Comcast ignores Warren Buffett’s warning as it reaches for Sky

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“No sooner has Warren Buffett warned of the difficulties that he and Berkshire Hathaway business partner Charlie Munger are having in finding good acquisitions at sensible prices than a bid battle has broken out for British satellite broadcaster Sky,” says AJ Bell Investment Director Russ Mould.

“Buffett is sticking to his valuation disciplines by avoiding big deals, as the development of Berkshire’s cash pile relative to the S&P 500 attests, but Comcast’s Brian Roberts clearly feels the numbers stack up when it comes to Sky, or that at least the strategic benefits make the putative deal worth the risk.

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Source: Berkshire Hathaway accounts, Thomson Reuters Datastream

Bid target bonanza

“American telecoms and television giant Comcast, which owns NBC, Universal Pictures, Dreamworks Animation and more, has launched a $31 billion, £12.50-a-share cash bid for Sky, an offer which trumps the £10.75 offered by the Murdoch family’s Twenty-First Century Fox business back in late 2016.

“The Murdoch bid did look a little opportunistic, as in dollar terms it represented no higher a sum than the one offered back in 2011, which equated to 700p a share, or £8 billion, once movements in the sterling-dollar exchange rate were taken into account.

“Investors in Sky will be understandably delighted, especially as Walt Disney’s own bid for Fox means there is third party involved, a situation which could lead to a pitched battle to get hold of Sky’s free cash flow, which has recently been boosted by the lower price paid for Premier League football rights.

“Sky has started to trade well over £13, a premium over the Comcast offer, which suggests investors will hold out for an enhanced offer for Sky from Fox - CMA clearance permitting - or Disney or even Comcast, so investors could be in line for cash bonanza.

“Besides sitting on their Sky shares, if they have any, investors might also like to remember that John Malone’s Liberty Global has a 10% stake in ITV, whose strategic and scarcity value could be enhanced if Sky is gobbled up by Disney or Comcast.

Buyers’ options

“Whether investors in Disney, Fox or Comcast will be quite so enthused remains to be seen, especially in light of Mr Buffett’s warnings about valuation in his annual letter to Berkshire Hathaway shareholders, in which he cautioned about how the availability of cheap debt meant that in 2017 ‘..... prices for decent, but far from spectacular businesses, hit an all-time high. Indeed, price seemed almost irrelevant to an army of optimistic purchasers.

“While it seems unduly harsh to bracket Sky in with this collection of ‘far from spectacular businesses,’ given its substantial subscriber base and strong competitive position that comes from its control of prime content, investors in the bidders and the target will need to assess the offer price carefully.

“At £13.33, Sky has a market cap of £22.9 billion and it ended its fiscal first half with net debt of £7.7 billion for an Enterprise Value (or all-in purchase price) of £30.6 billion.

“That compares to forecast annual free cash flow of some £1.5 billion to £1.6 billion a year, allowing for the lower football costs.

“That in turn implies a free cash flow yield of around 5% - which is still better than cash in the bank, the rate offered by 10-year UK Gilts or US Treasuries or the 4.4% dividend yield available from the FTSE 100 overall.

“Given the low cost of debt, a higher bid could – just – work from a pure financial perspective, although any marked rise in future borrowing costs could make it more difficult to get the numbers to add up.

“This may not stop a bid if Bob Iger of Disney or Brian Roberts of Comcast decide that Sky is too strategically important to them, even if Mr Buffett would be unlikely to be moved by such considerations alone.”

These articles are for information purposes only and are not a personal recommendation or advice.


The chart of the week is written by Russ Mould, AJ Bell’s Investment Director and his team.