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Return on assets is the hit by pitch of investing. A few days ago, a reader told me my post on Journal Communications had left him a bit confused. About midway through the article, he was starting to think this might be a good stock to buy. Then, my conclusion caught him a little off guard:

JRN has almost no downside. Sadly, it doesn’t seem to have a lot of upside either. There is a real danger investors will see their returns wither away as the time it takes to realize the value in Journal Communications proves costly. Time is the enemy of the investor who buys this kind of business at this kind of price. Objectively, I have to admit JRN is undervalued. But, I’m not sure it’s grossly undervalued – and I am sure there are better long term investments.

I did not do a very good job of explaining my position.

Journal Communications is undervalued. As I stated, I believe the constituent parts are worth somewhere between $1.25 billion and $2 billion. The $1.25 billion estimate is very low. I think it may be too low.

However, I am very pessimistic about the outlook for the kind of properties Journal Communications (NYSE:JRN) owns. The company’s earnings power is largely derived from newspapers, network TV affiliates, and terrestrial radio stations. None of these businesses provides a very good value to its customers. I hate to say that, but I believe it’s true.

Although the web’s most conspicuous growth has already come and gone (in the United States), the utility of the web continues to improve. I believe online content will continue to improve in quality and approachability. Local newspapers will operate online sites; but, the economics of such sites will be far less favorable than the monopolies they now enjoy.

Network television has already been weakened tremendously. Its importance to mass audiences will continue to diminish. There is little reason for network television. More fragmented cable and online sources can better exploit niches, whether those niches consist of a certain subject or a certain geographic area. The current network TV model of focusing on programs that can bring in large audiences is a very poor model. I know it has been the model for years. But, it’s flawed. It doesn’t offer value to audiences or advertisers.

Some of today’s most successful advertisers eschew the networks entirely. I don’t think they’re wrong to do so. No network television program is large enough to justly claim a mass audience. So, if it is only possible to advertise to tiny fragments of the public anyway, why not target specific segments yourself?

Networks have an even greater problem with viewers. The great advantage they should have is the cross – selling of their programs and the increased stickiness of their viewers. Unfortunately, they tend to adopt a model that mitigates these advantages. How many networks fill an adequate amount of prime viewing time with interesting, ongoing programming? Look at the schedule for these networks. You’ll notice some big holes in the schedule. The churn rate for network programming is way too high. They turn off viewers in the search for hits. The value of stability and familiarity is given no consideration at all.

The networks are playing on a much more level playing field than they should be. They have a huge advantage, a legacy inherited from a bygone era. But, they also have the advantages of customer complacency, deep pockets, and free publicity. Some network programming like the morning shows, the late night shows, national newscasts, and local newscasts do benefit from customer complacency. Viewers stick with something that they wouldn’t tolerate if it was unfamiliar.

People will still watch network television. It’s just that the playing field is becoming more and more level everyday. I’m not sure most investors appreciate the extent to which network television profits from its past. The same is certainly true of newspapers. Both newspapers and network television will lose this advantage. To the upcoming generation, these media are less distinct.

It’s hard to understand just how economically damaging a lack of distinction is for a media outlet. It destroys the franchise. Newspapers and network television will both look a lot like they have in the past. They will change with the times like everyone else. But, that’s precisely the problem. They will become more and more like the rest of the media.

My point here is the same one I made about Energizer Holdings (NYSE:ENR). A shift from alkaline batteries to lithium batteries will not do much to change the way many investors perceive Energizer’s business. However, it will cause a seismic shift in the profitability of the battery business.

Journal Communications will become a less profitable business. All of its properties have rapidly narrowing moats. Radio has, perhaps, the bleakest future of them all. But, so much has already been said about the future of terrestrial radio, that I have nothing to add to the debate.

So, what’s the bottom line? Journal Communications is a much better bargain than the Journal Register Company (JRC) – which may not even be a bargain at all (though Bruce Sherman believes it is. Last I checked, Private Capital Management held about 10% of JRC's shares). The problem with the Journal Register Company is that it isn’t all that cheap. Journal Communications is cheap. It generates tons of free cash flow relative to its price.

If you hold twenty – five or thirty stocks, Journal Communications will make a fine addition to your portfolio. However, if you hold a more concentrated portfolio, I think there are better long term bargains out there.

I believe both JRN and JRC would make better buys than the S&P 500. However, I wouldn’t particularly enjoy being an owner of a business that will be in decline for many years to come. They may both be bargains, but there is no reason for you to hold both. If you want to own a stock that’s this cheap relative to free cash flow, buy Journal Communications alone. JRN is selling at a much steeper discount to intrinsic value than JRC.

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Source: Journal Communications versus Journal Register Company (JRC, JRN)