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Analyst says Disney should divest FOX regional sports networks in six groups

Limited interest in the entire portfolio of 21st Century Fox Inc.-owned regional sports networks that Walt Disney Co. must divest to clear regulatory concerns about its larger buy of Fox assets could mean the FOX regional sports network slate will be broken up for a quicker sale, one Wall Street analyst suggested.

RBC Capital Markets analyst Steven Cahall makes the case in a report, writing that Disney could bolster interest by selling the 22 sports networks in six geo-contiguous blocks, topped by YES Network (US). Although the regional sports networks, or RSNs, face declining subscriber bases and escalating rights fees, they still command a significant level of subscriber license revenue, and the high-margin business throws off a lot of free cash flow.

In an analysis that cross-referenced the RSNs' footprint against the markets where pay TV distributors and TV station groups do business, among other factors, Cahall determined the most interested potential buyers are likely to be Sinclair Broadcast Group Inc., Comcast Corp., CBS Corp., Discovery Inc., and New Fox, or the Fox entity remaining after the deal with Disney closes.

"We don't see these names as being able to currently buy the whole portfolio, with the exception of Comcast, which could face regulatory obstacles," Cahall said. "Those that could buy the whole thing — AT&T Inc., Charter Communications Inc. Verizon Communications Inc. Facebook Inc., Inc. — probably don't want all of the RSNs."

However, he said private equity groups, including Apollo Global Management LLC and Blackstone Group LP, might have an interest in the entire RSN portfolio.

RBC Capital estimates that RSNs represent $21.0 billion of Disney's $71.3 billion deal for the Fox assets. Kagan, a media research group within S&P Global Market Intelligence, in June estimated the valuation of the RSNs had reached $20.60 billion.

Cahall wrote that YES, home to Major League Baseball's New York Yankees and the National Basketball Association's Brooklyn Nets, could garner the strongest demand at 11x EBITDA, while the other five groups could fetch 7x to 9x EBITDA. All told, the analyst estimates the six-block sale could produce a divestiture value of $16.9 billion and $14 billion after tax. That total not only lowers the cost of the FOX deal but benefits Disney as it looks to fuel the direct-to-consumer service it plans to launch late next year.

On the broadcast side, Cahall said Sinclair and Nexstar Media Group Inc. have the largest reach with stations operating in the FOX RSN footprints. Before its merger with Tribune Media Co. was derailed, Sinclair President and CEO Christopher Ripley expressed interest in RSNs. Sinclair could have designs on those serving Oklahoma, Wisconsin, Minnesota and the Midwest, the analyst said. Cahall believes Nexstar, on the other hand, is more likely to deploy its capital into broadcast stations.

New Fox will be rooted in news and sports content after it emerges from the Disney sale. The company secured rights to the NFL's "Thursday Night Football" and World Wrestling Entertainment Inc.'s "Smackdown Live" to complement those already held by FOX (US), FOX Sports 1 (US), FOX Sports 2 (US) and BTN (US). Although New Fox management may have wanted to keep the RSNs, tax considerations required the deal structure with Disney. Cahall wrote that he would not be surprised that if New Fox expresses interest in buying back some of the portfolio.

Cahall said that CBS likes sports and the strength of the broadcast network, and its rights would only bolster distribution and monetization of the FOX RSNs. Conversely, bundling CBS with RSNs could dilute CBS' appeal for some investors, he said. Moreover, the analyst noted CBS' ongoing corporate governance battles may limit its appetite for strategic M&A in the near term.

Cahall believes that adding RSNs would help Discovery gain carriage on virtual providers such as DISH Network Corp.'s Sling TV, Hulu LLC's Hulu with Live TV and Google LLC's YouTube TV. The limiting factor: the company is allocating 100% of free cash flow to deleveraging after its acquisition of Scripps Networks Interactive Inc. "We expect that Discovery would test the waters with investors before pursuing such a strategic acquisition while still digesting Scripps," Cahall wrote.

In addition to YES, which the Yankees are reportedly considering buying back, Cahall broke the RSNs down into five other groups: two networks under the Fox Sports Florida banner; eight under a Fox Sports Midwest/North flag; four apiece as part of prospective Fox Sports Southeast and Fox Sport West rosters; and three under a Fox Sports Southwest heading.