By J Collins,

Disney’s (DIS) purchase of certain 21st Century Fox (FOXA) assets will produce a number of winners and losers, presuming it wins the approval of global antitrust authorities.

And the winner is…

First, it would seem that Disney is the big winner because it has acquired a number of 21st Century Fox franchise film assets, several of which are perennials (that is, children’s films that can be re-released every generation, like the Wizard of Oz, etc.) Other Fox properties can be exploited much more readily and profitably across Disney’s other platforms, including their theme parks and merchandising assets.

As new generations are introduced to the Disney park experience, it is critical to keeping an active portfolio of park themes of interest to generations yet unborn. So, Disney wins by adding Fox properties to its theme parks that it can refresh every decade or so.

FOXA film franchises, such as X-Men, will undoubtedly be converted into theme park assets throughout the Disney empire in years to come. This will allow Disney to retire old franchise film assets, such as Dumbo (known best to today’s youngsters’ grandparents), with new film franchise assets, such as Ice Age, with which today’s children are more familiar. Indeed, some of the 21st Century Fox franchises, such as “Planet of the Apes”, The Simpsons, Alien, X-Men, Avatar, Night at the Museum, and other Fox franchises could even be grouped into a new theme park platform that could, theoretically, compete with Universal Studios for the older child (i.e., middle and high school aged) theme park market.

Finally, Disney will also be able to save the royalties it pays for franchise film assets of FOXA that it already exploits, like “Pandora, the World of Avatar“.

And the loser is…

The loser here, clearly, seems clearly to be 21st Century Fox, which, while earning Fox and the Murdoch Family a pile of Disney stock with the sale, as well as lighter debt burden, has clearly surrendered valuable, profitable, assets and franchises it is not in the best position to exploit.

Fox strategy seems to be to retain only those media businesses that produce time-sensitive, mostly live-viewed content, such as sporting events, news, business news, commentary, and other live content.

That’s a fine business, as far as it goes today, but it is unlikely to be a growth business in coming years.

Not only is one of the largest markets, the Fox NFL football franchise, falling because of the Kevin Kaepernick controversy, worries about traumatic brain injuries, and over-saturation, but the audience for television news programming and opinion TV is declining, as well. There is likely to be a dearth of viewers after the next 20 years, as the baby boom generation that grew up with Cronkite, Rather, Brokaw, Jennings, etc. as regular network news viewers dies off.

Moreover, as the big music labels learned when music recording technology went from the costly music studios in the Brill Building and Manhattan’s West Side to your musically talented (or not) teenage neighbor’s garage, today, everyone with an opinion can broadcast himself and even sell advertising.

With YouTube and Facebook LIVE, and countless other apps now developed or in the pipeline, experts (or anyone else) can spout off their opinion about whatever topic of the day they like and compete with Fox News’ signature opinion broadcasters. They can even interview guests.

While you’re far less likely to find another Kissinger broadcasting his own opinions from an ivy tower than you are to find a crackpot from the nearest tavern, you as the viewer can follow whoever you like. It’s the democratization of electronic opinion media, spread among the masses; not terribly all that different from Gutenberg’s press, for better or worse.

But from the perspective of 21st Century Fox, it is for the worse. Every set of eyeballs watching “The Peoples’ Media” for free about the news, business news, and opinion of the day isn’t watching Fox and isn’t boosting ad sales or Fox revenues. They might change that, somehow, with something like a subscription model, or hard-hitting, exclusive, news stories, but the value of exclusivity has a half-life of just hours.

Facebook, Twitter and lesser known crowd sourced news apps, like Citizen, can cover even local news events and offer opinion and, for us here, are often the “go to” sites for breaking news before traditional media gets out its first draft.

FOXA may be “cheap”, as another commentator offered here, but we doubt it is a long-term growth stock that will grow value, like Disney will.

Deal Structure

As Barron’s reports this week, the deal structure is complicated and details are murky.

Long story, short, is that Fox shareholders will end up with about 25% of Disney in what should be, for shareholders, a tax-free spin-off of Fox entertainment assets to Disney. (There is, however, apparently going to be a step-up in basis of the acquired Fox assets, which will trigger an estimated tax liability of $8.5 billion (or less under the new 21% corporate tax rate), which will be borne by the new Fox entity formed in the spin-off.)

We rather like that Disney is acquiring the FOXA assets for 515 million DIS shares, even aside from the tax implications. While it is dilutive for Disney shareholders, it is almost always preferable to issue shares for cash generating assets then to pay cash or to assume debt.

That’s not to say that the deal is without debt. Indeed, Disney will assume a reported $13.7 billion ($20 billion in debt less $6.7 billion in Fox cash) in FOXA debt associated with the spun-off assets, which is somewhat troubling, given the rising DIS debt-to-equity ratio.

Nevertheless, we believe that DIS can service the debt (and even pay it down) for the foreseeable future. Among other things, Disney has more than $4.7 billion overseas that should produce at least around $4 billion, net (and possibly more) when it is repatriated under the two-tier low-tax repatriation scheme of the new tax bill. It also has a strong history of dividends and buy-backs which can ensure debt service (albeit at risk to the share price should either of those have to be reduced to service debt.)

Disney also has some issues, prospectively, with trying to compete with Netflix (NFLX), particularly with content, although the Fox Hulu acquisition will allow the Fox properties to be streamed, along with Disney titles with more adult themes. (Obviously, a long-term strategy would be for Disney and Netflix to simply merge or cross-license properties to avoid what will ultimately be mutually disadvantageous competition. But there is not even a hint that such a thing is in the offing, to say nothing of antitrust issues.)

The Competitive Environment

The consolidation of Fox and Disney creates competitive pressures for other studios, too. Weaker studios, like Columbia (owned by Sony (SNE)) and MGM/United Artists are likely to be targeted by Universal (owned by CMCSA), the studio most on par with Disney because of its theme parks, television presence and release schedules. Columbia would likely be a more attractive cash-flow target because of its “007” and Spiderman franchises; however, MGM’s Epix offers an opportunity to compete with Netflix in cable studio series market.

Looming over all of this, of course, is Amazon (AMZN), which seems determined to involve itself in every aspect of peoples’ lives, and that is likely to include theatrical film distribution, sooner or later.

Amazon Studios has had some successes in direct to consumer productions, though not nearly as many as Netflix. It is clearly less plugged into Hollywood’s creative environment, for better worse. But Amazon could change that with the next script that could, quite literally, come in unsolicited – but still welcomed by Amazon- over the transom. And if you appreciate the genius of America’s people, you’ll bet on Amazon. (If for no other reason than because the “experts” at the agencies and studios have so often gotten it wrong.)

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