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Gatehouse Media (GHS) pulled off a successful offering this past week. But then of course, we seem to be in the type environment in which a lemonade stand might be able to pull off a successful IPO. Not quite 1999 here, but we're seeing more enthusiasm for IPOs across the board then anytime since early 2000.

The equity interests by Fortress in GHS got the deal done and gave it an initial pop. Fortress is a 'roll-up' specialist whose past success with BKD attracted investors to this deal.

One note here - While GHS has the trend of an aging US population at its back, GHS has the headwind shift away from print advertising trend to deal with. GHS is exactly the type of company that goes bankrupt during difficult economic times --- they're laying on hefty debt to acquire businesses that are annually not able to grow revenues in a 3%-4% GDP environment.

Again though, we're in an IPO period here when 'little things' such as that are glossed over by investors as greed has begun to take over. Interesting the lessons that need to be repeated over and over again.

Below is our pre-IPO piece for GHS:

.......
2006-10-18
GHS - GateHouse Media

GHS - GateHouse Media plans on offering 13.25 million shares at a range of $16-$18, assuming over-allotment is exercised. Goldman Sachs is lead managing the deal, Bear Stearns, Wachovia, Allen and Lazard co-managing. Post-offering GHS will have 34.5 million shares outstanding for a market cap of $587 million on a $17 pricing. The bulk of IPO proceeds will go to repaying debt. Both Goldman and Wachovia are creditors here so they will be receiving both underwriting fees and a portion of the proceeds as debt repayment.

Fortress Investment Holdings will own 61% of GHS post IPO. The segment of Fortress here is their private equity group. Fortress took control of GHS in 7/05. Fortress has recently brought two of their portfolio companies public in BKD/AYR. Both have done quite well in the aftermarket. Fortress plan appears to buy into a sector as a starting point. Then they'll utilize that initial purchase and begin 'rolling up' additional companies and/or assets in that sector with an eye towards becoming the leading player. They appear to be doing similar with GHS. On 6/6/06 GHS acquired all of the assets of CP Media and Enterprise NewsMedia, two Northeastern news publishing companies. These acquisitions essentially doubled GHS annual revenues. Each were brought into the fold by laying $400 million in new debt on GHS. Some of that debt will be paid off on offering, however GHS will be burdened with substantial debt post-IPO.

From the prospectus:

'We are one of the largest publishers of locally based print and online media in the United States as measured by number of daily publications. Our business model is to be the preeminent provider of local content and advertising in the small and midsize markets we serve.'

GHS current holdings include: 1) 75 daily newspapers with total paid circulation of approximately 405,000; 2) 231 weekly newspapers (published up to three times per week) with total paid circulation of approximately 620,000 and total free circulation of approximately 430,000; 3) 117 "shoppers" (generally advertising-only publications) with total circulation of approximately 1.5 million; 4) over 230 locally focused websites, which extend our franchises onto the internet.

This is a very curious offering in that print newspaper stocks have not performed well at all the past 2 years.

According to the Newspaper Association of America, total gross ad spending in local newspapers nationwide is still below total gross spending for the year 2000. In fact total local ad spending in all mediums is still below that of 2000. The growth in overall ad spending has been nationally, driven by two mediums: Cable TV and the Internet. Every other national/local advertising segments have been unable to significantly surpass gross ad spending from 6 years ago, with all local advertising performing the worst. GHS predominantly relies on local print advertising, a sector that has flatlined the previous 6 years.

Advertising accounts for 75% of GHS revenues.

In addition overall circulation of daily newspapers has declined annually this entire decade while overall circulation of weekly newspapers has flatlined for 10 years. GHS owns 75 daily newspapers and 231 weeklies.

The two blue chips in this segment are the Washington Post (WPO) and The New York Times (NYT). WPO's stock price is currently down 25% since the late 2004 highs, while NYT is down 40% from the highs in late 2004. The reasons are in the preceding two paragraphs. Note that GHS plans on achieving ad growth via the internet route for their dailies and even some of their weeklies. However both NYT/DPO has top of the line well trafficked websites, yet it has not been enough to a) overcome stagnant ad rates in and overall circulation of their newspapers and b) given any boost to the stock prices.

GHS strategy here seems pretty clear. They're attempting to consolidate a very stagnant sector and achieve operating growth through rolling up otherwise zero growth businesses. I imagine the endgame is to achieve operating efficiencies overall to squeeze out earnings growth. Still, we're looking at a stagnant(at best) sector here, with the two blue chips in the group not able to see their stocks gain any traction for two years.

The big risk for GHS going forward is an economic slowdown. The past few years during a 3%-4% growing economy, the local dailies/weeklies have not seen any real overall revenue growth. I would imagine a flat to slowing economy would mean pretty significant overall drops in local newspaper advertising. For a company like GHS whose strategy is to lay on hefty debt, rolling up acquisitions in the sector, a sharp drop in advertising revenues, could spell disaster. In fact it is a recipe for disaster, you do not want to be anywhere in the vicinity of a company like GHS in a slowing or stagnant economy.

GHS dailies and weeklies have been around for quite awhile, as is the norm in this sector. 70% of their dailies have been published for 100+ years. GHS generates revenues from 286 markets across 18 states with 1.75 million classified ads placed in the papers in 2005.

Financials

Debt is significant at $586 million. These debt levels to equity in a stagnant organic growth sector mean an automatic pass from me on this IPO. The annual interest rate on the debt is fairly low overall at 5% or so. GHS plans to continue to acquire, expect debt levels here to increase going forward.

GHS does plan on paying a dividend. It appears as if it may be in the ballpark of $0.50 a share annually. On a pricing of $17, GHS would be yielding approximately 3% annually.

Negative book value post-IPO.

Due to the recent large acquisitions, coupled with Fortress taking control in 2005, revenues/earnings are not comparable pre 2005.

Taking into account all acquisitions, revenues for 2005 were $384 million. Operating margins were 13%. Unfortunately interest expense wiped out 81% of operating earnings. When folding out all acquisition related expenses and other non-recurring expenses, GHS net margins for 2005 were 1 1/2%. Earnings per share were $0.17. On a pricing of $17, GHS would be trading 100 X's trailing earnings. This in a stagnant sector.

For 2006, through 9 months it appears revenue for GHS will be flat. I would expect 2006 revenues to come in around $390 million, a small increase from 2005's $384 million. GHS has experienced a bit of operating expense growth in 2006 though, predominantly SGA and depreciation. This has knocked operating margins down to 10%. Debt servicing through first 9 months more then ate up all operating earnings. Expect a loss for GHS in 2006.

Note there is approximately $0.70 a share in annual depreciation expense. So while GHS will be booking a small loss overall in 2006, cash flows will be a little bit better. the dividend will come out of these cash flows.

Conclusion

Fortress is attempting to do with GHS something akin to their operating strategy with BKD. With BKD though their strategy plays into the overall trends of an aging US population. The wind is at their back in that sector, high debt levels be darned. The wind is not at their back in the local print advertising sector. If anything it is a bit of a headwind. While overall economic conditions should not effect Fortress plan with BKD, a decent size US economic slump could very well derail GHS. Factor in too, that GHS is not growing revenues at all without acquisition and not booking a bottom line profit.

I'm passing on this deal.

Source: A Newspaper IPO?! Gatehouse Media Bucks the Trend