Far from Dead: The Case for 3 Newspaper Stocks

The digital age has not been kind to the newspaper industry. Not too long ago owning a newspaper was a lucrative enterprise synonymous with large circulation numbers, huge profit margins, and historically high stock prices.The newspaper industry, the second oldest mass media enterprise in the United States with more than 3 centuries of existence, had no outside competition because its structure was practically a monopoly and its core business highly localized.

This was before the newspaper business model was mercilessly dismantled by the web and its three-headed monster: Craigslist, Google, and the culture of free content. With the accelerated growth of the internet via the web browser in 1996, newspaper profit margins began to shrink at faster rates than ever before. Suddenly, news audiences and advertisers had a new platform and the desirability for print newspapers declined. The story is a familiar one but there are a lot of myths.

By 2006, big city newspapers such as The Philadelphia Inquirer, The Los Angeles Times, The Mercury News, and The Chicago Tribune were in serious financial trouble. Circulation numbers and balance sheets were a horror show and soon layoffs and leverage buyouts became the norm. Yet, the newspaper industry continues to be profitable accounting for more than $45 billion in annual sales. The level of consolidation has also increased to reduce high printing and personnel costs, but newspapers continue to be extremely vulnerable to economic downturns, declining readership levels, and new digital players that have an adverse effect on advertising revenues.

As a result, media pundits (among them Michael Wolff, Dave Winer and Robert Scoble), and a growing number of investors, are convinced the newspaper industry is dead and whatever steps some newspapers take to increase profits are seen as desperate attempts to revive a moribund industry. This perception or view is outright apocalyptic if not shortsighted and lazy simply because it fails to recognize one of the fundamental characteristics of the information industry--disruption as the result of innovation and new business models are nothing new to newspapers (newspapers survived radio, TV, and cable) and the fact that we now have multiple distribution channels will benefit newspapers in the long run.

New technologies made newspapers better in the past by increasing the speed of layout and printing. With the web the issue is about distribution and audience retention. However, newspaper executives did not anticipate the digital threat, and when they finally woke up to the cruel hyper realities of blogging, linking, digging, googleling, and twittering, they took too long to react, believing that their old-fashioned, monastic content model would keep the digital barbarians at bay. It didn't. But despite the lack of adaptability and declining ad dollars, the newspaper industry remains profitable.

I also suspect a lot of savvy investors are keeping an eye on it, waiting for the right opportunities to present themselves. For example, Gannett (GCI) and News Corp. (NWS) are making a profit, but they are overshadowed by the under-performing players and a few sensational financial flops that make juicy headlines. But it is a skewed picture. Surely, the stock prices of many newspaper companies will continue to fall, but it doesn't mean this will continue indefinitely. At some point this industry will figure it out. Further consolidation is also a likely scenario in order to cut costs and improve operating efficiency. There will be more victims, but this industry won't disappear, not in my lifetime at least. The industry will change and companies may have to get rid of printing operations altogether, but their core product and mission—to provide news and information to the public--will remain the same. Chris Anderson summed up the situation:

Surprisingly, the industry is just ten percent off its historic highs (much like the stock market) and is still twice as big as it was twenty years ago…What people forget is that industries peak at the top. Which is to say, at the very time that the first and second derivative people are writing off a business, those who can stand back and see the value still left in it can make a mint. Laugh at newspapers if you will, but I'll bet some private equity firm out there is looking...and licking their chops.

Nevertheless, bottoms are hard to predict in an evolving industry and recent purchases such as Sam Zell's Tribune deal are perfect examples of what can happen when eager investors looking for bargains ignore the complexities of the newspaper industry and decide to buy media properties at inflated prices with borrowed money. Retrofitting newspapers is not just about numbers and financial formulas--the industry is deeply embedded in tradition and multilayered editorial structures and hierarchies and its many stakeholders don't necessarily see growth, profitability, and return on assets as the only way to measure performance. That's why the dog-eat-dog approach Zell is so used to will not work if he continues to cut his newsroom staff. Yes, labor is the main expense for newspapers—taking about 40% of operating revenue—but it's also its main resource. Zell now runs the risk of becoming a liquidator rather than a savior of newspapers.

Journalists are not just middlemen as Dave Winer suggests, thus cutting your best people is not only a sign of bad management--it's a self-defeating short-term strategy. You can't replace skill, industry knowledge, analysis, and insight with technology in an industry where credibility is your main product. Many newsrooms are demoralized because job cuts have done nothing to remedy the financial picture, but they have progressively reduced the quality of reporting. Moreover, editorial concerns have been overshadowed by investor complains and managerial blunders. But one thing is now clear: Cost cutting alone won't save the newspaper industry--it will take creativity, innovation, and competent management to succeed. The bad news for investors: Very few companies exhibit these qualities at the moment.

Three publicly traded newspaper companies that I think are well positioned to thrive in the near future despite the growing problems that besiege the newspaper industry are New Corp., Gannett, and The New York Times Co. I base by opinion on the following criteria: a) Ability to monetize and exploit current and emerging web technologies b) Improved operating efficiency c) Strong brand.

News Corp.

New Corporation (NWS) is perhaps the single most diversified media entity on the planet with a mix of new and old media properties, including a motion picture studio, cable and satellite TV, a major book publishing house (Harper Collins), and MySpace. On a global scale there are very few companies that can match News Corp.'s reach and content distribution network, especially now that CEO Rupert Murdoch has decided to buy everything related to news media. News Corp is also the world's leading English-language newspaper company with publications in the U.K., Australia, Asia, and the United States. In the U.S. market, News Corp. now owns two of the nation's largest circulation newspapers (The New York Post and The Wall Street Journal) and the company is making a $580 bid for Newsday.

Owning newspapers in the developed world is now a problematic and risky operation, but when you have the cash flows that Murdoch has at his disposal there is plenty of room for experimentation and patience. Liquidity and capital resources are what set News Corp. apart from any of its peers in the newspaper industry. The ability to endure economic slowdowns and consumer shifting preferences without going into the red cannot be understated. Financially, News Corp. is in great shape, ending fiscal 2007 with $7.6 billion in cash. Murdoch is also first and foremost an old school newspaper guy--he made his name in the newspaper business and he understands the adverse economic realities that plague the industry now. He also knows his newspaper division can have a negative effect on the operating results of News Corp. if advertising revenues continue to slide. Therefore, to offset potential losses, Murdoch and News Corp. are betting heavily on the web. He knows the major threats to newspapers are new media formats and shifting consumer preferences. The strategy appears to be working, at least for now.

News Corp.'s newspaper division (which made up 16% of the company's revenues in 2007 and 2006) reported revenues of $4.5 billion in fiscal 2007 up from $4 billion in fiscal 2006, or a 10% change. Operating income for the newspaper division increased from $517 million in fiscal 2006 to $653 million in fiscal 2007, or a 26% increase. Part of this increase was the end result of higher internet revenues, favorable exchange rates due to the weakening of the U.S. dollar, and lower production costs. These figures do not include the recent acquisition of Dow Jones and its flagship publication, The Wall Street Journal which dominates the business and financial news arena. Murdoch will in all certainty begin to make changes at The Wall Street Journal by implementing some of the same strategies that have been successful in other News Corp. newspapers: shorter articles in the print version and more video content in the online version; more political and sports coverage in both print and online; and fewer business articles on the front page. This might not go well with traditionalists who view the WSJ strictly as a financial publication, but it is a proven strategy within News Corp. Whether it will work at the WSJ remains to be seen and there are many skeptics such as Fusion IQ's Barry Ritholtz:

In my opinion, this is a deeply misguided and risky undertaking, driven more by ego than profit motive...Murdoch's changes are both ambitious and perplexing: He is seeking to shift the Journal's coverage to include much more politics, more elections, more general government activity. The Journal itself reported the move to "put short articles on the front page or the fronts of sections that would not continue on inside pages." The fear that the paper might shift rightward in its news coverage has proven to be unfounded (so far); instead, it is the topics and subjects covered that is what is shifting. Coverage of Financial news is losing out to Mr. Murdoch's true love: Politics.

Murdoch's recent buying spree also puts him in a precarious situation in terms of newspaper ownership restrictions, particularly with the Newsday offer. Can Murdoch work this out to his advantage? "That depends on how strictly the F.C.C. sticks to their own rules on diversification of media ownership per city," added Ritholtz. However, if the deal is approved by the F.C.C. through a waiver, Murdoch and News Corp. will have an incredible amount of leverage in terms of negotiating advertising rates. This makes a lot of people uneasy, but it should put a smile on News Corp. investors if News Corp. executes.

Gannett Co., Inc.

Despite significant loses in ad revenue, Gannet (GCI) is successfully repositioning itself as a major multimedia news player by buying internet and mobile media properties to create an extensive ad network across multiple media platforms in the U.S. and the U.K. The company wants to become the digital destination for local news and information in all its markets. Indeed, Gannett's newspaper web sites in the U.S. are already attracting a large number of visitors. For example, Usatoday.com receives more than 43 million visits each month and, in fiscal 2006, online revenue for its local newspaper web sites increased by 24%. These are encouraging numbers, but Gannett needs to do more to offset the losses from print advertising which declined by 6% in fiscal 2007. Making things worse for the company is the real estate crisis which hit key Gannett states such as Arizona, California, and Florida. These are the economic downturns that make newspapers extremely vulnerable and keep investors away.

Despite revenue loses, Gannett reported an operating profit margin of 22% in 2007 thanks in part to the streamlining of operations by the company's management. But because more than 85% of the company's operating profits still come from newspapers there is a high level of risk involved if advertising and circulation revenue continues to decline. Another concern is the company's newspaper operating income which decreased in 2007, to $1.41 billion from $1.61 billion in 2006. However, historically Gannett has generated solid cash flows and the company appears to have adequate liquidity--ending fiscal 2007 with $77 million in cash.

In addition, with 85 daily newspapers (each with its online version), and 900 non-daily publications in the U.S. market, Gannett has considerable leverage in terms of news content and advertising space. In the U.K., the company is the second largest regional newspaper publisher both in print and online with 17 daily newspapers and 300 non-daily publications along with locally integrated web sites. This gives the company some flexibility by being able to offer a diverse audience with diverse lifestyles to regional, national, and global advertisers.

Gannett's future is obviously in the internet and the company seems to have the right strategy in place. The company's total internet audience according to Nielsen/NetRatings in January 2008 was 25.8 million unique visitors or 15.9% of the total internet audience in the U.S. This should not come as a surprise because the company has been extremely vocal about its intentions in the digital and mobile domains. Newspaper web sites also grew 27% in page views and 8% in unique visits.

No one knows for certain what the right business model is for online news content providers, but Gannett is trying different things at once. Through CareerBuilder and PointRoll, the Company is also trying to capture back some of the lost online classified and advertising revenue. Gannett is also training its print journalists to use video for their newspaper web sites, including how to incorporate ads in their video stories with the help of advertising and sales personnel. But print shouldn't be seen as a total liability. This company still controls a paid circulation of approximately 6.9 million, including USA Today, the nation's largest daily newspaper with a circulation of 2.3 million. For a mass ad campaign this model continues to be both effective and profitable. In 2007, Gannett also established a partnership with Microsoft Corp. making CareerBuilder the exclusive career search engine at MSN.

Social networking capabilities are also in place in many of the company's newspapers. For example, Gannett's web sites for moms have been a huge success. For instance, The Indianapolis Star's Indymoms.com site served as the model for the now more than 58 moms.com sites across the U.S. with a combined 7.5 million monthly page views and 550,000 unique visitors. Clearly this is a company that is not waiting to be rescued by a private equity outfit. The company's management understands who their competitors are and they know the internet holds the key to future growth. But crossing over to the internet is just half of the battle for newspapers. Once an online presence has been established, newspaper web sites have to compete with numerous players including Google, Yahoo!, Craigslist, and the thousands of independent web sites and blogs providing news content. But if newspaper companies like Gannett continue to execute in the local news arena and keep operating costs low in their print units, these companies have a good chance to succeed in the digital age.

New York Times Company

Selecting the New York Times Company (NYT) is the ultimately contrarian play. It is a risky proposition considering the current financial struggles at The New York Times, but it's hard to ignore this topnotch media brand. In his recent letter to shareholders Chairman Arthur Sulzberger outlined his multiyear strategy to transition The New York Times Co. from a print newspaper company to a digital, multi-platform media company:

• Introduce new products both in print and online
• Build research and development capabilities
• Rebalance the portfolio of businesses
• Aggressively manage costs

Sulzberger also highlighted the progress already made in some of these areas, stressing that a complete transformation will take time. Print continues to bring revenue, but print advertising and circulation are obviously declining. Therefore, the online side of the business needs to grow faster to offset these losses. Managing costs and improving operational efficiency are also essential. Operating profit from continuing operations increased to $227 million from a loss of $521 million in 2006. Moving into a new building has also allowed the company to combine its print and digital operations under one roof, cutting many costs in the process.

Sulzberger is also right in pointing out that the biggest assets are The Times and the Globe brands. Indeed, credibility in the news business is a powerful competitive advantage and that's what these two brands represent. Transferring this brand equity to a digital medium and monetizing on it is the key to the company's future. But will The Times Co. do it fast enough? Some believe that Sulzberger's management is the problem. That's highly debatable because the company's online initiatives haven't been given enough time to prove their effectiveness. But some of the early sign are positive. The New York Times web site alone has become the most frequently visited newspaper web site on the web with about 13 million unique visitors every month. Last year the company generated $330 million in digital revenues, up 20% from 2006. The company has also launched more than 50 blogs and loaded more than 2,000 video clips on NYTimes.com. The About.com group also reported double digit revenue growth in fiscal 2007 and the group just launched a new web site in China, a country with 210 million web users. In the print side, the Sunday print edition became the largest in the nation in terms of circulation. What the New York Times Co. needs to do is figure out how to monetize its premium news content which won't be an easy task.

However, another point of concern is the allocation of capital. The company has been losing a lot of money. As a result, capital allocation is a huge issue for The Times Co. and its future will depend on how well the company invests its cash. For instance, to improve operations, the company is investing in the consolidation of its printing plants into one facility that will save the company $30 million a year. Capital spending in 2008 is expected to decrease to $175 from $375 million in 2007. Despite these changes, the company is cash strapped--the company ended fiscal 2007 with $51 million in cash, leaving very little room for error. Many pundits such as Wolff believe The Times Co. will not recover because management is not doing enough to cut costs and because the company has lost too much of its value--The New York Times Co. is currently worth about $2.8 billion, down from almost $7 billion in 2002.

. That's exactly what's very attractive about The Times Co. right now---the fear and speculation surrounding the company. Fear is irrational and it has a tendency to distort reality. I'm not suggesting The Times Co. is not in serious trouble. However, this company is worth much more than that. Consider the low PE, yield, and huge price decline as Matt Cooper suggested in Portfolio.com. But the real question concerns its future value. How much is it going to be worth in the future? That's the real catalyst for making money from an investor perspective by buying at a discount. But what if the restructuring doesn't work under the current management? Is the worst case scenario the prospect of an acquisition? Then that's still a good investment at the current price. Acquisitions usually work in favor of the shareholders of the acquiree. This is what Wolff had to say on the mater:

It could, however, at, say, the 67 percent premium Murdoch paid for The Wall Street Journal, be worth somewhat more than $4.5 billion today. There are at least a handful of parties, in addition to Murdoch, who might pay that kind of dough—and quite possibly more bidders, and quite possibly at higher sums.

The fact that I see two hedge fund owning 20% of The Times Co. tells me there is a lot of value in the company and I don't see it as a legitimate taker over threat at either. It will take a much bigger player to raise that alarm. In this sense I agree with Wolff's assessment of the situation:

Given the Sulzberger's lock, this hedge-fund riffraff couldn't hope to take over the Times. They could only hope to enhance their notoriety by trying to take over the Times. But that's the rub: such nobodies can, one after the other, grow their stature by making a run, no matter how futile, at the Times—so why wouldn't they?

Forget the nobodies for now. The point here is to keep in mind the value of these brand and what it means in the media industry and to potential buyers. If it does go for sale it will go at a premium and if you bought at this levels the investment is a lucrative one. If it goes private you still make money.

Those who persist on writing obituaries on behalf of the newspaper industry are dead wrong. Robert Scoble's moronic hyperbole has no substance and exhibits a fundamental misunderstanding on how transformations in communication and media occur from a historical and technological standpoint. I personally believe the industry is finally adopting and will eventually catch up to the digital age, but the structural changes will be painful. The newspaper industry failed to recognize the extent and magnitude of the digital revolution and what it would do to its business model. The web was different than radio, TV, and cable--it was far more disruptive not just because it transformed the way content was distributed but because it took out the classified revenue in a short amount of time. But the idea that newspapers will disappear is unfounded.

The three companies I discussed here are all responding to the challenges of the digital age by incorporating online strategies that are already yielding results. But how do you debunk the myth that incumbent industries cannot adopt to change? You do it by doing your own research. Those who do stand to make huge profits.

Disclosure: None

Comments

[drmalaka]

NYT is one of the most inflated stocks around. Paying attention to anything that Sulzberger says is pointless. This is still a fat company with too many over paid employees and unioninze labor. Sulzberger is flat out as incompetent as they come, without nepotism this guy would not be qualified to shine my shoes.

Furthermore, investing in NYT is like investing in communist Russia. Sulzberger is an avowed socialist/progressive and when you invest in his company understand that you are not investing in a capitalist company that will do whatever it needs to do in order to make money. Sulzberger puts his politics ahead of business, he will take this company down to zero before he would accepted a $50 takeover offer from someone like Murdoch. He is using shareholder money to advance his socialist agenda, watching the value of the company decline while he tries to get Obama elected.

This is the same moron that decided the best way to cut costs and increase profits was to reduce the actual paper width, not the payroll.

This is a dead industry and what everyone needs to understand is that you can not take it digital in the same way. Digital revenues are at best 10% of what paper revenues are per user. This also shows the complete rip off that advertising in these papers has always been, with beefed up circulation numbers just to increase ad revenues. Well that business model is gone.

[Trader T]

NYT is overvalued. A stock price of 8-9 is more appropriate looking forward. They need some serious reductions in upper management as well a major reorganization which will be difficult due family ownership issues. Too much money is being spent on 'talent' that doesn't add to the bottom line.

[Roger W.]

At present the main purpose of the NYT is to push the political positions of Mr. Sulzberger not to make money. Investing in a company whose management regards it as their private toy and source of social position is not a formula for financial advancement.

[Donald E. L. Johnson]

What you're recommending is bottom fishing, catching a falling knife. This a very speculative approach to investing and traders should put only tiny parts of their investing capital in such trades.

So many companies have slumped tremendously after they looked cheap. Consider Motorola, Enron, Qwest, Ford.

Of the three stocks, Gannett looks most promising and NYT the least. This is not only because Gannett is willing to produce lousy editorial products and run newspapers like businesses while the NYT takes joy in turning off half of its potential audience with its hard left editorials and editorial bias in the newsroom. It's also because Gannett has enough cash to buy the NYT and the experience and expertise needed to turn it around.

NYT may be a strong brand in NYC, but its circulation is down sharply in the latest reporting period along with most other papers. And there is no bottom in sight. I pickup the Times every three or four months when big news is breaking. The daily is still a good read on many days, but I feel cheated when I blow $6 bucks on the Sunday Times, because compared with years ago and the WSJ, there is no there there.

Nice, comprehensive piece, but I'm thinking there's more hope than reality in your thinking at this point for newspapers. I think there is a pretty bright future for media companies like News Corp. and Gannett.

Ironically, because of hedge fund buying and, apparently, bottom fishing by contrarians, NYT has strong daily and weekly charts. NWS is still a sell. GCI is attempting to bottom with new buy signals on the daily and weekly charts. On point and figure charts, NYT ($19.60) has a bullish price objective of $24. GCI ($29.56) has a bearish objective of $18, and NWS ($18.23) has a bearish objective of $11. If these rally attempts fail, sell.

[gloria1234]

My hometown paper the San Jose Mercury News is privately held by MediaNews Group, and it is a great paper. I made $ going in and out of the Zell takeover, and I'm ashamed I did it. the LA Times is(/was?) a great paper. As for Newscorp goal to 'increase govt-politics coverage' @#$#$@^%%^&*^*= be v v afraid...The only news I pay for is the Merc (delivered); I enjoy NYT and WPost free online. Point being? I'm no expert. Apparently a) an American style stockmarket can annihilate a lot of industries and b) American style democracy depends on a free press (re the potential c)'s to this dangling syllogism, whatever...). I'll never buy a newspaper stock again.