SuperMedia: Buy Now?


SuperMedia (SPMD) is one of the largest yellow pages directory publishers in the United States. The company prints directories in 32 states and online. The company was loaded with debt and entered bankruptcy in March 2009. It emerged from bankruptcy in December 2009 and all bankruptcy court cases were finally completed in December 2011.

SuperMedia has a market capitalization of $35m, a cash balance of $150m and an enterprise value of $1.5b. The company's share price is around $2.25 and its cash per share is approximately $10/share. These kinds of numbers have attracted some well known investors - George Schultze owns 9.1% of the company; John Paulson owns 16% of the company (and has a representative on the board).

So is this a company worth investing in? Let's take a look.

History: SPMD was formed as a spin-off from Verizon (VZ) and continues to be the official directory in markets where Verizon was the exchange carrier. SPMD has agreements in place with the exchanges till 2036, under which SPMD is the official directory for the area served by the exchange and the exchange will not produce another directory.

Business: The company earns money through selling advertisements in its directories and online listings. Revenue has declined from $3.1b in 2007 to $1.6b in 2011. Yellow page directories are a dying business. Yet, in 2011 the company distributed 89 million directories. Additionally, the company has expanded its digital offering. In 2011, the company sold advertising to approximately 393,000 clients. The renewal rate was approximately 80%. No one client represents more than 0.2% of revenues - an extremely diverse base. The company could perhaps make for a nice cigar-butt type investment?

Operating Performance: In Q1 2012 - revenues declined 17% compared to Q1 2011. SPMD however was able to cut expenses by 24% resulting in margin expansion despite the revenue decline. Adjusted EBITDA currently stands at 40%. As the company's revenue has decreased, management has aggressively cut costs over the last two years. The question is how much further can management cut costs? The revenue decline seems to be secular - having decreased by over 15% in each of the last four quarters. SPMD has yet to arrest the slide in revenues and does not seem to be able to do so.

I checked on Alexa and their main website is the 458th in traffic rankings for the U.S. That seems high, except when it emerged from bankruptcy it was 371st. The company has thus lost ground on its web presence too.

Debt: When the company emerged from bankruptcy it had $2,750m of debt. Interest rates on the debt are high at LIBOR plus 8% - Currently that's 11.0% (due to LIBOR floors). The company is also required to make mandatory debt payments at the end of each quarter. To de-leverage the company, management has been actively buying debt in the market at prices well below par.

For example, SPMD reduced its debt by a face value of $60m by repurchasing the debt for $31m. By engaging in these types of repurchases and the mandatory principal payments - SPMD's debt is now $1.6b. The company has thus retired over $1.1b of debt since January 2010. Unfortunately as the company's revenue declines, its operating cash-flows also decline. Thus, the amount of debt it is repaying declines each quarter.

Last quarter the company repaid $69 million as part of the mandatory repayment and used another $31m to retire $60m of debt. All in all, the company was able to reduce its debt burden by approximately $130m during the quarter. As revenues continue to decline, the debt repayment amounts are almost certain to decrease. Assuming the company can keep repaying debt at this rate (a very optimistic assumption), it will take SuperMedia 13 quarters to repay all the debt. The company's debt matures in 15 quarters. That's not a lot of margin for error. A slowdown in the repayment schedule appears more realistic. In such a scenario, SPMD will be at the mercy of its creditors willingness to renegotiate debt.

Conclusion: If the company is able to stop (or reverse) its decline in revenue, it could represent an opportunity for outsize returns for equity investors. As it currently stands however, there is considerable risk betting on that outcome. Debt holders are likely to receive all cash-flows for at-least the next three years. Equity investors can probably wait for the revenues to stabilize or show an upturn before getting into this stock.

Some equity investors are betting on a merger or consolidation with Dex One (DEXO) or Yellow Media (YLWPF.PK). We think that's extremely speculative. While a merger is possible, and may result in a sharp increase in SuperMedia's market capitalization, we do not think it is wise to bet on the hope of a merger.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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