Phone Hacking Scandal: Options Ahead for Rupert Murdoch

A controversy involving the News of the World over hacking voice mails of 9/11 victims has forced Rupert Murdoch to oust Rebekah Brooks as CEO of News International, not before the tabloid published its last edition on Sunday, July 10 after 168 years of publication.

The Company has made mistakes. It is not only receiving appropriate scrutiny, but is also responding to unfair attacks by setting the record straight, James Murdoch said in a statement.

News International will run advertisements this weekend in all national newspapers.

We will apologise to the nation for what has happened. We will follow this up in the future with communications about the actions we have taken to address the wrongdoing that occurred. We are also sending letters to our commercial partners with an update on the actions we are taking, James Murdoch said.

Next week, my father and I will appear before the CMS Select Committee and will speak to them directly about our determination to put things right, the statement added.

Meanwhile, public reaction to the scandal in Britain was swift. On July 6, British Prime Minister David Cameron said a public government inquiry would convene to further investigate the affair.

Two days before, Cameron named Lord Justice Leveson as chairman of the inquiry, with a remit to look into the specific claims about phone hacking at the News of the World, the initial police inquiry, allegations of illicit payments to police by the press, and the culture and ethics of the British media.

The news came at a time when Murdoch is attempting a takeover of British Sky Broadcasting. The scandal ultimately forced Murdoch to drop the bid for BSkyB, in which News Corp already has 39 percent stake.

The scandal eventually garnered attention in the United States, where News Corp operates a multitude of news outlets including Fox News Channel and The Wall Street Journal.

Meanwhile, the Federal Bureau of Investigation is also probing into News Corp. (NASDAQ:NWSA), focusing on claims that the News of the World hacked into voicemails of victims of the 9/11 attacks.

So, when everything seems to be bleak for Murdoch, analysts are sensing some opportunities for the media giant.

Although concerns over the potential for wider fallout from the scandal - such as on NWSA's ownership of its current 39 percent stake in BSkyB or on NWSA's management stability - could cause further share price volatility, at this point, our view of the fundamentals of the company's businesses is unchanged, Wedbush Securities analyst James Dix wrote in a note to clients.

From the perspective of government officials, early acts of contrition carry more weight than later ones. In a typical corporate scandal, an option is for the company to sacrifice members of senior management, which it has done by accepting the resignation of Brooke.

In the normal course, the UK police investigation would proceed, ferreting out the scope of wrongdoing and working its way up the chain of command to apportion culpability.

However, there are at least two factors making this investigation anything but normal:

1) The political sensitivity of the potential targets of the hacking (from a murdered school girl to the Prime Minister), and

2) The albatross the police carry from allegations of coziness or even corruption in their dealings with the UK press (like taking payments for providing confidential information).

This provides an entrée for other governmental authorities to have more of a role than usual. Thus, for example, News Corp senior management may give testimony to the UK Parliament while the police inquiry is ongoing.

Although it is possible that US authorities may conduct inquiries, at this point we see those as secondary in importance, primarily because most of the conduct and evidence underlying the allegations to date is in the UK, Dix said.

One key issue for NWSA - the next line of defense

Dix said that one risk for News Corp is that, once the abandoned BSkyB bid has been digested, the hunger for political accountability might crave more meat.

In a 'typical' situation, the company would have had no BSkyB bid to sacrifice - another owner of News of the World might have had to consider other political pacifiers apart from closing the paper. Thus, at some point, NWSA may have to consider other options itself.

Dix said possible candidates include: News Corp's stake in BSkyB or at least how and who are involved in managing it, senior management changes at the company, sale of the UK newspapers, and a monetary payment for compensatory and/or punitive purposes.

Dix also sees several positives with News Corp including expectations for higher EBIT margins and the increasing mix of operating income from subscriptions and other recurring fees.

The company generates significant percentage of revenues from cable TV networks, which should improve the company's relative valuation versus peers over time due to cable nets' better growth profiles.

The key risks, apart from the phone hacking scandal, include the company's European exposure (about 30 percent of revenue) and investor concern about the company's skew of capital allocation away from substantial returns of capital.

The analyst, however, said the concerns over capital returns may have relieved as the BSkyB bid has been dropped, given the $12 billion of cash on the balance sheet at the end of the March quarter.

Dix has an outperform rating and $20 price target on News Corp stock.