Our bear case for JRC is straightforward:
- secular trends for the newspaper industry are terrible;
- the economic cycle is slowing, pinching the profitable classified ads category for newspapers;
- Journal Register has an even less appealing market profile, with exposure to slow growth Michigan and Northern Ohio (40% of circulation);
- the company has $750MM in debt, levering it at an industry-leading 6.2x, leaving it little financial flexibility;
- analyst estimates remain too high, and will likely come down before year end;
- JRC valuation is expensive at 9x EV/EBITDA;
- fair value for the JRC shares is $5/share.
So what has investors excited about JRC these days? We did a little sniffing around recently and this is what we heard:
- "Michigan isn't getting worse."
- "Private Capital Management has sold much of its stake, reducing overhang"
- "Merrill upgrade"
- "Asset sales are going well"
Let's take a look at these reasons individually, as we think it is hard to reconcile the move in the stock with these items.
"Michigan isn't getting worse" Michigan is an unmitigated disaster. Journal Register paid $415MM for these slow growth properties back in 2004 and is regretting it now. Auto job losses are tanking the local economy and depressing consumer confidence (neither is good for newspapers). Michigan ad revenues were down 15% in September, but management suggested things weren't getting worse on the conference. Obviously "not getting worse" is better than "getting worse," but the important thing here is what do analysts have in their estimates for next year. Analysts are looking for revenues to remain flat in 2007 suggesting the Michigan properties need to turnaround massively in short order, or the rest of the newspaper portfolio needs to offset Michigan. We are extremely skeptical of these estimates and believe management will lower guidance at the annual media conferences in New York in December.
"Private Capital Management has sold much of its stake, reducing overhang." We guess there is a silver lining to every cloud, but this is a stretch. Private Capital Management's Bruce Sherman was undoubtedly the biggest bull on newspapers in the country, amassing huge stakes in most of the publicly traded newspapers stocks. In a desperate attempt to cut his losses, he forced Knight Ridder to put itself up for sale. The auction was a flop and now PCM is exiting many of its positions. We have difficulty seeing the good news in PCM selling their newspaper stakes at 52-week lows.
"Merrill upgrade." There was not much new in this report. We viewed it more as a valuation call. It is always tough for sell-side analysts to maintain a sell rating, so they are always looking to move to a more positive (or at least neutral) stance
"Asset sales are going well." The company announced the sale of newspapers in Massachusetts and Rhode Island back in August. These are supposedly slower growth markets for JRC, so we are estimating they sell for 9x. EBITDA for these newspapers is probably heading to $8MM, so the company might get $72MM in proceeds. We estimate taxes of $5MM or so and roughly $67MM makes it to the balance sheet, reducing leverage a whopping 0.2 turns to 6.0x.
We think the JRC rally creates an interesting opportunity to build a short position in JRC before management inevitably cuts guidance for 2007.
Disclosure: Hanover Square has a short position in JRC.
JRC 1-yr chart: