Don't Pass Up Triple-Digit Upside From This Market-Leading 'Bad Apple'

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The old saying "one bad apple spoils the bunch" can apply to most facets of life, including investing.

But it doesn't always hold true. I don't think it holds true at all for a certain entertainment company notorious for its news channel's decidedly conservative political bent.

In fact, I've heard investors say they'd never buy the company's stock simply because of the news channel. But they might be more inclined to reconsider if they realized what they're passing up -- a chance at triple-digit gains from an industry leader that offers much more than news programming.

As I'm sure you've guessed, the "bad apple" I'm referring to is Fox News. "The bunch" is the media and entertainment conglomerate that controls it, Twenty-First Century Fox (Nasdaq: FOXA), which was spun off from News Corp. (Nasdaq: NWS) last June.

Actually, it's not fair to label Fox News a bad apple if you consider its value purely from an investing standpoint. The channel has tens of millions of regular viewers and generates more than $1.2 billion in annual revenue.

Whatever your opinion of Fox News, I suggest you put aside your political leanings for a few moments and take a closer look at Twenty-First Century Fox as a whole.

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FOXA has far outpaced the overall market, jumping nearly 50% in the past 12 months and more than 160% during the past three years. Superior net income growth of 41% a year during that time has been a key factor in this outperformance.

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Twenty-First Century Fox makes its money through four main businesses, the largest being cable network programming, which operates nationwide and accounts for 39% of total annual revenue of $28.7 billion. Besides Fox News, this segment has a variety of cable offerings such as Fox Sports and other sports channels, National Geographic U.S., and FX, which has gained acclaim for its original series.

The cable segment's regional sports networks typically have local broadcasting rights for most or all of the pro and college teams in their areas, creating a formidable barrier to entry for competitors. What's more, regional contract expirations are staggered so they don't all occur in the same year. This makes it virtually impossible for a competitor to wrest broadcasting rights from Twenty-First Century Fox in one fell swoop.

The cable segment is well ahead of its competitors in global expansion, particularly in European and Asian markets. Overall, it has joint ventures to provide programming in 170 countries and already obtains 15% of operating profits from international operations. Plus, global markets are far from saturated, and there should be plenty more opportunities for the cable segment to expand internationally.

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Filmed entertainment, Twenty-First Century Fox's movie segment, may not quite be a match for rivals like Walt Disney (NYSE: DIS), but it does generate about 30% of the company's total revenue and has released a number of high-grossing films in the past year such as "Ice Age: Continental Drift," "The Wolverine" and "Life of Pi." The segment has a couple dozen movie releases scheduled for 2014, and at least a handful could do well at the box office.

Twenty-First Century Fox Revenue By Segment

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The TV segment accounts for 16% of total revenue and has had a number of popular shows, with 10 new shows in development to replace older hits as they run their course.

The direct broadcast satellite TV division, which generates 15% of total revenue, consists of a wholly owned subsidiary in Italy and a majority-owned German subsidiary. The German subsidiary is the leading pay TV provider both in Germany and Austria, currently delivering 70 basic, premium and pay-per-view channels by satellite.

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Twenty-First Century Fox faces a couple key risks right now, one being the gradual shift away from cable TV and more toward lower-cost Internet-based streaming services like Netflix (Nasdaq: NFLX) and Hulu. Remember, cable is Twenty-First Century Fox's biggest revenue source.

Investors are also eagerly awaiting a Supreme Court decision on an appeal filed by four major broadcasters (one of which is FOXA) against Aereo, a company that charges customers a low monthly fee to watch live or recorded TV on computers or mobile devices without paying reuse fees to the original broadcasters. The broadcasters claim Aereo is stealing copyrighted television content, while Aereo says it's simply giving customers access to shows they could get with a personal TV antenna.
Risks to Consider: Streaming services are a serious threat to cable-centric companies like Twenty-First Century Fox. Additionally, Aereo is a fast-growing service, so a Supreme Court decision in favor of the company could ultimately hurt FOXA's ability to control pay-TV subscription fees and generate advertising, key revenue sources for all broadcasters.

Action to Take --> As things stand, I'm looking for FOXA to increase earnings per share (EPS) nearly 16% a year, from $2.63 currently to $5.48 in 2019. Such growth could easily support a price-to-earnings (P/E) multiple of 14, which implies the potential for the stock to rise 140% to about $77 from its current level near $32.

In a situation like this, I'd normally recommend buying immediately. However, I think it's best to wait until the Aereo situation is settled in June, since FOXA could plummet if the Supreme Court sides with Aereo. If that occurs, I'd hold off on buying FOXA and wait to see if it can adapt and maintain strong growth. But if FOXA is on the winning end of the Supreme Court decision, I'd grab shares as soon as possible since the growth trajectory described above would become much more likely.

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