The mooted merger between Nine and Fairfax is a sound move but Prem Icon shareholders may be wise to realise their gains now because the competition from global online rivals is only going to intensify, says Morningstar.

The cross-media deal, which is in essence a takeover by Nine (ASX: NEC), will create a combined media entity that will command 14 per cent of the Australian advertising expenditure pie, says Morningstar analyst Brian Han.

nine fairfax merger article

The Nine-Fairfax tie-up will command 14 per cent of the local advertising expenditure pie

Han values the combined Nine-Fairfax entity at $1.99 share on a discounted cash flow basis, with the potential for $62 million cost synergies.

However, Han warns that scale alone may not be enough to ward off "digital insurgents" such as Google, Facebook, Youtube and Netflix, whose share of the market is now more than 50 per cent - up from 30 per cent five years ago.

"Size and scale are unlikely to furnish the combined group with an economic and spare it from the structural headwinds wreaking havoc on traditional media, which will account for 70 per cent of the entity's aggregate earnings," Han says.

"As such we believe the current exuberance regarding the merger and its potential synergies provides an opportunity for shareholders to crystallise the recent gains in both companies’ shares."

Under the deal, which was announced in late July, Nine shareholders will own 51.1 per cent of the combined entity while Fairfax (ASX: FXJ) shareholders will own the balance. The designated chairman and CEO will both be from the Nine camp.

"The structural headwinds buffeting the traditional media industry (including free-to-air TV and newspapers) are persistent," Han says.

"We believe these challenges are the very reason Nine and Fairfax are seeking to merge, in a bid to bulk up, maintain relevance with audience/marketers, and be in a better position to amortise rising content costs over a wider audience base, as well as extract synergies from combining the two companies’ diverse operations."

Morningstar's fair value estimate for Nine is $1.70, 24 per cent below the current stock price.

Fairfax, the 177-year-old publishing house which owns venerable mastheads such as The Australian Financial Review and The Sydney Morning Herald, and The Age in Melbourne, is trading at 82 cents, above its FVE of 75 cents.

Han sees no regulatory hurdles to the deal following the relaxing of media ownership rules in October last year, which scrapped the "two-out-three rule" and the "75 audience reach" rule.

While Han applauds the deal he says it is worth remembering that previous tie-ups in the wake of media reform ended badly.

"We've seen this movie play out before," he says. "Perhaps we are still traumatised by our experience of the mid 2000s, when a flurry of deals ended with a combined value destruction of over 50 per cent."

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Lex Hall is content editor, Morningstar Australia

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