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By Jonathan Browning and Amy Thomson

(Updates with latest share price in 10th paragraph.)

July 14 (Bloomberg) -- Rupert Murdoch's News Corp. spent two decades building the largest U.K. pay-television company. His efforts to leverage that into new digital businesses were dashed by a scandal at a 168-year-old tabloid.

News Corp. was forced to drop a 7.8 billion-pound ($12.6 billion) bid for full control of British Sky Broadcasting Plc yesterday after a phone-hacking scandal at the News of the World prompted Prime Minister David Cameron's coalition government to side with the opposition Labour Party to block the deal.

Full ownership of BSkyB, which has 10 million subscribers, would have facilitated the bundling of print and pay-TV subscriptions by spreading content over different media platforms. That in turn would make New York-based News Corp. less susceptible to advertising sales at its newspapers.

"The modern business is in screen media, it's in TV, it's in cinema, and it's online," Douglas McCabe, an analyst at London-based media researcher Enders Analysis, said in a phone interview. News Corp., which already owns 39 percent of BSkyB, may attempt another bid at some point, he said.

Allegations that employees of the News of the World hacked into the voicemails of murder and terror victims and paid police for stories created an unprecedented political backlash against Murdoch in the U.K. He closed the newspaper on July 10.

About 3 billion pounds has been wiped off BSkyB's market value since the Guardian reported on July 4 that the News of the World in 2002 hacked into the voice mails of murdered schoolgirl Milly Dowler and deleted messages. Before the allegations, U.K. Culture Secretary Jeremy Hunt had said several times this year that he was minded to approve the deal.

Subscriber Surge

"The real question is, now can they not consolidate the growth story of BSkyB?" Claudio Aspesi, an analyst at Sanford C. Bernstein in London who has an "outperform" rating on BSkyB shares, said via phone.

Created from the merger of Murdoch's Sky Television with British Satellite Broadcasting in 1990, BSkyB has boosted subscription numbers tenfold in that period.

BSkyB's free cash flow climbed 60 percent to 615 million pounds in the nine months ended March, compared with 385 million pounds in the same period a year earlier.

News Corp.'s shares snapped a three-day losing streak in Australia after the BSkyB bid was pulled. The stock rose 3.5 percent to A$15.25 at 2:05 p.m. in Sydney, paring this week's decline to 9.1 percent.

Revenue at New York-based News Corp grew by 37 percent in the five years through June 2010, according to Bloomberg data. That compares with BSkyB's growth of 54 percent in the period, as exclusive rights to popular events such as the England's top soccer league and offerings including the History Channel and Disney Channel attracted customers.

Setback for James

The failed bid is also a setback for Rupert's son James Murdoch, 38, who was pushing News Corp. to generate more money from subscriptions at a time when many newspapers, magazines and TV shows are free online and films and music can easily be downloaded illegally.

James Murdoch has since 2007 been overseeing News International, the U.K. publishing unit that included News of the World. The younger Murdoch, the non-executive chairman of BSkyB, previously ran the satellite company for four years as CEO. Under his leadership, News Corp. started charging for the websites of The Times of London and The Sunday Times, following the example of the company's Wall Street Journal newspaper.

In March, James was promoted to deputy chief operating officer at News Corp. While the company said at the time he would move to New York, the phone-hacking scandal has kept him in London. News Corp. will probably consider retreating from the newspapers in the U.K., Enders Analysis's McCabe said.

Eight Arrests

"I think James would be quite happy to see them exit the newspapers," Johnathan Barrett, an analyst at Singer Capital Markets, said via phone. "Exiting the U.K. newspapers may not necessarily be such a bad thing, particularly if it takes off the issue of conflict with the ownership of those assets and they come back to bid for Sky in a year's time."

The company never fully considered the notion of selling the U.K. newspaper titles amid the phone-hacking scandal, a person familiar with Murdoch's thinking said, declining to be identified because the deliberations were private. The remaining newspapers under News International include The Sun, The Times and The Sunday Times.

London police have made eight arrests as part of the phone- hacking investigation, including that of Andy Coulson, one-time editor of the News of the World and former communications chief for Cameron. Coulson has denied any knowledge of reporters tapping phones when he led the paper.

News Corp. had been facing at least six investigations over the phone-hacking scandal and the BSkyB bid. Rupert Murdoch, James, as well as News International CEO Rebekah Brooks have been summoned to appear before lawmakers about prior evidence employees had paid police to get stories.

As the investigations make a fresh offer unlikely any time soon, the withdrawn bid may also dampen appetite for more investments in BSkyB.

"He had, whatever figure you choose to use, to invest in this, not just to buy it, he was going to invest more money in creating more products and expanding that business," said Charlie Beckett, director of the media institute Polis at the London School of Economics. "In that sense, it puts a whole lot of stuff on hold."

--With assistance from Robert Fenner in Melbourne. Editors: Simon Thiel, Kenneth Wong.

To contact the reporters on this story: Jonathan Browning in London jbrowning9@bloomberg.net. Amy Thomson in London at athomson6@bloomberg.net

To contact the editors responsible for this story: Kenneth Wong at kwong11@bloomberg.net