Friday 21st April 2017
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by James Lennon
As evidenced by Fairfax Media’s share price performance on both an absolute and relative basis over the last month or so, management’s intent to spin-off Domain Group has attracted a lot more ‘interest’ than we had initially expected. In essence, while we viewed the proposed separation of Domain Group from Fairfax Media’s other assets as being a positive development for shareholders, the resulting takeover interest was a surprise.
Although limited at this stage to press coverage and related speculation, what we do know is that private equity form TPG Capital has recently ‘run the numbers’ on Fairfax Media in an effort to get control of the company before it proceeds with its proposed spin-off of Domain Group. The rationale for doing so is based on the view that TPG Capital’s primary interest is likely to be Fairfax Media’s Domain Group given the private equity firm’s current and previous investments in global sector.
By taking control of Fairfax Media before it hives off a circa 35 percent interest in Domain Group through a separate listing, TPG Capital is hoping to limit the complexity and potential cost of the transaction. This of course makes some sense, with the key motive behind Fairfax Media’s decision to separate Domain Group from its other businesses being to enable the market to more accurately ascribe value to (i.e. price) its distinct business units.
The fact that Fairfax Media’s share price had responded positively to the proposed spin-off of Domain Group is evidence of this. While Fairfax Media’s share price has rallied further on news (ironically from a Fairfax Media publication) that TPG Capital is considering a tilt at the company ahead of the proposed demerger of Domain Group, this appears to have now given the private equity firm pause for thought.
While it remains to be seen whether the horse has already bolted for TPG Capital in light of the recent share price jump (and the fact that the private equity firm would need to factor in a control premium of 20-30 percent into its equation), there could be merit in waiting it out. This is based on the view that by doing so, TPG Capital may be able to acquire, albeit at a higher price, Domain Group, without having to assume the divestment risks attached to Fairfax Media’s remaining assets.
Although we surmise that the inherent value of Fairfax Media’s remaining (i.e. excluding Domain Group) assets exceeds what the company’s current market capitalisation implies, it could be difficult for TPG Capital to realise this value when divesting these non-core assets. The fact that, as with any leveraged buy-out, TPG Capital will be looking to divest these non-core assets as soon as possible given the high proportion of debt it will use to fund the acquisition will also likely be a factor.
Regardless of whether a takeover offer for Fairfax Media does materialise before or after the spin-off of Domain Group, it does in our view reflect positively on the company’s asset base and growth strategy. While it is difficult to provide any insights on the future prospects of Fairfax Media’s traditional media assets, we believe TPG Capital’s purported interest in Domain Group highlights to us that the asset is far from mature or ex-growth. A similar case in our view could be made for the company’s entertainment on demand offering, Stan.
Thus, while Fairfax Media is by no means a one-trick pony, we expect Domain Group to remain the key driver, at least for the next several years – press speculation regarding TPG Capital’s interest in Fairfax Media proves this, with the private equity firm’s ability to generate a sufficient IRR likely to be predicated on its ability increase Domain Group’s free cash flows to reduce its financial leverage and maximise the equity it realises on exit (i.e. the earnings multiple relative to peers).
While it remains to be seen whether recent press speculation regarding TPG Capital’s interest in acquiring Fairfax Media in its entirety will be confirmed by either party, it is worth remembering that current Australian media ownership laws prohibit a foreign buyer from owning more than 5 percent of an Australian media company without FIRB consent. This of course coincides with the level at which an investor must lodge a substantial shareholding notice with the ASX.
Given TPG Capital’s previous and current investments in the other online property portals such as RentPath in the US and PropertyGuru in Asia, it seems reasonable in our view to assume that where there is smoke there is also fire. With Fairfax Media’s proposed spin-off likely to go some way to ensuring that the inherent value of its asset base is more accurately reflected by the market, it follows that now is as good time for a prospective buyer to be running the ruler over the company.
Fairfax Media’s shares are currently trading at 16.5 times FY17 earnings and 2.48 times book value with a prospective dividend yield of 3.9 percent. While by no means cheap, the combination of management’s strategic initiatives and takeover interest are likely to support these metrics. From a technical point of view, resistance is located between $1.11 and $1.15, with the 61.8% Fibonacci retracement at $1.30.
While noting that some of the recent increase in Fairfax Media’s current share price can be attributed to speculation regarding a possible takeover by TPG Capital, we remain confident that company’s shares can sustain these levels (i.e. $1.10-$1.20 per share) longer term. Key in this regard will be management’s ability to extract value from its asset base through its strategic initiatives, which includes the spin-off of Domain Group and further restructuring its publishing business.
James Lennon is a senior analyst at investment research and funds management house Fat Prophets.
Disclosure: Fairfax is held within the Fat Prophets Concentrated Australian and Small/Midcap Portfolios.
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