Imagine your parents offer you two choices for a Christmas gift: Your mom offers you a gift worth $10. Your dad offers something worth $15. You can only choose one. Is there any reason you might take mom's offer?
Well, maybe you want to make Mom feel good. Maybe you know Dad will use his generosity to guilt-trip you later on and ask you to do chores. Maybe you like mom's gift better. In other words, a long-term view and qualitative factors might cause you to opt for a gift worth less money.
Which brings me to the Disney (NYSE:DIS) deal to buy Twenty-First Century Fox (NASDAQ: FOX) (NASDAQ: FOXA) for $52.4 billion in stock. According to CNBC, which cited unnamed sources, media rival Comcast (NASDAQ:CMCSA) had actually made Fox a higher offer, but the Murdoch family still opted to go with Disney. Why would that be? Exploring the answer to that questions is illustrative for investors.
While Disney and Comcast are each large, profitable companies, neither exactly had $52.4 billion sitting in their couch cushions, so the buyout was always going to be an all-stock deal. That means Fox shareholders wouldn't receive cash, but rather Disney or Comcast shares, along with shares of "new" Fox containing Fox Broadcasting network and stations, Fox News Channel, Fox Business Network, FS1, FS2, and Big Ten Network.
Prior to the deal, Disney and Comcast were trading at nearly identical valuations -- roughly 19 times earnings. I recently wrote why I thought Disney was an attractive buy, and apparently Rupert, Lachlan, and James Murdoch agree since they chose a deal that will give Fox shareholders 0.2745 Disney shares for each 21st Century Fox share they hold. In addition, I think the Murdochs believe Fox's assets would create more value under Disney than they could under Comcast. Here's why.
Disney vs. Comcast
First, I'll note that Comcast is no slouch. Like Disney, it owns a broad array of content assets, which it acquired via its NBC Universal acquisition in 2011 and its Dreamworks Animation acquisition in 2016.
Also, like Disney, Comcast owns several high-performing theme parks. In fact, revenue from its Universal Studios theme parks in Orlando and Hollywood and a 51% interest in Universal Japan grew at a similar rate to Disney's at 7.7% last quarter.
In addition, Comcast owns a very profitable high-speed internet and video distribution business, with nearly 30 million customer relationships. That broadband/cable footprint is actually something Disney doesn't have. So why did Rupert & Co. opt for Disney?
Content is king
While Disney doesn't have the distribution Comcast has, it's currently building a direct-to-consumer offering via its BAMtech acquisition, as well as its soon-to-be majority stake in Hulu. Therefore, the Murdochs likely believe content will be the differentiator going forward.
On that front, Disney is not only home to the 95-year-old Disney brand, but also Marvel, Pixar, and Star Wars. And while Comcast's Universal Studios did manage a hit with The Secret Life of Pets in 2016, that was Universal's only film to crack the top 10 last year. Disney, by contrast, had eight of the top 13 films of 2016, including four out of the top five. That is, needless to say, total box office domination.
That popularity has translated into outperformance at Disney's parks & resorts segment, which, despite being four times bigger than Universal's, slightly outgrew the Universal Parks at 8%, along with even better 14% profit growth.
The Murdochs likely believe Fox's big movie brands -- Avatar, Deadpool, and X-Men -- would generate more value under Disney's leadership than under Universal's. Given Disney's proven prowess in extracting value from well-known brands, I think that's a safe assumption.
The sports portion
While Disney is without peer at monetizing its entertainment brands, it also knows its sports. While its ESPN segment has suffered lately due to cord-cutting and increased content costs, ESPN is still the undisputed leader in live sports, and still commands the highest affiliate fees in the cable bundle. Moreover, live sports is one of the last bastions of traditional television that can still command premium advertising prices.
While the new Fox will keep its FS1 Sports channels, it will sell 22 valuable local sports networks such as the YES Network (home to the New York Yankees) to Disney. In addition, Disney will acquire international sports rights (mostly cricket and soccer) across India, Latin America, and Europe. In fact, the regional sports networks were actually the most valuable part of the deal, estimated at $22 billion of the $52.4 billion purchase value, according to Bloomberg.
An easy decision
While Comcast is a formidable company, Universal and Dreamworks are no match for Disney, and NBC Sports is no ESPN. In addition, Warren Buffett once called Disney's Bob Iger "a home run hitter." Apparently the Murdochs agree that Iger can extract more value from Fox's assets than anyone else and Fox shareholders will be getting shares of Disney to go along for the ride.