Journal Communications Is Still Undervalued Even After Significant Rise

| About: Journal Communications, (JRN)
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Journal Communications (NYSE:JRN) should trade at a higher multiple based on recent industry deal comps and a shift from publishing to broadcasting.

Company overview

JRN is a diversified media company that operates 20 publications (including the flagship Milwaukee Journal Sentinel), 35 radio stations, 15 television stations and provides commercial printing services.

Investment thesis

The broadcasting industry (including JRN) rose significantly YTD due to increased M&A activity and improving operating performance driven by higher advertising and retransmission fees.

However JRN trades several EBITDA turns lower than recent deal multiples.

Acquirers are willing to pay higher multiples due to the ability to realize significant, near-term cost savings, which reduces the deal multiple to a mid-single digit level in many cases.

The trend of newspaper publishers reducing their exposure to this industry, with a challenging secular outlook, should continue. Debt-fueled acquisitions of local television stations are attractive from the perspective of the acquirer given the high and rising cash flow and higher margins.

Furthermore, the value of a group of stations increases as it grows larger due to increased leverage over cable and satellite operators. This virtuous cycle (if you are a seller, vicious if you are a bondholder) should drive additional M&A activity.

The fact that the stocks of acquirers actually rose after the announcement (34% for GCI and 5.4% for TRBAA) as opposed to falling (due to the usual fears of overpaying or integration risk) should encourage CEOs to take advantage of a receptive market.

Everyone has a price: Why high insider ownership is not a dealbreaker

The high insider ownership at JRN does not necessarily prevent a takeover given that insiders at Belo owned ~42 percent of the voting power at the time of the merger.

Insiders will need to approve any sale given the dual class structure (Class B shares do not trade, receive ten votes per share and are primarily held by current and former employees, board members and members of the family of the former chairman). However, JRN removed one significant deal obstacle by acquiring all outstanding Class C shares with enhanced voting rights in August 2012, which resulted in a simplified capital structure and higher EPS.

JRN is generally a buyer of broadcasting assets (acquired two FM Stations in Tulsa, a radio station in Knoxville, a television station in Nashville* and a television station in Green Bay) and a seller of publishing assets (see below).

Although management discussed the possibility of more acquisitions on the most recent conference call, it could maximize shareholder value by following the lead of Media General, which sold its newspapers to Warren Buffet in May 2012 and merged with New Young Broadcasting in June 2013. A possible buyer is GCI, who said it was open to future deals even after its recent acquisition.

At a minimum, JRN should sell its newspapers, which should further increase its valuation as it would be a pure play broadcasting company. The newspapers should receive a reasonable multiple (at least not distressed) given the improving fundamentals and possible strategic interest (Buffett or Class B shareholders).

Factors supporting this valuation include the following:

  • JRN newspapers have a high market share (readership of the print newspaper and digital websites ranks first among the largest U.S. markets with a 60% penetration rate).
  • The Milwaukee Journal Sentinel (87% of publishing revenue) is the only major daily newspaper for the Milwaukee metropolitan area. Moreover, the Sunday Milwaukee Journal Sentinel is ranked number one in readership among the 50 highest populated markets in the U.S. and the daily newspaper is ranked number two (according to a 2012 readership survey conducted by Scarborough Research).
  • Circulation and page views (average of 36.6 million per month) continue to increase despite the introduction of a paywall in 1Q12 and a price increase for home delivery subscribers, which gives them full access to all digital products.

*This acquisition resulted in the significant increase in debt however the strong cash flow of the station due to its high market share (CBS-affiliate, a ratings leader in the Nashville market and one of the top three CBS affiliates in the U.S.) more than justifies the price and use of debt. In December 2012, JRN amended its credit facility, which provided additional financial flexibility.

JRN should trade at a higher multiple given the shift towards broadcasting

The shift over the past several years away from the declining publishing industry (through asset sales) with lower margins and towards the broadcasting industry with higher margins deserves a permanently higher multiple. The few remaining publishing assets are concentrated in the Wisconsin area, where JRN has a high market share (see above).

The broadcasting industry should benefit from two major growth catalysts.

First, the significant rise in high margin, retransmission fees (expected to amount to $3 billion this year from $758 million in 2009) should continue to drive strong cash flow growth. On the most recent conference call, management said retransmission fees will be a "material revenue driver" due to annual contractual rate increases in existing contracts and renegotiation of expiring contracts. In the mrq, retransmission revenue rose 145%.

Second, political ad spending should continue to grow. In the mrq, political and issue advertising revenues fell as 2013 is an "off year". However, spending should increase significantly ahead of the midterm elections next year.

Broadcasting revenue as a percent of total revenue continues to rise...

...while broadcasting earnings now account for more than 90% of total earnings...

Strong operating cash flow and low capex fund debt repayment and share repurchases

JRN repurchased $7.6 million of shares since the authorization of a $45 million repurchase plan in July 2011. Going forward, the focus is expected to be on debt repayment after the recent acquisition of a television station in Nashville.

In the mrq, adjusted EBITDA rose 33.2% to $15.4 million driven by strong performance in the broadcasting segment.

Risks

Pension liability. The defined benefit pension plan is underfunded by ~$79 million. This risk is mitigated given that effective 1/1/2011, the benefit accruals under the qualified defined benefit pension plan and the unfunded, non-qualified pension plan were permanently frozen.

Growth of DVRs. The growing use of DVRs and the ability to skip commercials could negatively affect ad rates.

Highly competitive markets. Each of the business segments face intense competition from other radio and television stations, newspapers, magazines, Yellow Pages, cable television, satellite television and radio, direct mail services, billboards and the internet in general.

Dependent on advertising. Advertising in radio, television and newspapers accounted for ~69% of total revenue in 2012. This revenue stream would be negatively affected by deteriorating economic conditions such as those experienced in 2008. Moreover, JRN generates a majority of its advertising dollars from a small number of highly cyclical industries such as autos and politics.

Newspapers face secular decline. Print advertising revenue continues to decline due to secular changes in the industry including the shift to reading online (with lower ad rates), free alternatives to paywalls and the migration of ad dollars away from newspapers (e.g. to Craigslist for classifieds). The shift to digital may not be able to offset the declines in print.

Conclusion

The target price of ~$11 is based on a 8.5x EBITDA multiple.

An important note regarding entry: Given the parabolic rise since the beginning of July, I strongly suggest waiting for a pullback to the 20 DMA at a minimum.

A maximum stop loss of 5% should be placed below the entry price to limit risk given the high probability of a near-term pullback. The time frame is one year.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.