Torstar Even Cheaper After Sale Of Harlequin

| About: Torstar Corp. (TORSF)
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Summary

The sale of Torstar's Harlequin unit is a win for shareholders.

Torstar's remaining assets now trade at a low free cash flow multiple.

Investors receive a safe 7% dividend yield.

(Editor's Note: Investors should be mindful of the risks in transacting in illiquid securities such as TORSF. Torstar's Toronto Stock Exchange listing TS-B.TO offers better liquidity.)

Eight months ago, I wrote about Torstar (OTC:OTC:OTCPK:TORSF) as a potential value investment. While the stock is up 30% since then, I believe the company is even cheaper now than it was then. The reason: the recently announced sale of the company's Harlequin business for $455 million.

This sale is great news for shareholders, much more so than what is reflected in the stock price, in my opinion. First, the multiple at which the company was able to make this sale is far in excess of the multiple at which the market is valuing the company. As a result, the company's discount to intrinsic value is now more evident. When I wrote about Torstar on September 5th, the entire market cap of the firm was $475 million. Now, it is selling a unit that contributed about 30% of the company's revenue and EBITDA for 95% of that market cap!

Of course, looking only at market cap numbers does not make sense when there is debt involved. Torstar's debt currently sits at $178 million. Management hinted on the conference call that it would pay it all down with the sale proceeds, which would result in a net cash position of $267 million. (Note that to arrive at this number, I also subtracted taxes on the sale of $10 million, which is at the upper end of the range management provided on the taxes owing as a result of the sale.)

At the current market price, the enterprise value of Torstar would become just $352 million upon closing. Considering the remaining segment of Torstar generated a 2013 operating profit (before asset impairments and restructuring charges, but after corporate costs, and assuming all corporate costs stay with Torstar) of $82 million, this results in a pro-forma EV/EBIT of just over 4.

Considering the market position of many of the company's assets (i.e. the leading source for local news) and its now much stronger financial position, I would argue that the company deserves an EV/EBIT ratio much closer to 10. This would result in an increase in the company's share price of around 75%.

Qualitatively, I also think Torstar has kept the more valuable part of the business. While Harlequin undoubtedly has a strong brand name that attracts some repeat purchases from customers, the unit has struggled of late. It is much better off in the hands of a strategic buyer like HarperCollins (the publisher, with parent company News Corp, that is purchasing Harlequin) that can remove duplicate functions and spread out its fixed costs over more units. Meanwhile, Torstar keeps the media companies (including the Toronto Star) which I believe have competitive advantages thanks to their local penetration, as discussed in my article eight months ago.

Torstar management has also stated that it remains committed to the dividend following this transaction. While the company was in debt, it was fair to speculate that the dividend was at risk considering the payout ratio represented a good chunk of free cash flow. But now, with a strong net cash position, Torstar's almost 7% dividend yield is very safe.

No investment is risk-free, however. Torstar has a number of risks which could derail this otherwise attractive situation.

First, it's possible the deal will fall through. The Canadian government reserves the right to reject the deal on cultural grounds, but management does not appear to deem this likely. Also, while this purchase represents only a blip in News Corp's cash balance, it is possible that due diligence results in a change of heart on the part of the buyer.

It's also worth noting that Torstar has a pension deficit of $35 million. It's not clear how much of that (if any) will be transferred as part of the Harlequin sale, but management is likely to provide an update on this later this week as the company announces its first quarter earnings.

There is also a risk that management blows the cash on a wasteful acquisition. Management is now going to evaluate how it can strengthen the business in the long-term, and it's possible that this process culminates in a transaction that ultimately destroys shareholder value. However, I'm comforted by the CEO's promise of patience and his recent track record with respect to safeguarding shareholder capital.

Finally, the company does own a number of old media assets, including newspapers. As such, one can expect further asset impairments and restructurings as the company will continue to require job cuts where returns deteriorate.

Torstar is cheap, has a strong balance sheet, has a number of local competitive advantages, and is making good capital allocation decisions. This formula is a recipe for shareholder success.

Disclosure: I am long TORSF. 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.

Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.