A.H. Belo: Huge Upside On Paper, Huge Risk From Strategy

Summary

• The paper case for AHC is hugely attractive: it's easy to model $3-plus in a liquidation scenario or ~100% upside.
• But the company is controlled by a descendant of the founder, who consistently reiterates his desire to keep the business running.
• That desire isn't necessarily wrong - but it leads to a strategy where success appears unlikely.
• The dividend is attractive, and there's some downside protection, but AHC is a far more difficult bet than the balance sheet would suggest.

If I could buy all of A.H. Belo (AHC) at Monday's close of $1.66 per share, I'm extremely confident I could make money - and potentially a good deal of money.

That's not because I'm a brilliant businessman or a brilliant negotiator. It's not because I have some special insight into the challenges facing the newspaper industry. Rather, it's because the value of the assets owned by A.H. Belo - including a hefty amount of cash - vastly outweighs the current market capitalization of AHC stock.

Of course, I don't own all of A.H. Belo (or any of it). Robert W. Decherd does. Obviously, Decherd doesn't own all of the company, but via a dual-class structure (and thanks to a deal with former CEO Jim Moroney, Decherd's second cousin), he controls 52.6% of the voting power. For most intents and purposes, Decherd does own A.H. Belo.

And Decherd has a different view of the company. To him, the Dallas Morning News, the core operating asset, is a family business. Decherd and Moroney descend from the Dealey family that founded the paper in 1885. Decherd joined Belo just out of college and basically rescued the DMN in the late 1970s. He spearheaded the sale of Belo's TV station business to Gannett (GCI) (which later split that business off into TEGNA (TGNA)), realizing over $60 million in the process.

Since Decherd returned to Belo in 2018, I've been skeptical that he planned to take steps to immediately realize the value AHC offers on paper. It's why I stepped away from the value case about eighteen months ago. Commentary from Decherd and Belo management last month, after the company delivered restated financials, suggests that skepticism was well-founded. And it creates a significant stumbling block to a value case that, on paper, looks particularly attractive right now.

The Asset Case

On paper, AHC is cheap. It might even be ridiculously cheap. At a current price of $1.64, the market capitalization sits at $35 million. Yet A.H. Belo closed 2019 with $48 million in cash. Per last month's investor update call, it expects to close this year with over $40 million on the balance sheet even after dividend payments and including cash invested behind the business. There's a $2.3 million tax refund on the way, thanks to provisions of the CARES Act that are not included in that total.

But the ~$43 million in pro forma cash isn't the only asset. Belo sold its headquarters last year for $28 million. It still holds a promissory note for $22.4 million, secured by the building. According to the 10-K, a second note for $375,000 was issued as well, as the buyer (a local developer) appears to have missed an interest payment amid pandemic-related troubles.

Even assuming foreclosure on the promissory note, Belo still owns a building that should be worth at least $20 million (in that outcome where a second sale requires a lower price). It has a printing facility in North Dallas that even Decherd has admitted "ultimately will be valuable" (presumably once the DMN ceases its print edition). That building is assessed at $16.5 million.

If A.H. Belo were to liquidate, it easily could wind up with some $75 million in cash ($43 million at year-end, $20 million for the headquarters, $12 million for the printing facility) at the absolute least. There are liabilities, including an operating lease liability for the new headquarters and a pension, both carried at $23 million.

But those liabilities are largely accounting issues. Surely, Belo could break its lease for a few million. The pension won't require contributions this year or next, according to commentary last month.

And this discussion hasn't mentioned the DMN or the marketing businesses Belo has acquired. If Belo wanted to get rid of the paper, it surely could find a way to do so while offloading the pension and lease requirements. It likely could go to Gannett and offer the business for the price of the printing facility plus the assumption of liabilities, similar to the deal Tribune Publishing (TPCO) made for the New York Daily News in 2017.

Gannett has an onerous debt load which would make such a deal attractive. It also owns the Austin American-Statesman, which possibly could provide some modest synergies for both the publishing and marketing businesses. From Gannett's perspective, if such a deal works, the equity can see an enormous benefit (its market cap is less than $200 million). If it doesn't, Gannett's lenders can worry about that in a restructuring that has a high likelihood of occurring anyway.

And if Gannett isn't interested, Tribune or hedge fund Alden Global might be. If that proves unpalatable, Decherd could use his clout in Dallas to raise a few million dollars to put the DMN into a trust.

However, it works out, there is some value in the paper and, particularly, the marketing businesses to someone out there. Certainly, there appears to be enough value to offload the lease, pension, and net working capital liabilities (the latter of which appears minimal based on year-end 2019 figures). There may even be enough value to get a modest purchase for the operating business.

However, an investor views the exact numbers, it's relatively easy to see at least a double on paper, which would require realized value around $70 million. But that paper value requires a strategy in which Belo - and namely Decherd - clearly isn't interested.

The Long-Term Strategy

A.H. Belo had to restate its financials owing to an impairment charge related to the company's consolidation of reporting segments. That process took some time (and the pandemic appears to have extended the delay), and so Belo was dark in terms of communication between the Q2 2019 call in late July and the investor update on May 12.

The message from Decherd last month was clear: A.H. Belo is staying the course. It is going to spend years trying to build a sustainable, profitable business on the back of the DMN and the marketing services business it's built alongside the paper.

In fact, the first question on the call was about the potential of a liquidation and/or short-term realization of shareholder value. Jonathon Fite of KMF Investments (an investment management firm located in north Texas) asked about the potential "100% ROI, if you will" implied in a liquidation scenario, balanced against the long-term plan.

Decherd's first sentence was telling: "Well, we don't run the analysis in that context." And it's worth repeating a later portion of his remarks in full [emphasis mine]:

Our Board has a very - a strong conviction about staying the course. We don't know what a sustainably profitable digital business looks like because one hasn't been invented yet, other than possibly The New York Times, depending on how you view the relationship between their print advertising and their digital - highly successful digital subscription and advertising environment. So from the standpoint of liquidation, we've said historically, the company is not for sale. We've looked at the question many times.

I'd go back, too, to a press release Belo issued in April detailing the company's response to the COVID-19 pandemic. Decherd was equally firm [emphasis again mine]:

Our Company is advantaged by comparison to most others, especially within the newspaper industry. This gives our Board choices to prioritize the long-term health of this great enterprise and support its reason for being - that is, to provide invaluable news and information to the people who depend on us and to the communities The Dallas Morning News has served for nearly 135 years.

Decherd isn't liquidating. He isn't selling the paper. Fite asked if Belo might acquire the struggling Fort Worth Star-Telegram, but Decherd (probably wisely) suggested, basically, that the DMN could take that business on the digital side for free.

Another questioner asked if Belo might consider delisting if its shareholder base became small enough, which appears a possibility (and probably not good for AHC from a short- to mid-term perspective). And the final question was about the proceeds from the promissory note. Per CFO Katy Murray, there is "no intent at this time" that the proceeds would be paid as a special dividend, as Belo has done in the past.

Last month's call doesn't signal a shift in strategy. As Decherd alluded to in his comments, Belo has been saying much the same thing for a long time.

But in my years following AHC, I don't recall the communication being quite this firm. There seemed a possibility in past years that the challenges facing the industry might eventually lead the company to focus on realizing near-term value, while finding a way to protect the core newspaper operations. (There have been rumors of an acquisition on occasion as well.)

That possibility no longer seems to exist. Belo is going to spend years, and capital, in an effort to build a sustainable and profitable business. The problem is that I'm highly skeptical that effort is going to work.

The Strategy Seems Unlikely to Work

Unsurprisingly, the newspaper business remains in decline. In 2019, print advertising revenue declined 10.1% year over year. Print circulation revenue dropped almost 7%.

The hope for the industry has been that the digital business - through both advertising and circulation - can offset those pressures to at least some degree. But it didn't happen in 2019. Digital advertising and marketing services revenue declined over 7%. Some of the pressure, per the K, came from the end of an agreement with Cars.com (CARS). But there seems pressure from programmatic ads on third-party sites (delivered by the marketing business) and fewer online ads at dallasnews.com.

Digital circulation did grow nicely in 2019, with revenue up 27%. But online subscriptions account for just 7.2% of total circulation sales, or less than $5 million. The print business lost almost as much circulation revenue just in 2019 ($4.71 million) as the digital business generated after years of effort ($4.94 million).

As bad as the numbers look, the outlook is even more dire - across the board. Declines in the digital marketing business appear to be continuing after a dismal 2018 (even excluding the impact of an accounting change, revenue fell double digits). Management was asked about those businesses, who saw a quick and marked reversal from impressive growth to declines in a relatively short fashion.

The answers aren't particularly promising. Murray noted that there was "extremely high cost of goods sold" with the businesses, which pressured profitability as revenue grew. DMN publisher Grant Moise, who used to head the digital businesses, pointed to the commodification of the product offering, and cited a shift to more retainer-based consulting business.

It's just not enough, however. And it's going to get worse given headwinds for the legacy newspaper business. Print still is over 92% of circulation revenue - and home delivery volume fell a staggering 28% in 2019. Rate hikes can't go on like that forever, if at all. Print accounts for 65% of ad sales (and a higher proportion for the DMN) - and too is heading in the wrong direction.

Profitability, even on an adjusted basis, continues to weaken. And at a certain point, cost reductions simply can't continue. The newspaper has to put out a product of some kind to attract even digital readers and subscribers.

I simply don't believe this strategy can work. It hasn't worked elsewhere, with (as Decherd noted) the possible exception of the Times. But that business has literally a worldwide reach (17% of digital-only subscriptions at the end of 2019 came from overseas) and vastly higher readership. The troubles at McClatchy (OTCPK:MNIQQ) and Gannett aren't just a matter of debt. The business is in decline, and no one has figured out a way to profit from whatever the 'new normal' turns out to be. I'm not willing to bet A.H. Belo necessarily is different.

Is AHC Stock Cheap Enough?

As I've written before, I have some sympathy for Decherd's direction of the company. As recent events show, local news is important. Yet the industry's overall health, let alone, the strategies undertaken by the likes of Alden have led to significant cuts in resources. It's almost certainly good for Dallas, and for Texas, that Belo is investing behind the Dallas Morning News.

But it's almost certainly not good for shareholders. The morality of that fact, and the importance of the board's fiduciary duty, is up for debate. At this point, though, it's pretty much irrelevant to the investment case for AHC. This is the strategy. There's little, if anything, minority shareholders can do about it.

In that context, the question is whether AHC is cheap enough regardless. The company isn't exactly setting its cash on fire: guidance for 2020 of an $8 million cash burn includes roughly half in dividend payments, and in the middle of a pandemic no less. Digital subscriptions have skyrocketed of late, which suggests the strategy might have more viability than skeptics like myself believe.

And the dividend, even after being halved this year, still yields close to 10%. The payout seems reasonably secure, given that Decherd cited it as part of the longer-term strategy. In that context, investors can wait a few years, get a reasonable chunk of their investment back, and reassess. Belo still should have net cash a few years from now (assuming realization of the promissory note or its collateral). Failure in the strategy might lead even Decherd to throw in the towel, leading to a new plan more closely aligned with shareholder interests. In sum, there's still a "heads I win, tails I don't lose much" argument at this level for patient deep value investors.

The core problem, however, remains: to stretch that metaphor, it's Decherd who is holding the coin. And what recent developments confirm is that he has no plan to flip it any time soon. At the very least, that suggests that investors who see value in AHC will have to be extremely patient. In a more likely scenario, the value that exists on paper now will be spent backing a strategy that seems to have little chance of success.

Analyst’s Disclosure: I/we 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.