I would like to present two asset plays in the newspaper industry.
News Corp. (NWSA): publishing conglomerate. Spin-off from 21st Century Fox. Over 90% of the market cap can be accounted through cash, listed investments, or a business with recent private market valuation. This leaves newspapers, book publishing and digital education "for free". Potential upside: c.60%.
New York Times (NYT): newspaper that is selling all non-core operations. It will be left with the New York Times and the eponymous building close to Time Square. Pension underfunding is going away with higher equities and yields. Potential upside: c.30-50%.
Don't invest in newspapers for the moat
You might be a romantic like Buffett and gather smaller newspapers at low price or a utopian like Murdoch and pay 40x earnings for the Wall Street Journal… But there is another way to make money out of newspapers: look at their assets. Real estate, securities, cash, or even other businesses: newspapers stocks are not about the newspapers anymore.
Newspapers have been shrinking for over a decade. Printing plants have been shut down, journalists have been let go. But cash has been reinvested. By now, often the other assets can make up for more than the entire market cap of the company.
In his early years, Buffett bought Sanborn Maps. He didn't buy it for the map capabilities but for the investment portfolio. That's the kind of trade we're talking about here.
Gannett (GCI) has shown that the assets next to the newspapers are not to be ignored. Its cash pile and capacity to lever up enabled GCI to finance the Belo acquisition without issuing shares ($1.5bn in cash and assumption of $715m of debt). $175m annual run-rate synergies were the cherry on top. Stock went up 25% after the announcement and is now up 44% YTD. It re-rated 8.5x to 10.5x earnings. GCI is showing the way so watch out for the next newspaper stocks using their assets to revive their share prices.
To illustrate that, look at Caltagirone Editore in Italy (CED IM, EUR0.80 share price). They have net cash of EUR 1.14 per share, listed equities of EUR 0.67 per share, other readily valuable assets of EUR 0.08 (net working capital, net of pension deficit) and real estate worth EUR 0.50-1.00 per share (it has been suggested that they are preparing to convert newsrooms to an Armani store). Restructuring has brought the company back in the black in Q2 2013 at the EBITDA line (H1 better than Q1). And EBITDA matters because capex is very low, net interest is an income and tax charges are low. Advertising remains a bet, even if advertising revenues have improved from down 24.5% yoy in Q1 to only down 12.9% in Q2 and TV operator Mediaset indicates July advertising in positive territory. Cyclical direction of advertising should trump the structural decline in the next 2-3 years as the latter only has a 5% impact per year. Three other facts offset the advertising risk: 1) the newspapers have strong market shares in their regions and they could benefit as 100 newspapers close, 2) they increased cover prices in February 2013, 3) the company is buying back shares.
But today we would like to focus on NWSA and NYT.
NEWS CORP ($9.2bn market cap)
Bottom line: market cap is explained by Australian media assets and net cash. Newspapers, book publishing and education arm are almost "for free". Prospectus and presentation are really worth reading.
1) Stake in Foxtel (50%) and Fox Sports Australia are worth $4bn.
News Corp doubled its stakes in both Fox Sports Australia and Foxtel in November 2012 for $2.235m ($2bn of equity and $235m assumption of debt) implying a valuation for these two businesses of $4.470m. After a fall of the Aussie dollar of just above 10%, we can assign $4bn value to it.
A) Fox Sports Australia (100% owned, $145m EBITDA)
- Seven sports channels for PAY-TV
- Distributed through Foxtel (100% owned), 80% of Foxtel customers take it
- Sports rights secured until 2016/2017
B) Foxtel (50% owned, $900m EBITDA, $2.1bn of debt)
- Foxtel is the only pay-TV provider in Australia with 2.5m subs and ARPU of $93
- Pay-TV penetration is still low at 30% compared to other international markets
- Foxtel has just launched IPTV as "Foxtel Play" and will start offering triple-play
- They have only achieved AUD40m of the targeted AUD70m synergies so far
2) Digital Real Estate worth about $2.3bn
- At AUD30.85 a share and with 131.7m shares outstanding, the market cap is AUD 4.063. With AUD at 0.92 and with 61.6% ownership, that values the NWSA stake at about $2.3bn.
- AUD160m EBITDA, AUD200m net cash, listed under REA AU
- The leading housing portal in Australia. Also market leader in Italy and active in a few other markets
3) Net cash of about $2.3bn
- Cash of $2.560m is well known
- But investors tend to overlook: the deferred tax assets of $400m, the receivables from the sale of their London headquarters $150m, the pension liabilities of $497m and the $200m cash at the Digital Real Estate subsidiary (given that we take equity value above)
- 21st Century Fox will indemnify News Corp. for civil liabilities from the News of the World scandal but there could be further liabilities ($100m maybe).
The three assets above are worth $8.6bn compared to a market cap of $9.2bn.
The following assets are almost "for free":
4) Newspapers with EBITDA (based on last nine months annualised) of $779m
- US newspapers: The Wall Street Journal, Barron's, Dow Jones Newswire, MarketWatch, etc.
- UK newspapers with 33% share of the national market: The Sun, The Times, The Sunday Times.
- Australian newspapers with 67% share of the national market, and 7 out of the top 10 national newspapers.
5) HarperCollins is worth $1.3bn at 8x EBITDA
- One of the top 5 global book publishers.
- Profitability is rising as they transition to ebooks (lower sales, higher margins) and they are able to do very accretive acquisitions.
- They acquired Christian book publisher Thomas Nelson for $200m, which improved their EBITDA from $86m in 2012 to $163m (last nine months annualised).
- CBS is likely a seller of Simon & Schuster. News articles have reported discussions between HarperCollins and Simon & Schuster. News Corp might have wanted to wait for the spin-off before such a merger. RandomHouse and Penguin have merged and are unlikely to be interested. News Corp seems the natural buyer given its deep pockets and the amount of synergies (ruling a private equity bid out).
6) Amplify is likely worth either zero or a lot. For the moment let's assume they are worth what they spent so far ($700m):
- Educational start-up intending to provide digital education materials to K-12 students.
- In a couple years either losses ($180m estimated for this year) go to zero, i.e. business is shut-down, or the business is profitable in a very promising market.
- They have won an RFP for 21,000 students in North Carolina and their product looks competitive. However Pearson-products have the lead in California.
Lastly, worth mentioning that their newspapers arm has pent-up pricing power and operational upside:
- WSJ subscription costs about half the price vs. NY Times and FT
- The Sun in the UK is moving its homepage to a paywall in August
- The one competitor in Australia (Fairfax Media) is struggling and raising prices steeply
On that basis, the newspaper business should trade at a premium multiple of for example 6x EBITDA. Putting then HarperCollins on 8x EBITDA and Amplify at invested capital ($700m) makes $5.9bn. That's about 60% upside. Even if you don't want to pay for Murdoch's skills that's plenty for any conglomerate discount you might want to apply.
NEW YORK TIMES ($1.8bn market cap)
Bottom line: the real estate is worth half the market cap leaving the stub on 4.0-6.3x P/E
Their share of the New York Times Building is worth about $924m
- The New York Times Building is located at 620 Eighth Avenue between 41st and 42nd Street (West of Time Square).
- NYT owns floors 2 through 27. Forest City Ratner owns floors 29 through 52, as well as street-level retail space. The lobby and floors 28 and 51 are jointly owned.
- In March 2009, NYT entered into a sale and leaseback agreement for 21 floors at a sale price of $225m (750k rentable square feet). NYT has the option to buy back the 21 floors for $250m in 2019. The option is well into the money.
- NYT still owns 6 floors outright (185k rentable square feet).
- How much is this building worth? There are 935k of rentable square feet. Boston Properties targets low $80s/sqf for 250W 55th, but let's assume $75/sqf to be conservative. At 95% occupancy that's a rent of $71.1m per year. Net operating income margin of office REITs are about 65% which at a capitalization rate of 5% makes a valuation of $924m.
Pension deficit has come down to about $290m after-tax (it benefits from higher interest rates)
- NYT's pension plans were underfunded (meaning the present value of future obligations exceeded the fair value of plan assets) by $699m as of Dec-2012 (10k, p.45)
- NYT mentions that a decrease of the discount rate by 50bps would increase the underfunding by $153m (10k, p. 46).
- Assuming a 75bps increase in the discount rate since the start of the year would reduce the underfunding by roughly $230m, leaving an underfunding of roughly $470m. After a 38% tax shield that's about $290m of pension underfunding.
- It is also likely in my mind that equities and interest rates continue to increase over the next couple years taking care of the pension underfunding.
Other net cash of $257m.
- Cash and cash equivalents are $820m. They have risen through the many divestitures in 2012, notably About.com ($316m), Regional Media Group (regional newspapers, $140m), Fenway Sports Group (Boston Red Sox, $100m).
- Short-term investments are $135m.
- The sale-leaseback transaction is accounted for as a financing transaction. As such, NYT continues to depreciate the building and accounts for the rental payments as interest expense. The net sales proceeds were accounted for as debt. The difference between the purchase option price of $250m and the net sale proceeds of $211m is being amortized over a 10-year period through interest expense. Debt related to the building is currently $225m.
- Debt excluding the sale-leaseback and capital lease obligation amounts to $473m.
Boston Globe and Worcester Telegram & Gazette worth probably $100m.
- They have been put up for sale in February 2013. Evercore Partners is managing the sale process. It is expected to fetch around $100m according to press articles.
- The potential buyers include Rick Daniels, a former president of the Globe, and former Time Inc. Chief Executive Officer Jack Griffin, in partnership with cousins Steven and Ben Taylor, whose family once owned the newspaper.
Enterprise value multiples of 2.2-3.5x
- Total of all the assets above roughly $991m. That gives an enterprise value of $787m.
- 2012 EBITDA was $256m. Assuming Boston Globe contributed $30m (inline with what JPMorgan estimates), that gives an EBITDA after divestiture of Boston Globe of $226m.
- On that basis NYT trades on 3.5x EBITDA.
- On the more optimistic side, moderate equity increases and another 100bps increase in yields could erase the pension deficit entirely. On that basis EV would be $497m and EV/EBITDA multiple would be 2.2x.
Hypothetical price/earnings valuation of 4.0-6.3x
Adjusted for the assets, we've seen that the equity value was only $787m (= to the enterprise value), or $497m excluding pension underfunding.
What would earnings be under that scenario?
We want to assume that depreciation will converge to capex in the long-run. 2012 capex was $35m. Assuming $9m for Boston Globe (given heavier manufacturing activities), that would give $26m of 2012 capex for NYT pro forma for Boston Globe divestiture. This gives an EBITDA minus capex of $200m.
Interest expense would be zero given the assumption of no excess cash nor debt. That gives a profit before tax of $200m. Tax rate of 38% would bring a net income of $124m.
On that basis (adjusted for the excess assets), NYT trades at 6.3x P/E. Assuming a further rise in yields and no pension underfunding, NYT trades at 4.0x adjusted P/E.
Concretely, if the stock should trade at 5.5x EV/EBITDA (the Gannett multiple before the Belo acquisition) that's 2.0-3.3x upside in $256m EBITDA or about 30-50% upside.