Murdoch and other people’s money

So you’ve seen the headlines. First Fox’s proposals to consolidate its interests in Sky Italia and Sky Deutschland into BSkyB, described by many as a “tidying up” exercise. Now we are treated to something more substantial to explain the earlier moves; an $80bn (c.$86 ps) plus offer for Time Warner.  The newswires are of course buzzing with analysis of the commercial logic and potential regulatory pitfalls of the proposed deal, along with the inevitable speculation about how much more can be squeezed out of Fox. There is another issue at play here however, that investors need to heed; the growing disconnect between voting control and equity risk.

There is nothing new about cascading shareholding and voting structures being used to exert control over companies.  While these companies perform to their potential, then shareholders usually turn a blind eye to the asymmetric relationship between risk and control. An enlightened despot however may be followed by a less capable one and that unfortunately is when the disenfranchised sheep learn about the equity risk premium.

21st Century Fox has two classes of equity, 2.23bn of the ‘A’ non-voting ordinaries with a market value of approximately $73.6bn and 0.712bn of the voting ‘B’ shares currently worth around $24bn.  The Murdoch family controls this c.$98bn of market value with a 39.4% stake of the ‘B’ voters; in other  words, with under 10% of the risk equity (39.4% x $24bn =$9.5 /$98bn = 9.6%).

This disconnect between risk and control however is not just limited to this top layer of ownership, but cascades down via a series of subsidiary layers which effectively leverage this disparity further with each step down. Take for example Fox’s European broadcast interests; 100% of Sky Italia, 57% of Sky Deutschland and 39% of BSkyB. The Murdoch family control all of these assets, although with an effective equity risk exposure of only 9.4% for Sky Italia, 5.4% for Sky Deutschland and 3.7% for BSkyB. But the fun doesn’t stop here though. Earlier this year, Fox proposed to fold its stakes in Sky Deutschland and Sky Italia into BSkyB – the purported ‘tidying up’ exercise. Regardless of the inherent risk that Fox would extract a ‘control’ premium from BSkyB for these assets, such a move would have further transferred equity risk on these assets to external investors while maintaining control by Murdoch. The effective share of Murdoch’s equity risk for his stakes in both Sky Italia and Sky Deutscheland would have dropped to a mere 1.4%. For Fox, this deal would also have released around $11bn of cash with no effective reduction in control on these assets. Even were Fox to consolidate its share of BSkyB’s increased debt, this would still add almost $7bn to Fox’s funding headroom.

So back again to this Time Warner offer. 40% is in cash with the remainder in shares; not the ‘B’ voters however, but the ‘A’ non-voters. If Murdoch senior aims to leave management control to Murdoch juniors, he cannot afford to relinquish control at the top of this chain otherwise it will be game over. If this is his wish, and there is nothing to suggest otherwise, then speculation that he will sweeten the pot for Time Warner with an issue of voting shares seems wide of the mark.