m is likely to be. Also, what of the longer-dated revenue synergies? Assuming $50m of synergies, the broker estimates the uplift to EPS for Nine could be around 5% in FY20 and 14% in FY21. Based on the broker's existing FY19 forecasts the proposed merger would create an entity that generates pro forma revenue/EBITDA of $3.01bn/$590m.

Synergies are expected to come from combining old media assets and removing the overlap between the Nine newsroom and the Fairfax Metro journalism unit, yet the main justification for the transaction is actually the investment in new media, Citi suggests. This includes Domain, Nine's digital division and STAN, which are likely to be the key growth drivers in the future.

The risk for Fairfax shareholders, Citi believes, is that Nine's share price is implying continued strong performance in TV advertising markets. The broker continues to believe current growth in TV advertising is cyclical rather than structural. The risk centres on any further decline in the Nine share price, which could necessitate the deal terms being improved in order to gain Fairfax shareholder acceptance.

The main debate for Morgan Stanley is whether it creates substantial value for Nine shareholders. Compared with hypothetical scenarios explored in prior research, which were significantly more accretive, the main difference appears to be a 22% premium for Fairfax shares versus Morgan Stanley's scenario of nil, and the cost reduction target being much lower than theorised.

Moreover, Nine will acquire all Fairfax assets versus the broker's scenario of cherry picking Domain, STAN, Macquarie Radio and metro media/digital sites. In sum, to justify the premium and create value, Morgan Stanley expects Nine will have to deliver higher cost reductions, higher revenue growth and exit some of the non-core Fairfax assets.

Counter Bids?

In terms of potential counter bids UBS envisages two types: an industry bid such as Seven West Media ((SWM)) or a private equity bid for Fairfax. Importantly, the Nine bid is virtually all scrip and thus, if Nine shares trade materially lower, the attraction of the deal to Fairfax shareholders fades. This is also a key question for Morgan Stanley: whether the premium for control is sufficiently large enough to succeed.

Citi suggests Seven West would be able to generate similar cost synergies and is most likely the source of a competing bid. Nevertheless, this would be challenging given Seven West's higher debt levels and lower market capitalisation. For Seven West to submit a bid with a similar ownership structure – 51.1% of the group – the broker estimates it would need to raise almost $1bn in debt to beat the Nine offer by 5%.

The likelihood of ACCC intervention is low. UBS expects the ACCC will take a fairly broad view of the market and consider the remaining diversity of news operators to be sufficient. Citi concurs as the companies have very little overlap and both are relatively small parts of the overall advertising industry.

Transaction

Fairfax shareholders will receive 0.3627 Nine shares for every Fairfax share held along with cash consideration of 2.5c per share. The offer implies a valuation of 93.9c per share for Fairfax, a 22% premium to the prior close. Nine will need to issue around 834m new shares. The transaction is subject to shareholder approval, court approval and no regulatory objections. It is expected to be completed before the end of 2018.

FNArena's database shows two Buy ratings and three Hold for Fairfax, with an $0.86 target that suggests 4.4% upside to the last share price. There are three Buy ratings, two Hold and one Sell (Citi) for Nine Entertainment, with a target of $2.22, signalling 0.3% upside to the last share price.

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