Last weekend, Comcast (NASDAQ:CMCS.A) prevailed over Twenty-First Century Fox (NASDAQ:FOX) (NASDAQ:FOXA) in a blind auction to buy European pay-TV and media giant Sky. Fox, of course, has already agreed to sell itself to The Walt Disney Company (NYSE:DIS) for $71 billion, so Disney was pulling the strings here.
Now Disney has a choice between keeping Fox's existing 39% stake in Sky and remaining as a minority shareholder or selling its shares to Comcast. Given the massive premium the latter has offered for the business, Disney should gladly take Comcast's cash and walk away.
Comcast is paying a pretty penny
The Sky saga began in December 2016, when Fox offered 10.75 British pounds per share to acquire the 61% of the company it did not already own. This represented a healthy 40% premium to Sky's pre-offer share price and valued Sky at 11.4 times its fiscal 2016 adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA), including debt.
However, once Comcast got involved, a bidding war erupted. Comcast's winning bid was 17.28 pounds per share -- 61% higher than Fox's initial offer.
To be fair, Sky's value has increased over the past two years, with fiscal 2018 adjusted EBITDA up 8% relative to fiscal 2016. Nevertheless, most of the increase in the sale price came from a higher valuation. Including debt, Comcast is paying a lofty multiple of 15.5 times adjusted EBITDA for Sky.
There's no reason to stick around
Respected media analysts Craig Moffett and Michael Nathanson recently argued that Comcast is overpaying for Sky, which is still at its core a satellite TV provider. (The satellite TV industry is fading in relevance due to the rise of streaming.) Yet Comcast felt that it was strategically critical to buy Sky to diversify its business beyond the U.S. -- and perhaps to spearhead a push to create a global streaming platform.
By contrast, Disney won't derive any strategic value from maintaining a 39% minority stake in Sky. Without control of the business, there won't be any synergies with the rest of Disney's operations. From a purely financial perspective, it's hard to imagine Sky living up to its pricey valuation.
The 39% Sky stake is worth a little more than $15 billion at a price of 17.28 pounds per share. Selling to Comcast would reduce the amount of debt Disney takes on in the Fox acquisition. This would make it easier for the company to invest in organic growth initiatives, like its upcoming direct-to-consumer streaming service.
In the long run, a lower debt burden will also allow Disney to return more cash to shareholders through share buybacks. Given that Disney trades for less than 11 times EBITDA, the company would almost certainly be better off investing in itself (through buybacks) rather than remaining as a minority investor in Sky.
What about Hulu?
A recent CNBC article suggested that Disney might trade its Sky shares for Comcast's 30% stake in Hulu. This doesn't make sense, though. Just two years ago, Time Warner bought a 10% stake in Hulu for $580 million, implying a $5.8 billion valuation. While Hulu is surely worth more than $5.8 billion today -- a filing related to the Disney-Fox deal pegged its value at $8.7 billion -- it is clearly worth nowhere near the $50 billion valuation that would be necessary to make Comcast's 30% stake worth $15 billion.
A more plausible interpretation of the report could be that Disney wants to use its Sky stake as leverage to convince Comcast to sell its 30% of Hulu at a reasonable valuation.
Owning 90% of Hulu would allow Disney to capture virtually all of the upside from the former's growth. On the other hand, Comcast would have less of an incentive to send compelling content to Hulu if it no longer had a financial stake in the service. Part of Hulu's attraction has always been that it was owned and operated by several major content producers and distributors.
By acquiring Fox, Disney is already gaining majority ownership of Hulu, allowing it to control Hulu's creative and strategic direction. The rationale for owning the rest of the service is much less clear-cut. As a result, there's no good reason for Disney to hold out with respect to Sky. It should direct Fox to tender its shares to Comcast, thereby reducing the total cost of the Disney-Fox deal by a substantial sum.