With Yellow Media (YLWPF.PK) (TSX:YLO) and AT&T (NYSE:T) releasing their Q1 results, I thought it would be appropriate to update my comparison of Yellow Media to AT&T's Advertising Solutions division which a majority stake was sold to Cerberus in early April. Referring to the chart below:
The first thing that sticks out when looking at the AT&T numbers is the huge decline in EBITDA and margin. While the revenue decline appears to be slowing down, EBITDA declined an outstanding 33% with margin declining from 34% in Q1 2011 to 26.5% in Q1 2012. When the Cerberus deal took place in April, the company very likely had a preview of these numbers. This is where the big myth comes in that Cerberus paid merely 1.74x EBITDA for 53% of the division. It paid 1.74x 2011 EBITDA for a business, which it knew had a 33% decline in EBITDA in Q1 2012 and thin margins that are getting thinner by the quarter. YP Holdings LLC is a business in distress, where Cerberus will attempt to extract value by turning it around.
Contrast that to Yellow Media. The company took a nearly $3 billion hit to goodwill in Q1, with one of the reasons being the Cerberus deal, which valued the AT&T business at a supposedly low metric. While the industries are the same, the two companies are in completely different situations. Yellow Media's business is scaling down but it is not in distress. Looking at Q1 2012 numbers, the revenue decline is 17% (13% from continuing operations) and EBITDA decline is 23% (21% from continuing operations) when comparing with Q1 2011. Bad, but not nearly as bad as AT&T's division. The most telling aspect of the business transformation to digital is the EBITDA margin. It came in at 50.5%, which is down 4% from Q1 2011 but essentially flat when averaging it against the last three quarters. An argument could be made that Q1 is seasonally the strongest based on the above chart. The counter-argument to that is every quarter has seen a decline in Yellow Pages businesses so by default Q1 would appear to be the strongest. The point is that as Yellow Media transforms to more and more of a digital company every quarter, it has managed to maintain its margin over the last four quarters, which the AT&T business has failed to do. Even when assuming that Q1 has the seasonally strongest margin that would imply a respectable 46-47% margin for Yellow Media for the full year.
Referring to the last line in the chart tells you another very interesting story. Yellow Media's EBITDA as a percentage of YP Holding's EBITDA shows a very clear year-over-year trend. In 2010 Yellow Media averaged about 56% of YP's EBITDA. In 2011 that ratio spiked to 66% and now in Q1 2012 it spiked again to 74%. Since Q1 has a history of being about 2-3% lower than the full-year ratio, it's reasonable to expect to it be 76% for the full year. If we assume the Cerberus effective valuation of the AT&T business of $1.8 billion to be based on what it knew for 2012 as opposed to 2011 numbers, it would be reasonable to say that Yellow Media's business would have a floor at 76% of that number, or $1.36 billion.
Yellow Media has become the pariah of the Toronto Stock Exchange but from a business perspective its metrics are reflective of the Canadian business climate at large rather than being in a so-called dying industry. For instance, its average revenue per client on a yearly basis was $3,367 in Q1 2012 vs. $3,444 in Q1 2011, down 2.2%. Contrast that to Rogers (NYSE:RCI), the largest Canadian wireless communications company, which saw average revenue per client (on a monthly basis) drop from $59.91 to $57.65 from Q1 2011 to Q1 2012, a 3.8% decline. Or compare Yellow Media's margin to Loblaw Companies, the leading Canadian supermarket chain, which saw its ever so thin EBITDA margin drop from 6.6% in Q1 2011 to 5.9% in Q1 2012. Despite the increase in revenue, Loblaw's EBITDA shrank 10% from $455M to $409M.
Plenty of Canadian companies have margin and revenue pressures associated with greater competition. Yet their enterprise value isn't getting hacked to death like Yellow Media's. The company has a problem with capital structure. The transition from a print business to one online is in a de-scaling phase until online revenue overtakes print in importance, but the business itself is far from unprofitable. Loblaw has an enterprise value of around $15 billion vs. Yellow Media's of about $1 billion when you consider the market prices of all debt and equity securities. Hardly seems fair to value Loblaw securities 15 times greater than Yellow Media's when both have shrinking EBITDAs and Yellow Media achieves over a third of Loblaw's EBITDA. While the argument can be made that Loblaw has a lot of hard assets, it's the return on those assets that matter the most unless you are liquidating the company.
This is where the value proposition for the equity comes in. Bondholders have publicly declared that they wouldn't object to taking an equity stake in the company in lieu of the debt repayment but have no official say in the issue until at least one year from now when Yellow Media could possibly default on repayment of the 2013 bonds, but most likely the issue cannot be forced until 2014. The danger associated with waiting that long is employees who see the state of the company and see their stock purchase plans deeply in the red will become demoralized or leave, thus hurting the business' value. Bondholders will "pay" shareholders in order to assume control of the company as soon as possible. That payment could be in the form of a restructuring where shareholders get a minority stake in the new company, or it could come in the form of a buyout of shares by a private entity acting on the interests of the bondholders. How much could shareholders get? It's dependent upon the negotiation skills of Yellow Media management but my previous article suggested that Yellow Media's enterprise value should be around $1.8B, leaving around $300M for equity. With the Q1 financials for Yellow Media and YP Holdings being released, the Cerberus deal can be seen in a whole new light, which increases the floor for the enterprise value on Yellow Media.