Dealtalk: Newspaper spin-off Murdoch's best hope for Sky deal

By Victoria Howley

LONDON (Reuters) - A spin-off of Rupert Murdoch's British newspapers is looking more likely as a way of defusing public hostility over his role in the UK media and keeping alive his hopes of eventually buying British Sky Broadcasting <BSY.L>.

Though described as "pure rubbish" by the 80-year old media tycoon, a separation of News International "is possible or even probable," one banker said, given the phone hacking crisis that has rocked the News Corp <NWSA.O> empire.

"Given how ugly this has all become, News Corp has to do something to contain the matter," the banker said.

"Spinning off the British papers into a separate entity with editorial independence seems like the most achievable option."

News Corp is facing a public enquiry in the UK, and separate probes by the FBI and Australian authorities since reports emerged that one of its tabloids hacked into voice mails of murder victims.

It abandoned its long-held goal of controlling British pay TV broadcaster BSkyB, withdrawing its $14 billion offer for the 61 percent of BSkyB it does not own on July 13, a strategic blow because Sky's heavy investment in new technology is set to pay off in the next few years.

Bankers with experience in the media sector but not working for either News Corp or BSkyB said the abandoned deal could offer a clue about how a separation of News International might occur.

"You could see News Corp separate the British newspaper business and put an editorial trust on top of it, something similar perhaps to the Scott Trust (which owns Guardian Media Group)," a second banker said.

Scott Trust Ltd is the ultimate parent of Britain's Guardian newspaper, a rival of News International's Sun, Times and Sunday Times publications that has taken an active role in reporting the hacking allegations.

Its remit includes ensuring the financial and editorial independence of the newspaper.

Before the Sky deal was pulled, News Corp had promised to spin off the influential Sky news channel as an independent company to guarantee its editorial freedom, although it would maintain its 39 percent stake.

The undertaking was in response to claims by critics that the deal would give Murdoch too much influence over British media and public opinion.

The U.S. conglomerate adopted a similar strategy in 2007 to persuade the controlling Bancroft family to support its acquisition of Dow Jones, including the Wall Street Journal.

A committee of five U.S. media grandees was set up to oversee editorial integrity only six months after a News of the World Journalist was jailed for hacking voicemails left for members of the royal household, in an earlier chapter of the scandal.

Bankers said a separation of News International was more likely than a sale of the newspapers because of a lack of buyers.

Notwithstanding the outcome of the various investigations, British newspapers have been hit hard in recent years by declining advertising revenue and fierce competition from online news providers.

The loss-making Independent and Independent on Sunday newspapers were sold to Russian billionaire Alexander Lebedev, owner of the London Evening standard, for just one pound just over a year ago.

"No-one in their right mind would want to buy a UK newspaper right now," a third banker said.

"There is an outside chance that a Russian oligarch might turn up, but there will be zero interest from trade or private equity buyers until the investigations are resolved," the banker said, adding that the UK investigation could take around two years.

Even though the papers account for just over $500 million in revenue, or 5 percent of News Corp's total, the phone hacking scandal has wiped about $5 billion off the conglomerate's market value.

Some shareholders have been urging the group to shed the newspaper business for over a year on the basis that it is a drag on the stock price.

News Corp declined to comment.

(Additional reporting by Georgina Prodhan; Editing by David Cowell)