If you have been paying attention to the media sector over the past several years, you will have noticed significant merger and spin-off activity. With this activity comes opportunity for profit. Given the changes that media companies have been facing in the past several years as emerging technology erodes their once dominant positions, achieving increased operating efficiency through consolidation and asset separation becomes increasingly important.
From observation of previous spin-offs and acquisition activity in the media sphere, I have come to believe that this media consolidation process is formulaic, and happens in two parts: Division of assets through spin-offs and subsequent acquisitions by larger companies.
For patient investors who are correctly positioned, I am of the opinion that there are significant rewards to be had from this type of activity in the sector. For this reason, I was very excited to read about The Tribune Company's (OTCPK:TRBAA) decision to spin off its publishing business in July and have been waiting for 2014 to draw close.
I believe that this style of asset division, which I call the "One-Two," is a prelude to value-realizing events for shareholders, and investors will be well served to examine The Tribune Company.
What The Tribune Company Does
(Quoted text courtesy of Google Finance)
A thoroughly diversified media conglomerate, the company currently operates in "publishing and broadcasting and entertainment. In publishing, the Company's daily newspapers include the Los Angeles Times, Chicago Tribune, The Baltimore Sun, Sun Sentinel (South Florida), Orlando Sentinel, Hartford Courant, The Morning Call and Daily Press. The company's broadcasting group operates 23 television stations, WGN America on national cable and Chicago's WGN-AM."
The company also owns several websites, some in partnership with other media companies in addition to its independently held portfolio. In addition, having been in operation since the later part of the 19th century, the company has accumulated significant real estate holdings.
The Numbers on The Tribune Company
With a market capitalization of $6.4 billion, the company is one of the smaller media conglomerates. Currently priced at $71.50 per share against a book value of 52.81, the company is trading at a modest premium to its underlying assets. Having emerged from bankruptcy with a sound financial position and a much smaller debt load, the company currently has approximately $0.60 cents on hand for every $1 of debt that it carries in addition to a current ratio of over 2.5, currently standing at 2.81. The company pays no dividend.
An Example Of My "One-Two" Asset Separation Thesis: The Belo Corporation
The spin-off of the Belo Corporation's (BLC) newspaper assets into a small discreet company, the A.H. Belo Corporation (AHC), provides an excellent example of this type of asset division in a multimedia company. Broadcasting assets, which typically involve a large amount of debt, are spun off from publishing assets which are typically left with a large cash position and no debt.
In 2008, shareholders of the Belo Corporation saw their assets split along publishing and broadcasting lines. Though the timing of this spin-off was less than opportune, investors are very well served to survey the performance of these two companies, as their similarity with the Tribune company provides an important guide for the future. The A.H. Belo Corporation, which specializes in local papers, carries zero debt, pays a healthy dividend and has appreciated significantly over the past several years. The broadcast assets of the Belo Corporation were able to exist independently for several years until receiving a recent bid from the Gannett Corporation (GCI), the publisher of USA Today and a national media conglomerate.
A larger company purchasing broadcasting assets can also yield substantial savings due to operating redundancies being eliminated. I believe that the Tribune's assets are likewise attractive for this reason. If I were to speculate as to which companies are likely to purchase the Tribune's broadcast assets, it could potentially be either Gannett or a large media company like Time Warner (TWX).
It is also important to note that the Tribune company owns many assets in partnership with other media companies, including shared ownership of the Food Network with Scripps Networks (SNI) and website assets with the McClatchey and Gannett companies. The Tribune's relationships with these companies raise the possibility of the company's stake in these assets being sold to these partners.
Taking a Hint From Regulations
Despite the fact that many companies own television, radio and newspaper assets as a single entity, it is difficult for long established companies to sell themselves outright to unlock value for shareholders. In addition to often being family owned companies, FCC cross-ownership regulations prohibit "cross-ownership by a single entity of a daily newspaper and television or radio broadcast station operating in the same local "market." Under the 2007 revised rule, the FCC evaluates a proposed cross-ownership combination on a case-by-case basis to determine whether it would be in the public interest - specifically, whether it would promote "competition, localism and diversity."
While many companies have a diversified portfolio of media assets, the companies themselves, which have a long operating history, are "grandfathered" into the system and are thus exempt from FCC regulations. While this once conferred a significant operating advantage to many of these companies, as the value of their newspaper assets declined, it made it significantly more difficult for these companies to put themselves up for sale. While significant operating redundancies can be eliminated through the ownership of broadcasting assets, this market efficiency cannot be realized in the present due to the fact that many companies own newspapers as well. The logical answer is to spin these assets off. Any time I see a spin-off of this nature announced in a media company that has a diverse media portfolio, I immediately become interested in the potential for realizing value through spin-off investing and the vastly increased likelihood of the company's broadcasting assets being sold.
While the process does take significant time to realize, and may not come to fruition, I believe that investors are significantly benefited from these asset separations due to the fact that they will receive broadcasting assets that are significantly more attractive to potential buyers and thus more valuable (as they retain an embedded call option on future catalytic merger activity) in addition to cash rich, debt free publishing spin-offs that are often likewise attractive for reasons which I will now discuss.
Don't Discount the Publishing Assets
While it is undeniable that many digital sources have supplanted traditional forms of print based news, Warren Buffett has gained considerable attention for investing in small, local papers in the past several years. His rationale is that the market for local news and local advertising will always remain robust, particularly if it's a de facto monopoly in a "one newspaper town." Tribune Publishing owns a large portfolio of local papers operating in both major metropolitan areas such as Los Angeles (Los Angeles Times), Chicago (Chicago Tribune) and Baltimore (The Baltimore Sun) in addition to smaller cities where the regional advantage is more pronounced.
In addition to local papers retaining several market advantages, it is important to take into account that efforts are being made to monetize the digital content of local papers through subscription revenues online. I believe that while ad revenues from print media will decline, subscription and revenue from online advertising will help to soften the blow. Another redeeming quality with many newspapers is the fact that they have been operating for a long period and thus carry a large amount of assets that have either been fully depreciated or are carried on the books at lower than market price.
A final area of opportunity is the fact that due to structural reasons, spin-offs are often undervalued and subject to intense selling pressure in the immediate aftermath of the distribution, unlocking significant potential for the new entity to be purchased at attractive prices. Further supporting my belief that there will be a case of bargain valuation is that other publishing spin-offs have zero debt and large cash positions, allowing investors to more easily calculate intrinsic value.
Despite the fact that the Tribune's broadcasting assets have the potential to be very attractive to the right buyer, there are significant risks investors must be appraised of.
It is important to understand that the company might have to bear losses in its print newspaper operations over a longer period, as its newspapers begin to transition into the digital realm using the subscription based model. Furthermore, this transition might not be successful.
Media companies are also particularly vulnerable to a decline in the broader economy due to their often high debt loads and their dependence upon selling ad space. While the Tribune emerged from bankruptcy with its assets restructured and a vastly more manageable debt load, there remains significant risk of another economic downturn impacting the company's main source of business in both its broadcasting and publishing segments.
The final area of risk is that while the company's assets will be more attractive after a spin-off, there is no guarantee of the company's broadcasting assets being acquired. Despite this fact, I believe that the market will appraise the Tribune's parts in a more generous manner than the whole company, due to the fact that the company's publishing operations will likely be both debt free and retain a significant cash position. In addition, I believe that the broadcasting assets of the company will command a higher valuation due to the fact that they are now more marketable than they were previously.
I believe that the pending spin-off of The Tribune Company's publishing arm represents an excellent opportunity for investors to realize value due to the company's diverse portfolio of assets that stretch across publishing, television, radio and the internet. I also believe that for patient investors, this asset division represents a prelude to further activity that will occur in the future. If one can use past deal activity in the sector as a guide, the potential of further asset sales is very real and could contribute to significant value-creating events for shareholders.
Investors are also furnished with several methods to play this deal, including purchasing shares before the spin-off occurs to receive a tax-free distribution in addition to accumulating shares of the newly created publishing entity in the aftermath of what I expect will be heavy selling pressure.