Rupert Murdoch is one of the biggest media moguls in the world, and Twenty-First Century Fox (NASDAQ:FOX) (NASDAQ:FOXA) is the centerpiece of his empire. Murdoch made a bid to expand that empire last month: Twenty-First Century Fox offered to pay about $80 billion for Time Warner (NYSE:TWX.DL), according to recent media reports.
While Time Warner has a variety of valuable assets, Rupert Murdoch's strategic rationale likely centers around two things: sports and HBO. Time Warner's Turner division has TV rights for key sporting events, including MLB and NBA playoff coverage and the NCAA basketball tournament. Meanwhile, HBO is the top premium cable network.
Expanded sports content and the HBO network would help Twenty-First Century Fox in the fight against Netflix (NASDAQ:NFLX) in two ways. First, sports programming is much more resistant to cannibalization by subscription video services like Netflix than TV shows and movies. Second, HBO represents a potential vehicle for a Netflix competitor in the Internet video market.
This could be huge
So far, Time Warner has rejected Fox's overtures. Time Warner CEO Jeff Bewkes claims that Twenty-First Century Fox's offer undervalues the company, and that he doesn't believe Fox is capable of putting together an attractive offer. There are also potential antitrust concerns related to the potential merger of two of the top TV/movie production studios.
But none of this means that a deal won't happen. At least one major shareholder of both companies is in favor of a merger. As for the competition concerns, they can almost certainly be addressed through divestitures. For example, Fox is reportedly willing to sell or spin off CNN, a Time Warner property that competes with Fox News.
Lastly, while Time Warner rejected Fox's initial proposal, Fox has the wherewithal to sweeten its offer significantly. While Fox would need to issue more than $20 billion of debt to cover the cash portion of its first offer, its borrowing capacity is probably much higher.
The combined company would generate operating income of more than $10 billion, which could support a significant debt load. Additionally, divestitures could bring in billions of dollars of cash. Lastly, the estimated $1 billion of merger synergies from combining Fox and Time Warner would hypothetically offset the interest on $20 billion of debt at an average interest rate of 5%.
The first prong
So why is Rupert Murdoch willing to spend at least $80 billion -- and perhaps more -- to acquire Time Warner? As noted above, the Turner Sports operation is one key piece of the puzzle.
Due to the growth of Netflix and other streaming video services, many consumers have found that they no longer need cable to watch high-quality movies and filmed TV content. Indeed, many people prefer the convenience of the on-demand, any-device viewing that Netflix offers, even in comparison to cable companies' "TV Everywhere" offerings.
But sports fans still want to watch games live. This means that cable channels with high-quality sports content have lots of leverage relative to cable providers -- for many people, sports is the only thing preventing them from cutting the cord.
Fox owns a sizable collection of regional sports networks, and it recently started a would-be ESPN competitor called Fox Sports 1. But while Fox is transferring some MLB rights from its broadcast station to Fox Sports 1, its nascent sports network is still way behind ESPN.
The addition of Turner Sports' marquee content would make Fox Sports 1 a more credible competitor. The opportunity here is huge. ESPN's value has been estimated at more than $50 billion, as it commands affiliate fees of $5.54 per subscriber according to SNL Kagan. That's a guaranteed revenue stream of about $6.6 billion per year -- before advertising.
The other side of the coin
Controlling sports content is mainly about playing defense against Netflix. But owning HBO would allow Twenty-First Century Fox to go on the offensive. Fox's significant investment in Hulu demonstrates its interest in the subscription video market. However, Hulu has not proved to be a very effective Netflix competitor.
By contrast, HBO has over 100 million subscribers globally, including a large, loyal U.S. subscriber base. It already has the HBO GO app, which could potentially allow Time Warner to market HBO as a stand-alone product in the U.S., rather than as part of cable packages.
Together, the Fox and Warner Brothers studios produce an incredible amount of content. If the two companies merged, held on to all of their content, and sold it in a subscription-video format, they could potentially overtake Netflix as the leader in Internet video.
There's logic here
Time Warner is one of a handful of U.S. media giants that are well prepared for the storm of disruption that the Internet video revolution is unleashing. Its control of sports content makes its top two networks (TNT and TBS) key pieces of basic cable packages, while HBO dominates the premium cable landscape just as much as Netflix dominates the streaming video market.
With this in mind, it's no surprise that Rupert Murdoch is interested. By combining Twenty-First Century Fox and Time Warner, he could build a powerhouse in sports (maintaining relevance in the old cable TV world) while controlling enough high-quality TV and movie content to give Netflix a run for its money in streaming video. Don't expect Murdoch to go away quietly.