Nine Entertainment's proposed takeover of Fairfax Media is giving shareholders a reason to celebrate, but obstacles lie ahead for long-term investors, says Morningstar analyst Brian Han.

In a note following the announcement of the deal yesterday, Han described Nine's (ASX: NEC) valuation of Fairfax (ASX: FXJ)  at 84 cents a share (based on the closing stock prices on July 26) as "generous", representing a 20 per cent premium to Morningstar's fair value estimate of 70 cents for the 177-year-old publishing empire.

"[It's] little wonder the board will unanimously recommend the proposal to shareholders," he says.

Han says the deal – pitched as a merger – presents Fairfax shareholders with a chance to crystallise the stock price gain. This is because Morningstar sees Nine's shares as overvalued on a midcycle sustainable earnings basis, trading at a 50 per cent premium to their FVE of $1.50.

As part of the deal, Fairfax shareholders will receive 0.3627 Nine shares for each Fairfax share, along with $0.025 in cash per share.

Fairfax Media Nine Merger

However, Han sees risks on the horizon for investors who decide to remain with the Nine supergroup. Namely, he says the company's long-term value is hostage to how it competes against the onslaught of digital disruptors such as Google, Facebook, and Netflix.

Han says there's the chance an interloper may crash the party and make a play for Nine, puncturing the corporate premium built into Fairfax's stock price.

"This is not as outlandish as it may sound, especially if a traditional media operator (say, News Corporation) decides to diversify away from print and pay TV in Australia," Han says.

"A free-to-air TV network with a 50 per cent interest in a popular subscription video on-demand service called Stan may just fit the bill."

Completion of the proposed is expected by the end of calendar year 2018. In the meantime, Fairfax's stock price movement is expected to mirror that of Nine until completion – after which it will be delisted.

Morningstar sees no impediments to the deal, including an ACCC review which is scheduled to take 12 weeks. Han says the loosening in media ownership laws last year was key to the deal.

"The October 2017 passing of the media reform package has removed the legislative hurdle to this proposed merger, while the competition regulator's views are likely to be enlightened by the current digital inquiry showing the challenges facing traditional media from proliferating digital onslaught."

Analysts says the Nine-Fairfax deal would have been unthinkable this time last year owing to the "2 out of 3" rule, which prevented one company from owning a TV station, radio station, and newspaper in the same area.

This and the "75 per cent audience reach" rule were abolished in October last year, clearing the path for media mergers.

 

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Emma Rapaport is a reporter for Morningstar Australia

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