TPG Consortium's indicative $A1.20 to $A1.25 a share proposal to acquire Fairfax Media is pitched at a substantial premium to Morningstar's assessment for the group.
Analyst Brian Han said in a market note at the A95c per share cash consideration for the businesses it planned to keep, the consortium was valuing Domain at 18 times forecast 2017 operating profit, or $A2.01billion ($NZ2.14billion).
The Sydney Morning Herald, The Age, the Australian Financial Review and Events businesses came in at five times the combined forecast, or $A170million.
The value assigned by the consortium to Domain was ''especially aggressive'', compared with Morningstar's value estimate of $A1.23billion.
Domain is the online real estate and property arm of Fairfax.
The 18 times multiple attributed to Domain was close to the 22 times the multiple commanded by REA Group whose domestic earnings were more than three times Domain's and still growing faster, Mr Han said.
''Critically, the consortium's desire to include the metropolitan newspapers illustrates their still strategic and promotional importance to growing and sustaining Domain's market position longer term.''
Morningstar had assigned a 50% probability the $A1.20 to $A1.25 proposal would turn into a binding offer and a 50% probability the proposal failed and the stock dropped back to its fair value.
The 50% probability reflected the dilemma Fairfax found itself in, he said.
Allowing the proposal to proceed left the group at the mercy of a ''litany of conditions''.
If the proposal was successful, Fairfax would be mainly left with a bunch of regional print assets facing severe structural challenges.
The situation was further complicated by the revised media reform package announced in Australia at the weekend, Mr Han said.
If passed by Parliament into law, it could open up options for Fairfax, either as a target for another suit or allow the group to turn itself into an acquirer.
There were two components to TPG Consortium's indicative proposal, which included the Ontario Teachers Pension Plan Board.
It was structured to be executed through two interconditional schemes of arrangement to implement.
The first was an acquisition of Fairfax containing just Domain, the Australian metropolitan newspapers, Events and digital businesses, on a debt free basis for $A2.2billion, A95c per share.
The second part was the demerger and listing of New Media Co, containing Fairfax's Australian community media, New Zealand media, the 55% shareholding in Macquarie Media radio, the 50% interest in streaming company Stan and assumption of all of the group's current $A112million in net debt.
Fairfax shareholders would receive shares in New Media, which the consortium valued at A25c to A30c per share.
Given the complexity, Mr Han said it was little wonder the proposal came with a litany of conditions.
They included a satisfactory completion of due diligence, requisite regulatory approvals, a unanimous recommendation from the Fairfax board and its agreement to help the interconditional schemes of arrangements.
It also explained the Fairfax board's guarded statements with respect to the proposal, highlighting there was no certainty it would lead to a firm offer or that the deal could be executed as proposed, given the complexity in splitting Fairfax along the lines desired by the consortium, he said.
The TPG proposal allowed Fairfax to retain a controlling 60% to 70% shareholding in Domain, while floating it off in a separate listed vehicle, so Domain's value could be liberated and reflected in Fairfax's share price.
Fairfax operated in an industry undergoing unprecedented changes. The traditional print-based publishing business model was being completely dismantled by proliferating news and information outlets in the digital space, Mr Han said.
''Consequently, given more than 70% of its revenue is still sourced from the print publishing industry, Fairfax Media faces enormous structural headwinds as consumers migrate from newspapers to the digital arena and advertisers follow suit.''
The question then came down to whether the strength of the company's mastheads and editorial resources were sufficient enough for management to successfully move to the digital arena, he said.
In an effort to readjust its cost base to falling revenue, the company's editorial resources were being cut. That could prove costly, as the editorial strength had, to date, been the competitive edge - along with the masthead brand recognition allowing Fairfax Media to maintain its strong presence in the online environment, Mr Han said.
