Lee Enterprises (LEE) is a newspaper company focusing on delivering local news to small geographical markets. Ever since the financial crisis in 2008, the company as well as the industry has been in the doldrums due to over-leverage and a very rapid subscriber churn from printed media to online sources. But, are all newspaper companies really as bad as what most media claimed them to be? This article aims to convince you why Lee is different from the rest.
Economics of the company
The main beauty of this company is its focus on small geographical markets. Why this is strategy essential for its survival against the onslaught of the internet can be explained in a few reasons:
1) Slow transition to online sources: Residents living in these small towns are usually older folks as the younger ones are often in the city trying to carve out a career of their own. Such older residents are often averse to the internet and would rather read off printed media instead of the computer. This, nevertheless, only slows down the transition of the community to internet sources; as the younger generation matures and the older generation withers, there will still be lesser and lesser print media readers. Despite that, it does buy time for Lee to seek a good online monetization plan to return the company to profitability.
2) Low competition: Many articles from online sources often publish works which are very general or cover only larger cities. The main reason for this has to do with how bloggers or online writers are compensated: by page views. With higher page view counts guaranteeing higher income for these writers, these writers often aim to write articles which can capture the most page views. Henceforth, small towns are often skipped by these authors as they do not provide enough critical mass to compensate them for their efforts. Also, news providers (big, small or independent) know that competition will be intense if they attempt to move into a market where there is already an incumbent serving it, making a lose-lose situation a certainty. Furthermore, since general news is usually the same and local news has already been covered by the incumbent, new entrants might find it hard to convince people to switch over to their papers. Why bother to convert when the paper I am reading already has the stuff you have? Consequently, this lowers the threat of new entrants (both printed and online) in the small markets Lee is serving and gives it a near monopoly of the area - thus ensuring the survivability of its business.
3) High interest in local news: Online sources mainly cover general news as explained above and residents of smaller communities have only little interest in those. They are mostly interested in knowing what is happening in their small little town and are therefore willing to give their support to the paper (or medium) which is able to provide them.
4) Credibility: News agencies such as Lee are still seen as the most credible source of information even though the medium through which people prefer to consume its data has changed. Such credibility still gives demand for the products offered by news agencies.
Source: Annual reports of GCI, SSP and LEE
As can be seen from the table above, the annualized decrement in newspaper subscribers for LEE is a lot lower as compared to its peers Gannett and E.W. Scripps. Although it is absurd to expect print subscribers to return, investors can still take comfort in the fact that a slow decrease is granting Lee Enterprises crucial time to build up its digital strategy.
Reasons why the under-valuation will be corrected
According to my valuation, I have derived a value of $3.09 per share vs. a $1.67 market price (as of 14th June 2013). That is almost an 85% rise if the market price were to be corrected. The current undervaluation, I believe, is largely due to: a) the large debt position of Lee enterprises b) the current circumstances of the newspaper industry c) the poor US economy, being priced into the stock.
1. Large debt: LEE has chalked up massive debts during 2005 due to its acquisition of Pulitzer and caused the current low market price; the large debt is pressing down on the value of equity for the company (value of firm = value of equity +value of debt). However, as can be seen in the graph below, LEE has been very quick in reducing its debt.
Source: LEE Annual reports
And the table below shows the rate of decrement after 2005:
2005 to 2012
Debt to Equity % change Annualized
Long term debt % change Annualized
As such, the value of equity can be expected to climb as LEE pays back more debt.
Moreover, back in April, LEE managed to secure some debt refinancing from Berkshire Hathaway (BRK.A); I am sure an experienced investor like Mr Buffett would not lend money to a company if he believes that they do not possess the earning power to pay him back.
2. Decline of the industry: The price of the company's shares was also hammered down due to the plight of the newspaper industry; in reaction to this secular trend, LEE has erected paywalls to most of its websites and mobile sites and has since garnered good results.
Print Users penetration
Print and online penetration
Total penetration of markets
Source: LEE Annual reports
As can be seen from the table above, online and print and online penetration has been steadily increasing over the years. With the introduction of paywalls, I am inclined to believe that the bleeding in revenues will eventually stop and profits returned; albeit not back to former days of glory.
3. Poor economy: The final reason causing the suppressed price can be attributed to the poor economy. With a slow economy, demand slows and companies will tend to cut down on advertising budgets, resulting in a loss of revenue for companies depending heavily on advertising to survive. Nonetheless, the US economy is slowly improving although there were a few speed bumps along the way. Demand is slowly returning and eventually advertising budgets will too.
To conclude, based on the reasons above, I think that the market has misconstrued the value of Lee Enterprises greatly and hence created a good entry point and profit opportunity for investors.