Not many businesses endure for 170 years. The New York Times (NYSE:NYT) has. After 160 years of existence, however, it looked like the business might not survive to see the next decade. In the aftermath of the 2008 financial crisis, faced with a mounting debt load, a declining legacy print business, and few answers on how to turn things around, the New York Times scrambled to reinvent itself.
Today the Times has done what no other legacy publisher has – transformed into a digital subscription-based powerhouse poised to rapidly scale under a new business model. Here I’ll explore how they pulled it off and consider what the future might hold.
The New York Times was founded in 1851 by Henry Raymond. Ironically, given the papers now left-leaning tilt, Raymond is also one of the founders of the Republican Party. Selling papers for a whopping one penny per copy, the Times grew handsomely under Raymond until his death in the 1880s.
Newspaper circulation collapsed after the financial panic of 1893, and the Times nearly went bankrupt before Adolph Ochs purchased a controlling interest for $75,000. Ochs, who had experience turning struggling papers around from his background running the Chattanooga Times, successfully turned the Times into a thriving business. By 1934 circulation was up from 9,000 to nearly 800,000. Today the times is still controlled by the Salzberger family, fifth generation descendants of Ochs.
From the ’30s to the early late ‘90s the Times steadily grew into one of the most widely circulated newspapers in America. With this success came a thriving advertising business.
Print Advertising Model
Newspapers used to be one of the most attractive businesses in the world. When a newspaper reached scale, it was the go-to place for businesses to advertise. If retailers, service providers, and consumer goods companies wished to reach their audience en masse, putting ads in the newspaper was the best way to do so. This gave publishers major pricing power.
Year after year newspapers would practically yawn as they increased the price to advertise in their papers and there was not much customers could do. Subscriptions added to publisher’s revenue pool but were a far less important part of the business compared to selling advertisements.
Large profits and healthy cash flows from a lucrative advertising business left managers and shareholders fat, happy, and complacent.
From the 1970s to the early 2000s, capital allocation went awry. The business used profits from its core advertising business, combined with lots of debt, to basically light shareholder’s money on fire. During that span they acquired magazines, television and radio stations, real estate across Manhattan, and even a stake in the Boston Red Sox (a sin for a New York company) and the Liverpool Football Club. With access to the internet gaining steam, the Times opted to ignore the threat of online news and instead focus on building a sprawling empire of disparate assets.
Stubbornly sticking to the traditional print model, the Times failed to invest in building an online presence. Subscribers steadily flocked to free news sources on the internet, taking advertising dollars with them. When the financial crisis gripped the country in 2009, the New York Times stock price had dropped over 90% from its mid-2000’s peak. Losing money and under a mountain of debt and pension obligations, the 160-year old business was staring over the precipice.
Source: Mine Safety Disclosures
In order to evade bankruptcy, the Times went into survival mode. To generate cash the company eliminated its dividend and shed assets for a fraction of what they paid years earlier. They sold their stake in the Red Sox, numerous radio and television stations, and even conducted a sale-leaseback for part of the lavish Manhattan headquarters. Finally, the company took a quarter of a billion-dollar bail-out loan from Carlos Slim, a Mexican telecom magnate. Slim also received warrants, which he later exercised. He still owns 10% of the company today.
The company used the cash to pay down debt and give itself a runway to reinvent its business model. Having cash in and of itself did not change the fact that the Times’ core business was dying. The board finally succumbed to the fact that advertising dollars now accrued to aggregators like Google and Facebook, and competing with these behemoths for ad space was a losing battle. So, they decided to pivot.
Source: Mine Safety Disclosure
In 2011, the company abandoned its reliance on advertising and made a commitment to become a subscription company. This was a seismic shift after relying on advertising dollars for over 150 years. The Times put up a paywall which required readers to purchase a subscription if they wanted to read more than a few free articles. This was an audacious move at the time when free access to news was becoming the norm. They doubled down on content and more importantly, digital initiatives. Company leadership realized that analyzing your subscriber base was as important as producing quality content. They hired hundreds of engineers, added board members from other technology companies, and aligned the company around its new vision. Slowly, the new model started to gather steam.
For the first several years, digital subscribers trundled along below 1 million. In 2016, after years of tinkering with subscription rates and models, subscriber growth began to take off. As of the end of 2020, the company had nearly 7 million digital subscribers. At its peak, print subscribers topped out at roughly 1.6 million in the early 2000s.
Source: 2020 10-K
Although the business had rapidly added digital subscribers, subscriptions were still far less profitable than selling ads in the heyday of print. To that end, despite the breakout in digital subscribers, the company’s revenue is essentially flat from 2011 to 2020. This, however, masks what is really going on under the surface.
Running a digital subscription business is very different than running a print-based advertising business.
In its legacy form, costs scaled closely with revenue. As circulation grew, so did raw material costs, print production costs, and delivery costs. The only costs that remained relatively fixed were the salaries for reporters and journalists. Growth was also constrained in the print model as the company could only ramp up capacity to print and deliver newspapers so quickly. To cover the higher costs, print subscriptions command a much higher price than digital. An annual subscription to the print version of the Times costs around $700 compared to $200 for a digital subscription. In the company’s new model, all of these variables are flipped.
Low Marginal Cost of Subscribers
The Times incurred significant upfront costs while building a successful digital subscription business. The company employs over 700 engineers and nearly 1,800 journalists whose salaries can now be spread across a much larger subscriber base. Though digital subscriptions bring in lower annual revenue per subscriber, with the fixed cost infrastructure now in place, each additional subscriber comes at almost no marginal cost to the company.
So, the subscription model is all about scale. Of course, if a business never achieves scale, it will fail. This was the big risk the Times took when it began this undertaking. They decided it was better to succeed or die quickly while transforming the business than to die slowly trying to limp along in a declining advertising market. It’s also probably why more newspapers haven’t successfully copied the Times yet. In the early days of building a subscription business, fixed costs dwarf revenues from a small subscriber base. Previous asset sales and debt elimination gave the Times enough of a runway to muscle through this period.
The company appears to be nearing a point where subscribers grow to where they cover the fixed “content costs” and each additional subscription dollar drops almost entirely to the bottom line. Qualitatively, this is how a subscription business succeeds, and I’ll look at what that might mean quantitatively for the Times later.
Data-Driven Retention and Pricing
Because scale is so critical in succeeding with this model, the Times has spent significant resources in understanding how to acquire, price, and retain subscribers. This requires operating as almost an equal parts journalism and tech company. The secret to their success in driving subscriber growth in recent years appears to come from a combination of attractive introductory rates combined with algorithm-based retention strategies.
In 2019, the company decided to require that users register on their website even to access free content. This enabled the Times to have direct contact with potential subscribers. Next, they introduced $12 for 12 weeks promotional pricing. These initiatives, combined with a doozy of a news cycle in 2020 - from the pandemic, to a contentious election and civil unrest, there was no shortage of newsworthy events – resulted in subscribers signing up in droves. Once a subscriber dips their toe in the water the company uses data to pull them all the way in.
The company uses engagement and other data to predict who will accept price increases above promotional pricing, and to what extent. Some subscribers will go straight from promotional to full price, and others will go somewhere in between. Interestingly, they’ll only ever impose stepped-up pricing on 80% of subscribers that are due for an increase. They use the other 20% as a control group to measure the success of their models and improve future iterations. As CFO Roland Caputo explained on the February earnings call, their algorithms are working.
“On the step-up pricing and the retention question, yes, we've got a model that's choosing -- chooses 80% of the subs that go to either step-up or full price and that's max because we like to have a 20% hold up because we constantly want to test the efficacy of the model versus a random sample. And the model is beating the random sample by a statistically significant amount. Also, we've inched up the number going straight to full price. So that's more than 50%. Now a bit more than 50% has to go straight to full price. And the kind of the real proof of the model's efficacy is that we actually now see the retention on those has to go to full price slightly ahead of those who don't, which say the model is very good at picking those who have a lower elasticity to price...So couldn't be happier with the way that's all going.”
Roland Caputo, CFO, February 2021 earnings call
Because of the unusual nature of last years’ news cycle, it would be overly optimistic to assume that digital subscribers will continue growing at 50%+ annually. It does seem that the company’s data-driven methods will continue to drive healthy subscriber growth for many years, which I’ll discuss more below.
On the qualitative side, a subscription business is far preferable to an ad-based business from the consumer’s perspective. As a subscriber, you pay for content that you enjoy, without having to wade through annoying ads. The model is a win-win, as the Times enjoys far superior long-term economics, gets to focus on their core competency of producing content, and consumers receive a better product.
Besides the benefits of scale and user experience, the Times benefits in a few unique ways compared to other subscription businesses.
To run a subscription business you need content. You can either create the content yourself, or pay to host other people’s content on your platform. It’s far more profitable when a subscription company owns their own content, again because of scale. If a company owns the content, it doesn’t cost any extra for an additional subscriber to consume the content. Conversely, if the content is leased, generally the owner of the content gets a royalty on every incremental consumer of the content, negating the benefits of scale.
Take Netflix and Spotify – two highly successful subscription businesses. Netflix spends billions of dollars annually to create its own content, and to bring content created by others to its platform. Netflix owns most of its content, but it is extremely expensive to create. Also, Netflix has bandwidth and streaming costs which scale with volume growth. Spotify doesn’t own the songs that users stream, and must pay a royalty to the artists on a per-stream basis. The Times enjoys the best of both worlds. “Content”, or journalism costs, pale in comparison to creating a hit TV series, and the Times owns the content, allowing it to grow profits far faster than revenue. Of course, the Times probably has a much smaller addressable audience than Netflix and Spotify, but it’s worth noting the attractiveness of an at-scale digital news subscription business compared to other forms of media.
Additionally, from a relative competitive position, the Times is in excellent shape. The situation is somewhat reminiscent of Dropbox, which I wrote about last year. Dropbox has the same business model and is reliant on subscription growth and retention. However, Dropbox is competing directly with Google, Microsoft, and other tech behemoths, which makes me squeamish. The Times, on the other hand, so far stands head and shoulders above other publishers in terms of the success of their digital subscription business, giving them a huge leg up going into the next decade.
Source: Mine Safety Disclosure
The Times has a handful of important revenue streams. I assume you can tell by now that the most important is digital subscription revenue. Digital subscription revenue surpassed print subscription revenue for the first time in 2020, and the trend should accelerate, though print subscriptions will remain a material portion of revenue for the foreseeable future. After historically comprising 75%+ of revenue in the past, advertising now accounts for less than 25% of revenue. Other revenue consists of things like licensing, leasing of some of the space at headquarters, and live events.
Source: Author, Company Flings
The most interesting part for future opportunities apart from standard news subscriptions lies within other digital properties. The company owns the Daily, the most popular podcast in the world by a considerable margin. The Daily received more than 2.5 billion downloads in 2020. It consists of a ~30-minute daily podcast discussing timely news stories. The podcast is free and makes money from advertising. The audience is incredibly valuable to advertisers as listeners skew younger and tune in habitually. The company also operates popular independent cooking and crossword puzzle apps that generate $40M+ in high-margin revenue. All of these digital products are growing rapidly and benefit from the same low incremental costs for additional users.
In stark contrast to in 2008, the company is now debt-free, has a surplus in its pension program, and recently exercised the option to repurchase the space in the headquarters that it was forced to sell and lease-back during the crisis. The business has $880M+ of cash on the balance sheet and is in rock solid financial shape.
The growth in intrinsic value of a subscription business is mostly a function of two variables; the number of paying subscribers and average revenue per subscriber (ARPU). Here’s what those variables have looked like the past three years.
Source: Author, Company Filings
Source: Author, Company Filings
As you can see, the trends are going in opposite directions. Digital subscribers are growing rapidly while ARPU is dropping. Initially this might seem like cause for concern, but it’s really just a function of the rapid growth in new users paying an introductory price in 2020. The company is showing an ability to retain subs at a higher subscription price, but time will tell how sticky their brand is. Many subscribers will undoubtedly drop off, but from what the company has disclosed so far, I think they’ll retain enough new subscribers at higher prices whereby ARPU chugs higher in the coming years.
Print circulation will continue to decline, though it will remain important for many years as the company fully transitions to digital. The business has exercised pricing power historically to partially offset declining print subscribers, but the terminal value of that revenue stream will eventually approach zero.
Last year advertising revenue dropped over 20%, mostly due to the pandemic. This segment is closely tied to economic trends and should see a rebound this year, but will inherently fluctuate over time. The success of new digital products like the Daily and a huge push in digital advertising prowess should lead to steady growth alongside subscribers. After all, advertising dollars follow eyes and ears.
The New York Times does not screen well presently. The company looks very expensive at over 50x GAAP earnings. 2020 headline numbers say little about the Times’ long-term earnings power once the digital business matures. To estimate future earnings power, we need to know something about the total addressable market (TAM) and subscriber growth.
A few years ago, company leadership set a goal to have 10 million paying subscribers by 2025. It looks like they’ll blow by that goal, and they’ve admitted it was too low an estimate. Recently, the company has stated that its addressable market is somewhere around 100 million+ subscribers, up from a previous estimate of 30 million. They now have a decently large international presence (18% of subs), and as is the case so often with internet companies, their TAM is expanding. As the internet has broadened their journalistic reach, the Times has expanded from a niche left-leaning college-educated news source, to a much wider audience, both geographically and culturally.
The company ended 2020 with 6.7 million digital subscribers. I don’t think it’s reasonable to expect another year of 50% growth in subs, and the company agrees. Management said they expect more growth in subs than in 2019 but less than in 2020. This means they expect to add somewhere between 1 and 2.5 million net new subscribers, which seems achievable. ARPU should start to trend up during the back half of this year as well as introductory pricing expires for the deluge of 2020 new subscribers.
Let’s say the company gets to 14 million digital subscribers in five years by adding 1.5 million subscribers (midpoint of this years’ expectation) per year. This is less than half their original estimate of their addressable market and less than 15% of their updated estimate. Conservatively, I’ll assume ARPU doesn’t budge and remains at 2020’s seemingly depressed level. If you extrapolate recent print subscription and ARPU trends (subs declining 5% annually and ARPU rising 2% annually) and layer in a mix of advertising and “other” revenue consistent with 2020, I can see ~$3B of revenue within five years.
Keeping variable costs consistent as a percentage of revenue and inflating fixed costs (mainly product development and SG&A) at 3% annually and total costs would be around $2.2B. Throw in some interest income on excess cash and the company could feasibly earn close to $600M in pretax profits in the next five years. This compares to $200M in 2020. Below are a few scenarios that seem reasonable.
Source: Author, Company Filings
$600M in pre-tax profits would put the company currently priced at around 14x pre-tax earnings. A scaled digital-subscription business with multiple high-margin revenue streams and a loyal following is almost surely worth more than 14x pre-tax profits. Mature subscription businesses today often trade well north of 20x. Also, if ARPU creeps back up to historical levels and ancillary digital products are better monetized, there could be considerable upside. Those trends are hard to predict though. Below is an illustrative range of potential 2025 outcomes based on different subscriber levels and a 20x pre-tax valuation multiple in the out-year and the assumptions I've laid out above. source: Author
This exercise is a bit more hand-wavy than I typically like, as it requires a number of assumptions and can provide a false sense of precision. I use scenarios like this to get a ballpark range of probable outcomes based on key variables. I do think this illustrates that investors buying into the Times at 50x earnings today aren’t like, you know, insane. However, the company sure looked a lot cheaper in mid-2020. While I think the business is likely to do well, the valuation doesn’t offer a wide margin of safety presently.
That could change quickly. The company will surely encounter bumps in the road on the way to a mature digital-subscription business, and the share price is bound to be volatile when that happens.
The Times will face plenty of challenges not limited to balancing price increases with customer retention, managing costs in the declining print business, unexpected further fixed costs, and warding off other publishers envious of the Times successful transformation. As competition heats up, we’ll learn a lot about how loyal the Times subscribers are. If I had a better handle on this question, I might even be comfortable buying into the company near the present valuation. As of now, I don’t know if the business has a strong enough brand to withstand a pricing onslaught from other publishers such as the Washington Post or the LA Times. To me this is the biggest risk and one we should learn more about in the coming year or two.
The Times bet the company on a radical transformation a decade ago, and so far it’s paying off. Subscription businesses are often simple, predictable, and profitable and enjoy high-margin, sticky revenue streams; all things we like to watch out for. I’ll be interested to observe the business closely as it completes the transformation in the years ahead.
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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.