The shares of Twentieth Century Fox have exploded upwards recently and Wall Street is asking why. In any discussion of this company, we believe it is important to stress the backdrop underlying the market’s fervor.
Many observers of the economy have raised questions about the vitality of the consumer sector (they cited the dip in the savings rate, the sapping of real spending power by inflation, the consumers’ fear over the President’s energy message, his leveraged position, and so forth). Others questioned the lasting power of capital goods spending, pointing to rising capital costs, reduced profitability, and so on. Within this context, investors (and speculators) were focusing on pockets of the U.S. economy which could defy broad GNP classification.
The motion picture industry is perceived to be one such segment. In fact, U.S. box office revenues (in current dollars) were at a record level in the first quarter of this year. Thus, in a stock market environment Where the “hot stock” performance players are anxious to take rifle shots at particular stocks or groups, upside breakouts result. This is the case, we believe, with Twentieth Century-Fox.
The company has been at the vortex of deals, mergers, (not to mention rumors). Two such surfaced recently. Others are likely to surface. Moreover, Fox has certain characteristics which help fan speculation: the company is a “pure” motion picture company; its book value was over $16.00 at.year end.l976 (which we could adjust readily to over $25 per share without any change in the value of the motion picture library); and its balance sheet is strong. This provided the perfect setting for a spurt in stock price and the move was ignited by the movie critics who just bubbled over Star Wars. The market has grasped ‘by now what is occurring at Fox. Or has it?
Many questions are likely to be raised as the giddiness of an 80% burst in the stock is reflected on in more sober moments. Is Star Wars (and Silver Streak, The Omen, and Silent Movie just before it) the sign of a new, more disciplined approach to successful (i.e. profitable) movie making, which so far has eluded the management team of Mr. Stanfill. Secondly, will wall Street soon settle down (just as it did following MCA’s enormous success with Jaws) and ask, what are the earnings from a movie like Star Wars worth? Also, why hasn’t someone pointed out the hurdles a potential suitor must face in light of Fox’s ownership of three broadcast properties.
[drizzle]We do not have an answer yet to the first question simply because we believe more time must pass. We must see how disciplined management is in reinvesting the new cash flow back into motion pictures. We would be disturbed if net cash back into movies moved upwards sharply. Also, management was not brilliant in its distribution strategy for Star Wars. But based on recent signs we are encouraged.
As for evaluation of these earnings, we repeat our statement made with Jaws (July 31, 1975) and our model. We are constantly asked: What are one-shot (therefore a 1x multiple) earnings from a picture like §t§r Wars worth?” We contend that such earnings are worth an S&P multiple on the addition to base earnings power that the retained income from such a movie provides. The quality of deals Fox’s management will make should be a tip-off of the value of Star War earnings that will accrue to shareholders on a secular basis. More specifically, we do not believe that Twentieth Century-Fox’s return on equity over the past five years is an indication of management’s potential. In the first instance management was preoccupied initially with improved liquidity; then it was caught up with a takeover imbroglio, and when it could do deals management smartly chose to purchase TV stations. Thus, with the improved corporate liquidity likely from a major hit (like a discovery well) such as Star Wars, management could become increasingly confident and bold in acquisitions.
C3PO + R2-D2 = Profitability – In the boxes are a model for computing the increment to a multiple from a one-shot boost to earnings.
We recognize there are lag effects to reinvestment of capital, and the possibility that new projects will yield the average return of past periods when management was not so venturesome with its capital, but we believe our approach helps provide a basis for evaluating both the fundamental value as well as speculative potential for Twentieth Century-Fox. we look with favor on this increasingly volatile stock.
Mario J. Gabelli, C.F.A./dh
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