LEE Enterprises (LEE) was and still is an undervalued company that I continue to own, but there are even greater opportunities on my plate right now that I can't fail to notice. Call me crazy, but I've been called that before and I don't really seem to mind. I am looking at opportunities trading at equity valuations equivalent to 1/10th of their free cash flow. That is to say, for every dollar you put in, you are looking at $10 of cash flow a year in a business that you own. Yes, it's nuts. Imagine being able to put in $5000 and collect $50,000 a year of free cash flow going forward.. just saying. The valuations in this market subset are insane.
Who am I to say that I know what Warren Buffett would buy? I picked out LEE at a much better entry price than he did. What can I say? I don't fault companies for making things out of paper. In the meanwhile, the market has seemed to lose faith in anything that relies wholly or partially on paper products.
Beyond not holding companies to arbitrary and unreasonable standards, I've spent the last decade studying thousands of companies and analyzing my methods of valuing them in accordance with frameworks developed from my research into how Warren Buffett and other successful billionaire investors determine that which is worth owning from that which is not.
Let's take a look at Lee in comparison to a few other companies that are perceived to be in the paper advertising industry:
|$ Millions USD||EBITDA||NET DEBT||Debt/EBITDA|
One of the first things you'll notice is that on a Debt/EBITDA basis, LEE has 2x as much debt as SuperMedia (SPMD) and Yellow Media. Dex One carries a little more debt, but still is comparably less leveraged than Lee Enterprises. So, how does that translate into valuation?
|$ Millions USD||EV/EBITDA||Mkt Cap / FCF||EV/FCF|
So it appears that there is a situation where the valuation is lower on the phone book companies, the debt is lower, and the free cash flow is higher for any given revenue dollar. Crazy, right? Dex One (DEXO) and SuperMedia have been buying back their debt at fractions of their issuance value.
The Reporting Persons support the current management team and applaud its efforts to date. In particular, the Reporting Persons believe:
management has done an extraordinary job of cutting costs and increasing margins, despite a secular contraction in revenues, by eliminating over $500 million of expenses;
the Company's cash flow is managed well, including successful debt reductions through below par repurchases and early payments (over $1 billion of debt has been retired over the last 27 months);
management has made a good decision to focus on growing its online media solutions business and is building a unique business model that will be integral to its core small and medium-sized business clients; and
management has done an admirable job of generating as much cash flow as possible from its existing legacy print directory business.
However, it appears that the market is failing to appreciate the Company's impressive, albeit ongoing, turnaround. As a result, the Company's stock price does not reflect the Company's current intrinsic value or its long-term prospects. The Reporting Persons acknowledge that this mispricing may be due to the fact that the Company's strategy is one that requires time and good execution. Moreover, this strategy is being executed while industry peers in the local search advertising industry are similarly growing their online search and advertising capabilities.
Given this landscape, the Reporting Persons believe this to be an opportune time for the Company to take advantage of an industry that is ripe for consolidation, as is widely acknowledged by industry insiders and analysts. The Reporting Persons believe that the Company should at this time consider all strategic alternatives available to it including, but not limited to (i) an acquisition of or a merger with one of its yellow pages competitors, such as Dex One, Yell Group, Yellow Media, Local.com or Cerberus Capital's Yellow Pages, or (ii) a sale of the Company to a large-scale internet company, such as Google, Groupon, AOL or Facebook.
Dex One Corporation, in particular, appears to be a prime acquisition candidate for the Company.
The Reporting Persons believe that the Company should command a multiple in the range of four to five times enterprise value based on trailing twelve-month earnings before interest, taxes, depreciation and amortization (EBITDA) in such a deal.
The implication of commanding a multiple of 4-5x EBITDA when they are currently trading at 3x EBITDA is that SuperMedia is a 20-bagger+.
If you take a look at the debt maturities of SPMD, you have a lot coming due in 2015. S&P and all credit ratings agencies are forced to drop their ratings when companies are able to extinguish debt below par.
(CCC+/Negative/--) latest subpar debt repurchase does not affect our current corporate credit rating on the company. Our issue-level rating on the company's term loan due 2015 remains at 'D'. Per Standard & Poor's criteria, the ability to do ongoing subpar repurchases of this issue is tantamount to a default. We expect the issue to remain at this rating level until the company no longer has the authorization to buy back debt below par.
We believe SuperMedia's liquidity and adjusted debt leverage will not change materially as a result of this transaction, as the company is using $33 million of cash and must keep at least $50 million in cash as per its amendment dated Nov. 8, 2011. Lease- and pension-adjusted leverage, pro forma for the subpar debt repurchase, decreased to 3.0x for the 12 months ended Mar. 31, 2012, from 3.9x over the same period last year. We anticipate that the company will continue to repurchase debt in the open market below par with roughly 32.5% of its free cash flow, as defined in the credit agreement. The agreement stipulates that SuperMedia must repay 67.5% of the debt at par. We believe the company will need to continue repurchasing debt and stem revenue declines in order to be able to refinance the credit facility by Dec. 31, 2015, which we regard as an unlikely scenario.
Is the situation as bad as the analysts say that it is? I don't think so. Will they be able to refinance their debt? Yes. Is SuperMedia underleveraged? Yes, most companies assume that 4x EBITDA is where you can take your debt levels, indicating that the current 3x is underleveraged. I love that they are closing out debt at less than par:
The $60 million debt reduction accomplished through open market repurchases utilized cash of $31 million.
Let's take a look at two of their acquisition targets and why I think that perhaps George is wrong about Dex One being the best acquisition target.
1. Dex One:
As the recommended acquisition/merger target, we have to look at Dex One first. The first and most important thing to do is to understand that this is not a business that is dying. The easiest way to do that is to simply look at their year over year guidance and compare the two.
Dex One Corporation announced that it has affirmed fiscal 2011 guidance and expects revenue of $1.475 to $1.500 billion and adjusted EBITDA of $625 to $650 million for fiscal 2011.
Dex One Corporation reaffirmed fiscal 2012 guidance and expects revenue to be in the range of $1.225-$1.300 billion and adjusted EBITDA in the range of $500-$575 million.
The takeaway from the above two statements is that revenues and earnings are decreasing, but not in a "Oh my gosh the sky is falling" fashion. Their guidance for 2012 FCF comes in at $360M. That's a lot of money for a company with a market capitalization of $45M. That's an especially large sum when you note that they decided to retire $425M of debt in the first four months of 2012. Mission accomplished.
2. Yellow Media:
I prefer Yellow Media (YLWPF.PK) as an acquisition target, myself. It's just a lot harder to understand because there are so many moving pieces.
It is truly a purposely misunderstood opportunity. I have built a cash flow analysis here. Otherwise reference the table below, which is the worst case scenario where the bank doesn't help out at all and the company starts buying back debt under the prevailing agreements and closes out debt at an average of $0.70 on the dollar. Note that this is a premium to the $0.50 where the company's debt is currently trading.
The first tab assumes that Yellow Media gets 0 cooperation from the banks and is forced to "Go it alone" and closes debt at the prevailing market prices.
The second tab illustrates a more likely scenario, where Yellow Media is able to renew their credit facility to the extent of $300M for a duration of 2 years. They close out debt at market prices and come out kicking and screaming. The reason that they are more likely to be able to renew their credit facility is twofold.
If you are too lazy to read and would just rather listen to me scream about how undiscovered this opportunity is, try this.
|2011 - Q4||2012 - Q1||2012 - Q2||2012 - Q3||2012 - Q4||2013 - Q1||2013 - Q2||2013 - Q3||2013 - Q4||2014 - Q1||2014 - Q2||2014 - Q3||2014 - Q4||2015||2016||2017||2018||2019||2020|
|Online - quarterly change (+/-)||2.25%||2.25%||2.25%||2.25%||2.25%||2.25%||2.25%||2.25%||2.25%||2.25%||2.25%||15.00%||15.00%||15.00%||15.00%||15.00%||15.00%|
|Print - quarterly change (+/-)||-4.40%||-4.40%||-4.40%||-4.40%||-4.40%||-4.40%||-4.40%||-4.40%||-4.40%||-4.40%||-4.40%||-15.00%||-15.00%||0.00%||0.00%||0.00%||0.00%|
|Debt||2011 - Q4||2012 - Q1||2012 - Q2||2012 - Q3||2012 - Q4||2013 - Q1||2013 - Q2||2013 - Q3||2013 - Q4||2014 - Q1||2014 - Q2||2014 - Q3||2014 - Q4||2015||2016||2017||2018||2019||2020|
|Credit Facility - NRT||3.3||2.1||1.8||1.5||1.2||0.9|
|Credit Facility - RT||2.6||2.6||2.6||2.6||1.3||1.7||1.7||1.7||1.7|
|Debentures 2017- 6.25%||2.9||2.9||2.9||2.9||2.9||2.9||2.9||2.9||0.9||0.0||0.0||0.0||0.0||0.0||0.0||0.0||0.0||0.0||0.0|
|Medium Term Notes|
|July 2013 - 6.50%||1.5||1.5||1.5||1.5||1.5||1.5||1.5|
|Dec 2013 - 6.85%||1.5||1.5||1.5||1.5||1.5||1.5||1.5||1.5||1.5|
|Apr 2014 - 5.71%||2.5||2.5||2.5||2.5||2.5||2.5||2.5||2.5||2.5||2.5|
|Feb 2015 - 7.30%||2.5||2.5||2.5||2.5||2.5||2.5||2.5||2.5||2.5||2.5||2.5||2.5||2.5||1.5|
|Feb 2016 - 5.25%||4.2||4.2||4.2||4.2||4.2||4.2||4.2||4.2||4.2||4.2||4.2||4.2||4.2||16.8||2.8|
|Nov 2019 - 5.85%||1.8||1.8||1.8||1.8||1.8||1.8||1.8||1.8||1.8||1.8||1.8||1.8||1.8||7.1||7.1||7.1||7.1||6.4|
|Mar 2020 - 7.75%||5.8||5.8||5.8||5.8||5.8||5.8||5.8||5.8||5.8||5.8||5.8||5.8||5.8||23.3||23.3||23.3||23.3||23.3||5.8|
|Feb 2036 - 6.25%||0.3||0.3||0.3||0.3||0.3||0.3||0.3||0.3||0.3||0.3||0.3||0.3||0.3||1.1||1.1||1.1||1.1||1.1||1.1|
|Interest adj (timing)||6.9||2.9|
|Other finance charges||1.9|
|Change in operating assets/liabilities||47.9|
|Net inc/(loss)-disc Ops||2.9||0.0|
|Cash on hand - opening||52.0|
|Cash from asset sales||72.0|
|Excess cash for period||(A - B)||182.5||14.7||70.4||65.8||61.6||43.5||54.7||52.5||51.7||36.9||50.1||47.9||45.8||185.5||187.9||234.0||268.8||309.6||379.4|
|Credit Facility NRT 4.4%||250||45.0||25.0||25.0||25.0||25.0||105.0|
|Credit Facility RT 4.4%||16||16.0||-239.0||239.0|
|Debentures 2017- 6.25%||184||184.0|
|Medium Term Notes|
|July 2013 - 6.50%||130||91.0|
|Dec 2013 - 6.85%||125||87.5|
|Apr 2014 - 5.71%||255||178.5|
|Feb 2015 - 7.30%||138||138.0|
|Feb 2016 - 5.25%||320||320.0|
|Nov 2019 - 5.85%||121||121.0|
|Mar 2020 - 7.75%||300||300.0|
|Feb 2036 - 6.25%||17||17.0|
|total opening debt||1891|
|Cash flow for period||(C - D)||86.5||228.4||45.4||40.8||36.6||-300.5||54.7||-38.5||-35.8||36.9||-128.4||47.9||45.8||47.5||-132.1||50.0||268.8||188.6||62.4|
Below are two reasons why it is likely that the bank will renew their credit facility and the price will soar overnight.
1. They presently have a credit facility drawn totaling over $400M. If the company wants to play dirty because they perceive that the bank is not playing fair, they can let the Preferred As turnover into debt... and then let the bank fight with the A shareholders over the cash. I believe that it makes more sense from the bank's perspective to work this out ahead of time. Why? They get their money back over time with less effort and are paid to do it. Otherwise, the bank could potentially get tossed into a highly unpredictable CCAA scenario where they might end up getting less than par back.
2. The company's DEBT/EBITDA is less than 4, running at 2.9x. Historically, companies are able to leverage up to 4x. In fact, if you pay attention to what they say, they have a history of being begged to leverage up. They chose not to, played it conservative, and now all of the market participants are in an unreasonable tizzy because all of their peers were foolish, levered up and have been restructured. I believe that Yellow Media is, in fact, underleveraged given their capacity to lever up right now. Unfortunately, they do not have the ability to match their capacity because of the prevailing pessimism across analysts who, as far as I can tell, are straight lining or accelerating the drop off in print.
I think that the models they are using aren't fair or reasonable. Not only that, I'm baffled in regards to how they are using their models to support an intrinsic valuation of $0.01 for a company that is making 30x that in earnings per year. Long story short, the revenue drop offs are not steep enough to justify the present valuation.
As you will notice, Yellow Media never runs out of cash (Accumulated Flow never goes negative) and they are able to meet their obligations as they come due in both scenarios (in the excel file). Market perception is under the influence of extreme pessimism and has declared that this is a dead horse, but is it really?
If you believe that my forecast is reasonable; that is to say that they are a solvent company, my advice is as follows: load up on the Preferred C and Preferred D shares. They are not a play on valuation, but on solvency and refinancing, which at least from my perspective is completely out of the picture of reality. I think that the analysts and bondholders are fantasizing about worst case scenarios that are so bad that I would argue that they are beyond unlikely.
Right now, I have been buying Yellow Media's Preferred C's and D's for $0.25. At a par value of $25 and a dividend that is cumulative at greater than $0.40 cents a share per quarter on both of them, I am locking in a 100-bagger with a 500% cumulative yield once they start paying out. I anticipate that they will pay out their present share price in the next 200 business days upon conversion of the series A to common, triggering a dividend payment of the cummulated dividends on the Cs and the Ds. This equals over 3x of what the present cost to own is. I call that my "RISK-FREE-RETURN-OF-CAPITAL." Risk-free 200% return just for playing? Count me in. This absolute ridiculous opportunity indicates just how mispriced the entire sector is.
TLDR; Buffett Would Buy SuperMedia If He Knew About It
This all brings me back to the initial premise, would Warren Buffett be buying SuperMedia? Absolutely. His style with Lee Enterprises was to play both the debt and equity sides. I suspect that if I had several billion at my disposal and I was him, I would be doing the exact same if I knew about SuperMedia.
This leads me to believe that he does not yet know about SuperMedia. That's too bad, really, for him. In the meanwhile, I will be snapping up shares.
He would say: "Be greedy when others are fearful."
But, I would say: "Uncertainty will certainly work for me."
Disclosure: I am long LEE, SPMD, DEXO, YLWPF.PK.
Additional disclosure: I also own the preferreds of all preferred classes of Yellow Media as well as various debt instruments.