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Shares of Gannett (GCI) spiked upwards, trading with gains of more than 20% over the past trading week, despite a 6% correction on Friday.

The media company known from USA Today and Careerbuilder.com announced the acquisition of Belo (BLC), in order to create a diversified multi-media company. Shareholders are applauding the strategic move into a more stable and profitable business. Despite the jump in Gannett's shares following the announcement of the deal, there is still upside at current levels.

The Deal

Gannett announced that it has entered into a definitive merger agreement under which it will acquire Belo. Gannett will pay $13.75 per share in cash for Belo, valuing the equity of the firm at around $1.5 billion. Including the assumption of $715 million in debt, the deal values Belo at $2.2 billion.

The deal represents a 28% premium compared to the closing levels on the day before the announcement. This deal accelerates the transformation of Gannett into a higher-margin multi-media company.

The transaction has already been approved by the boards of directors of both companies. Directors and executive officers of Belo who hold 42% of the voting power, already agreed to tender their shares.

Following the deal, Gannett will nearly double its portfolio of television stations to 43. The company will be the largest affiliate group for CBS and NBC.

CEO Gracia Martore commented on the rationale behind the deal, "We are thrilled to bring together two highly respected media companies with rich histories of award-winning journalism, operational excellence and strong brand leadership. We have been successfully transforming Gannett into a diversified multi-media company with broadcast, digital and publishing components across high-growth markets nationwide, and this is another important step in the process."

For the year of 2012, Belo generated annual revenues of $714.7 million, up 10% on the year before. Net earnings almost doubled to $100.2 million. Operating assets of the firm are valued at $1.43 billion based on the latest share count, valuing the operations at 2.0 times annual revenues and roughly 14-15 times annual earnings.

Gannett reckons it can generate $175 million in annual synergies three years after the closing of the deal. Non-GAAP earnings are expected to be accretive by $0.50 per share within the first 12 months of the closure, accompanied by significant free cash flow accretion.

The transaction multiple comes in at 9.4 times average EBITDA for 2011 and 2012, is expected to come down to 5.4 times if one factors in the expected synergies. Gannett expects to receive both cost synergies and revenue synergies. The company has more leverage in discussions about licensing fees with cable and satellite distributors, while it can boost revenues by attracting more nationwide advertisers.

The deal is expected to close before the end of 2013. The deal is subject to approval of two-thirds of Belo's shareholders, anti-trust approval and permission of the Federal Communications Commission.

Valuation

Gannett ended its first quarter of the year with $142.8 million in cash and equivalents. The company operates with $1.45 billion in total debt, for a net debt position of little over $1.3 billion. The net debt position of the firm will increase significantly towards $3.5 billion following the deal.

Gannett generated annual revenues of $5.35 billion for 2012, up 2% on the year. Net earnings fell by almost 8% to $424.3 million in the meantime.

Trading around $25 per share, the market values Gannett at $5.7 billion. This values the firm's equity at almost 1.1 times annual revenues and 13-14 times annual earnings.

Gannett currently pays a quarterly dividend of $0.20 per share, for an annual dividend yield of 3.2%.

Some Historical Perspective

The latest rebound in Gannett's shares is welcome news for long-term shareholders, which have seen very poor returns. Shares traded around $90 in 2004, falling to lows of $2 in 2009 in the aftermath of the financial crisis. The recovery has boosted the share price to current levels around $25 at the moment.

Between 2009 and 2012, Gannett has consolidated its revenues around $5.5 billion. The company has reported solid profits in the meantime.

Investment Thesis

Gannett estimates that the deal will be hugely accretive as a result of sizable synergy estimates. Therefore, the share prices of both companies spiked upwards on Thursday following the announcement of the deal. Especially the jump in Gannett was surprisingly large.

For starters, Belo's share price jumped up to $13.77 following the announcement of the deal, two cents above the offer price. Shares continued to gain ground in Friday's trading session on the back of hope for a higher bid on top of the acquisition premium. Consequently the market capitalization of the firm increased by $340 million following the announcement of the deal.

Yet the real interesting action took place in Gannett's shares, which rose some 25% following the announcement, boosting the value of its shares by $1.17 billion. This represents roughly the entire market capitalization of Belo before the announcement of the deal.

Combined, both firms saw their market capitalization increase by around $1.5 billion. This largely reflects the $175 million in annual synergies to be expected. As such, the market seems to already be fully pricing in the expected synergies, or even estimate that synergies could be higher than the current expectations.

The deal will roughly double Gannett's broadcasting revenues, which only make up 15% of total revenues at the moment. The unit is already the fastest growing division of the firm and makes up already half of total operating income. The unit is earning more than the well-known publishing business, which generates five times more revenue.

As such, the market action does not already incorporate the expected synergies, but also shows the market will start to value Gannett differently. The company is no longer a lagging traditional media company focused on print, but is transforming itself into a television company with increased prospects for growth and earnings. This transaction should be accompanied by higher valuation multiples.

On top of this, Gannett implicitly reiterates that it thinks its own shares are undervalued. The company is not using shares to finance the deal as it relies on cash at hand and borrowings instead. Actually, Gannett is announcing a new $300 million share repurchase plan, enough to repurchase over 5% of its shares outstanding, to be executed in the coming two years.

All in all, annual revenues will approach the $6 billion mark after closing the deal, marking the first sign of growth in years. Pro-forma earnings could be boosted towards $525 million per year, steadily increasing towards $650 million factoring the after-tax impact of synergies at statutory tax rates. While the $3.5 billion debt position is a bit on the high side, the overall valuation at 0.9 times annual revenues and 9 times earnings is very appealing, especially considering the solid dividend payouts.

This deal is truly a winner for both shareholders in Belo and Gannett. Despite the jump upwards following the announcement of the deal, Gannett might still provide excellent value as it moves in the right strategic direction and continues to trade at appealing valuation levels.

Source: Gannett - Shareholders Are Applauding The Acquisition Of Belo