The scandal over phone hacking at Rupert Murdoch’s News of the World is casting a shadow over a far more valuable business than the now-defunct tabloid. When the furor broke, Murdoch was on the verge of winning his long battle to acquire the 61 percent of Britain’s media crown jewel, British Sky Broadcasting Group, that his News Corp. (NWSA) does not already own. The outcry over revelations about the tabloid forced Murdoch to back away from the $12.6 billion deal, which would have required government approval.
Now some regulators and angry politicians are turning their attention to News Corp.’s controlling 39 percent stake in BSkyB. Even before the climax of the phone hacking scandal, they had been voicing concerns about News Corp.’s tight grip on Britain’s lucrative pay-TV market. Now the critics are getting louder. Prime Minister David Cameron and other political leaders are calling for a review of media ownership in the U.K., where the Murdoch family is by far the largest proprietor. The chief executive officer of broadcast regulator Ofcom, Ed Richards, said in a July 22 letter to lawmakers that he was investigating the conduct of BSkyB’s controlling directors and shareholders—including “any relevant conduct of News Corporation”—to determine whether the company should continue to hold its approximately 40 licenses. In Britain, broadcast licenses can be revoked if a company is deemed “not fit and proper” to hold one, though this has happened only once.
At risk for News Corp. is the open faucet of cash from BSkyB. Revenue at BSkyB soared 54 percent in the five years through 2010, vs. a 37 percent increase at News Corp. For the fiscal year ended June 30, BSkyB is expected to report operating profits of $1.7 billion on revenue of $10.6 billion, up 24 percent and 14 percent, respectively, from the year earlier, estimates London consulting firm Enders Analysis. It is also possible that the Murdoch family could be forced to loosen the reins on BSkyB if the hacking scandal leads to James Murdoch’s departure as chairman of BSkyB or regulators put restrictions on News Corp.’s ownership. News Corp. controls four of the board’s 14 seats. BSkyB’s board was scheduled to meet on July 28.
“News Corp. executives and non-executive directors have shown themselves completely unable to control what was going on in the paper and making sure the company’s acting within the law,” says Chris Bryant, a Labour Party Member of Parliament whose phone was hacked by News of the World operatives. “That raises questions about whether they should have any stake in BSkyB.”
The story of BSkyB began with a shrewd £1 investment by Rupert Murdoch. That’s how much he spent to buy Sky Television, a struggling satellite company, in 1983. (Murdoch also assumed some debt.) He turned it into a powerhouse by giving British viewers bored with the BBC’s stuffy offerings what they wanted—sports and first-run movies. “Murdoch and his executives made a success out of BSkyB because they were populists, trained in a newspaper culture,” writes Mathew Horsman, a media consultant, in Sky High, his book on the satellite operator.
A turning point came in 1992 when BSkyB won the rights to Britain’s Premier League soccer matches. That meant sports-crazed Brits who wanted to watch Manchester United play Liverpool pretty much needed to pay BSkyB first. From there the company grew rapidly into the leader in British pay TV, with an estimated 80 percent market share. BSkyB has more than 10 million subscribers for big-name movies and shows such as Martin Scorsese’s Boardwalk Empire. It’s also become a major player in Internet and phone services.
Since BSkyB was created through the 1990 merger of Murdoch’s Sky Television with British Satellite Broadcasting, Murdoch has only 39 percent of the shares—more than enough for control but too few to claim its full cash flows and financial results for News Corp. Last year, BSkyB’s earnings contributed $354 million, or 14 percent, of News Corp.’s $2.5 billion net income. Had News Corp. fully acquired BSkyB, Enders Analysis estimates, the satellite operator would have accounted for 25 percent of the company’s annual revenues and close to 30 percent of its operating income. Enders forecasts that BSkyB could crank out annual growth approaching 10 percent over the next few years, which would have offset cyclical revenues in News Corp.’s ad-supported businesses.
Most important, News Corp. would have gotten full access to the pay-TV operator’s hefty cash flow—more than $1 billion in the first three quarters of the 2011 fiscal year—to fund other acquisitions. “The merger was a very cheap way to get a very valuable asset for a company like News,” says Michael C. Morris, an analyst at Davenport & Co. “Deals like that don’t come along too often.”
Now regulators may get tough with BSkyB. The company is facing a probe from the U.K. Competition Commission into its dominance of the television distribution of first-run Hollywood movies. In February the commission said BSkyB earned “excess profits” from showing these films, but it has not yet suggested a remedy. (The company told the Daily Mail its prices were fair.) In addition, the company is appealing a ruling by regulator Ofcom that it must lower the prices it charges competitors to carry Premier League soccer matches.
The big question will be whether management at BSkyB will be rocked by the News of the World scandal. In recent days two former employees of News International, which published the tabloid, have said that James Murdoch’s testimony on July 19 before a Parliamentary committee about what information he received before authorizing a large settlement paid to a phone-hacking victim was “mistaken.” Murdoch responded in a statement that he stands behind what he said. Analysts say that if the younger Murdoch is found to have misled Parliament, the board or U.K. regulators might require him to step down as BSkyB’s chairman. If News Corp. executives are proved to have blessed corrupt practices or covered up illegalities, their actions could taint BSkyB and endanger its licenses.
British law gives Ofcom wide discretion in defining “fit and proper.” Explains Tony Ghee, a media law partner at Taylor Wessing in London: “It is a probity test. Are you the sort of person we can trust to be a broadcaster?” On its website, Ofcom states that because of Murdoch’s stake of almost 40 percent, “Ofcom must take account of News Corporation’s conduct in assessing whether BSkyB is and remains fit and proper as a licence holder, as well as the conduct of BSkyB itself.”
News Corp. and BSkyB refute the notion that their standing as broadcasters in Britain is threatened. “News Corp. has contributed greatly to the choice and quality of broadcasting in the U.K.,” says News Corp. spokeswoman Miranda Higham. Says BSkyB spokesman Robert Fraser: “We strenuously refute any suggestion that Sky is not a ‘fit and proper’ holder of a broadcasting license.” The company’s future in the Murdoch stable will depend on whether regulators agree.