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Fake News Losers

|Includes: New York Times Co. (NYT)

New York Times, Co. (NYSE:NYT)

Ironic fake news loser: high legacy costs, unfunded pension deficit, cultural mismatch, combined with capital destruction lead to no way out.

INVESTMENT HIGHLIGHTS

New York Times efforts to modernize and transition from print to digital has had mixed results and will fail. New York Times is trapped by legacy costs and embedded structural disadvantages, to wit a $500 million pension fund deficit.

  • Efforts to achieve significant penetration in digital ad space is too little, too late in a market place dominated by Google (NASDAQ:GOOGL) & Facebook (NASDAQ:FB).
  • New York Times capital allocation & dividend strategy does not match its business strategy.
  • New York Times is on the same path as Washington Post & Boston globe; collectors' items serving egos of billionaire investor.
  • New York Times, after the Trump Bump, will experience dwindling revenues, ebit and eps, a culture clash, a mismatch of demographics, old print vs. younger digital readers.

PRIMARY RISKS

  • New York Times is able to restructure and spin off its legacy business and pension costs and have opportunity to realize higher valuations based on digital media growth.
  • New York Times is able to make very fortuitous digital media acquisitions and growths its way out of this trap.
  • New York Times is acquired by higher multiple digital player that want the New York Times brand cache and pays a significant premium to fair value.

Throwing the Christians to the lion's very likely out drew the great oratory of the Senators in the Roman Empire. Lower common denominator economics is timeless. Hello Buzz-feed, Drudge and Breitbart. Goodbye to all the news fit to print. The New York Times' pile on and ridicule Trump strategy is a very crowded one. And is likely to produce pyric results. It is disappointing that an organization of New York Times' intellectual cache cannot manufacture a more original path to obtain digital growth.

THE DECLINE OF THE PRINTED MEDIA INDUSTRY 2000-2017

New York Times bought Boston Globe in 1993 for $1.1billion and sold it in 2013 for $70 million, an equivalent of 7 cents on the dollar.

The Washington Post, a Warren Buffet core holding for many years, exceeding $7.5 billion in market value was sold for $250 million to Jeff Bezos in 2013.

Gannet (USA Today): $15.7 billion market cap in 2005, now has a market cap just over $1billion, a 90% decline.

We believe New York Times will meet a similar fate in the next 3-5 years. Is Mark Cuban waiting in the wings to add New York Times to his collection?

The print news industry is on the endangered species list. The Industry like a shrinking island of diminishing cash flow in a natural progression of tech obsolescence.

Like other epic transformations of leadership, we witnessed the pony express succumb to Western Union, mainframe to laptop, Sears to Amazon (NASDAQ:AMZN), and now it is printed media to digital. All remaining survivors are desperately invoking a cut and digitize strategy with decaying balance sheets, not covering cost of capital in a slow withering decline, as incurable as cancer, these are the winds of change.

INVESTMENT THESIS:

New York Times efforts to modernize and transition from print to digital has had mixed results and will fail. New York Times is trapped by legacy costs and other embedded structural disadvantages, to wit a nearly $600 billion pension fund deficit.

  • Efforts to achieve significant penetration in digital ad space are too little, too late, in a market place dominated by Google (NASDAQ:GOOG) & Facebook .
  • New York Times capital allocation & dividend strategy does not match its business strategy.
  • New York Times is on the same path as Washington Post & Boston Globe, collectors' items serving the egos of billionaire investors.
  • New York Times after the Trump Bump, will experience dwindling revenues, ebit and eps, suffer from a culture clash, mismatching demographics, as it tries to transition from print to digital media.

An irony of unintended consequences occurs as the New York Times strives to increase its digital presence, it finds itself more and more into the realm of news unfit to print, championed by internet startups like Buzz Feed, Huffington Post and others, where they may be alienating their lifeblood, the longtime legacy readership in pursuit of a less profitable, more fickle, less interested millennial oriented readership on a digital platform.

As Shown in this 2014 survey most New York Times readers do not own a tablet, not encouraging for monetizing its Digital revenues:

Facebook and Google, without providing any original content, dominate the Digital Global digital ad market.

The media industry is currently faced with huge challenges. The revenue from print has reduced across the industry. This is despite the fact that marketing budgets have been increasing. According to GroupM,the digital market share will reach 33%. Digital will get $77 cents for every new ad dollar compared to 72 cents in 2016. Unfortunately for NYT and other media companies, most of these revenues will go to the Google and Facebook duopoly.

DIGITAL MEDIA Valuations are HIGH: But not for NYT

Huffington Post was acquired in 2011 by AOL for $ 315 m at 10x TTM revenues, the revenue growth rate was 22%.

Business Insider was launched in February 2009 and is based in New York City is another example. "Founded by DoubleClick's former CEO Kevin P. Ryan, Dwight Merriman and Henry Blodget it is the overarching brand that includes Silicon Alley Insider(launched May 16, 2007) and Clusterstock (launched March 20, 2008). The site provides and analyzes business news, and aggregates top news stories from around the web. In 2011, the online newsroom employed a staff of 50, and the site reported a profit for the first time ever in the 4th quarter of 2010. In June 2012, it had 5.4 million unique visitors. It now averages around 70 million unique visitors, monthly.

Business Insider also hosts industry conferences, such as IGNITION, which explores the emerging business models of digital media. In January 2015, Business Insider launched BI Intelligence, a subscription-based research service that provides data and analysis on the mobile, payments, eCommerce, social, and digital media industries. The site each year publishes editorial franchises such as the "Digital 100: The World's Most Valuable Private Tech Companies".

In September 2015, Axel Springer SE announced that it had acquired 88% of the stake in Business Insider, Inc. for a reported $343 million (€306 million). After the purchase Axel Springer SE will hold a stake of approximately 97%, and Jeff Bezos' personal investment company will hold the remaining shares. It paid an estimated 9x TTM revenues.

Business Insider and Huffington post were acquired for 9-10x revs, offer much higher growth rates, , less employees, have lower cost defined contribution vs legacy defined obligation retirement plans for employees. Thus have higher growth and higher operating margins than print media companies.

Case in point: New York Times 2011-2016 operating margins= 12- 16%, revenue growth rate 1-3%. trading at 1.3x Revenues., an 80%+ discount valuation to leading digital media properties. New York Times has over 3000 employees vs. about 50 for Business Insider.

Increasing Digital Traffic is not translating into more revenue vs. decline in print revenue

"The Times generates about 60 million unique visitors (U.S.) a month. One million of them pay; 59 million don't. That's less than two percent. The rest of the digital audience supplies attention which the Times monetizes through advertising, but then again, it's those one million paying readers who consume a greater slice of the page views, doubling their value. It's the more 1.15 million print payers who are responsible for all the print reader revenue - and all the print ad revenue. What's been one net impact of all that digital reader revenue? It's a goose egg - but an important one. Without that almost $200 million in revenue, each quarter would be bathed in red ink, with revenues down in low to middle single digits. With that revenue, though, during the Mark Thompson years, we've seen 2014 full-year revenue growth of 0.7 percent and 2013 full-year revenue growth of 0.5 percent. Zero, practically. Now, even with a million digital subscribers, it's mired around zero ("The Newsonomics of zero and The New York Times")."

Source: Nieman Foundation at Harvard

New York Times stock chart 1980-2017: a depressing reality of secular decline

New York Times Balance Sheet Since 1994: (Red = debt) Increasing Debt Levels

(does not include nearly $600 million of underfunded pension obligation or over $400 million in lease obligations) thus New York Times is burdened by a much higher debt load, with over 80% debt to equity than the 25% D/E ratio that pension rules allow it to report. Thus, New York Times acquisition options are significantly limited.

ROE and ROA - return on equity and return on assets demonstrating management's lack of deftness in a very difficult environment.

New York Times stock has tanked despite increased borrowing to fuel growth.

Source: Stockpup

Poor Capital Allocation Decisions: share buybacks have destroyed capital.

New York Times has generated a 3% ROA as of late, while its WACC is over 6.7%.

On January 13, 2015, perhaps realizing the destruction at hand from the buyback program. the Board of Directors terminated an existing authorization to repurchase shares of the Company's Class A common stock and approved a new repurchase authorization of $101.1 million, equal to the cash proceeds received by the Company from an exercise of warrants. As of February 17, 2016, repurchases under this authorization totaled $84.9 million (excluding commissions) and $16.2 million has not been completed.

Table 1: Key Financial Ratios (2015-2011)

New York Times Weighted average cost of capital (OTC:WACC) calculation: (using the capital asset pricing model formula: Cost of equity= Risk free rate of return + Premium expected for risk.

Cost of equity= Risk free rate of return + Beta x (market rate of return - risk free rate of return).

So, the cost of equity is: 0.25 + 1.54 x (6.00 - 0.25) = 9.89%

The net cost of debt is 4%.

Including capital lease obligations, a ratio of 54% debt to 46% equity yields a WACC = 6.70%

This means NYT WACC is nearly 2x recent ROA.

Results from the Trump bump are starting to diminish. The New York Times experienced a significant uptick in digital subscriptions during the election time now post-election site traffic is starting to decrease this could be a harbinger of a regression to the mean baseline of lower growth or of no growth.

Source: Similar Web

As seen in the chart above, traffic increased from September to November as more people visited the website to read more about the happenings in the political scene. After the election, the number of visitors has dropped.

The chart below comparing New York Times and Washington Post shows the same trend.

New York Times is at a huge structural disadvantage to compete effectively with new digital media upstarts. Not only from a legacy, higher cost of operations print business, but also from a cultural perspective; a mismatch of demographics of sorts, old print vs younger digital.

"For Buzz Feed and Smith, the choice to publish fits with a workplace culture shaped as much as anything by the ascendancy of Twitter( TWTR) and Facebook( FB) , now the country's largest sources of news even though neither does any actual news reporting.

Buzz Feed, as is well known in journalism circles, rattled cages and ruffled feathers early in its history by publishing piles of lists on seemingly trite and low-brow subjects all aimed at appealing to a largely millennial audience. Its larger purpose became clear as Buzz Feed founders John Johnson and Jonah Peretti proved that the site could generate bucket loads of traffic to which it could sell advertising from brand marketers looking to reach those same millennials.

As described from the perspectives of a digital and print media leaders, "by a digital media and Cash from ad sales combined with funding from investors including Comcast's ( CMCSA) venture arm has bankrolled a smart and deep newsroom that has had its share of big scoops despite typically aggressive competition from the Times, Post and many others.

The New York Times, meanwhile, has a far different calling, and business model. The Times, like most news organizations to the left of Fox News, has sparred with Trump over the past 18 months. Yet despite its many misgivings about the tone and direction of the new administration, it didn't view publishing the 35-page dossier as a public necessity anywhere near that of the secret war detailed by the Pentagon Papers in 1971.

"We, like others, investigated the allegations and haven't corroborated them, and we felt we're not in the business of publishing things we can't stand by," Times editor Dean Baquet said in explaining his newspaper's decision to only describe the 35-page dossier rather than reprint it.

There has always been a great range of journalistic ethics in this country. What a tabloid would publish, The Wall Street Journal might not. Yet the debate over Buzz Feed's decision both illustrates and transcends the internet's impact on political life and the media.

"Whether it's WikiLeaks or Buzz Feed, these organizations have different traditions, different standards; they're creations of a digital age where news information flows more freely and the attitude is an open-source environment," Sesno said. "That means the responsibility is more on the news consumer to determine whether something is credible than on the news organization itself. Still, this whole story occupies a very troubling gray area."

New York Times high legacy operating cost combined with pension deficit and a high debt load will prevent it from engaging in an aggressive acquisition campaign to grow its digital business.

New York Times has significant risk to eps from its pension plan; There are two sources , 1) anunfunded amount must be charged vs eps on an amortized schedule on $600 million over 10 years or $60m hit to eps and, 2) return assumptions of 7%, which may be 2%-3 high, on $ 2 billion projected pension obligation, this creates another $40 million -$60million drag on eps or in total $100 million -$120 million vs as stagnant and flat 13% ebitda margin on revenues of $1.5 billion = $165 million, less interest expenses and lease expenses of $40 million , all these costs = $160 million offsets on eps.

New York Times legacy of employees and pension & retirement costs is its albatross. Even if the employees accept early retirement offers, the pension benefit obligation is still there.

The following benefit payments, which reflect future service for plans that have not been frozen, are expected to be paid:

Table 3: New York Times Benefit Payments for Qualified and Non-Qualified Retirement Plans

All Values in Thousands

(1) While benefit payments under these plans are expected to continue beyond 2025, we have presented in this table only those benefit payments estimated over the next 10 years.

The asset allocations of the Company-sponsored pension plans by asset category for both Long Duration and Return-Seeking Assets, as of December 27, 2015, were as follows:

This is an allocation mix that has averaged about 5.5% before fees since the year 2000. New York Times is assuming it can average 7.1% on its pension assets which is out of step with the plan's asset allocation strategy, or it can attempt to achieve these higher returns by undertaking a more risky asset allocation that the pensioners and plan administrators might object to. At current returns and asset mixes the plan will achieve a growing annual shortfall that will necessitate an even higher hit to annual eps to make up the difference.

Under its current regime and mix we estimate the total plan shortfall as follows:

Annual deficit from unrealistic return assumptions (160 bps on $2.3billion in assets) = $35 million per year

Annual contribution to make up existing pension deficit over 10 years ($600 bill shortfall) = $60 million per year

$ 95 million pension charges per year on a base of 165 million shares = potential hit to eps each year = $0.59 per share.

New York Times, in its current no growth state, is generating about $96 million in net income at an estimated 6% net profit margin = .60 eps so, the pension plan costs if expensed would wipe out eps this year.

However, under current accounting precepts and ERISA rules, companies are given a long ramp to smooth out pension issues and the New York Times will not have to take an accounting adjustment to eps this year of this magnitude. But it has had to make significant contributions in excess of $30 million in 2014 and 2015 and likely will do the same as these issues mount and likely increase these charges against eps the reasons above. We estimate that the charge to earnings could be $0.18 -$0.20 in eps for 2017-2018. Thus, we estimate New York Times eps to be in range on $0.40- $0.42 for 2017

VALUATION

for NYT, D = 1, to smooth out lumpiness of eps, use less volatile EBITDA

(k {required rate of return} = 9.9- g (growth rate) 1/10 = 10x

New York Times EBITDA for 2017e = $0.80 eps

Fair value = $8.00

or

We estimate 18x multiplier on the mean level of New York Times over the next ten years (a current market level estimate based on today's conditions), we estimate New York Times will trade at $7.56 as the burden of the legacy business model of print and pension drags will limit growth for New York Times shares for the foreseeable future. This can be seen in Table 3 below.

We use a blend of these two approached, 50/50, and derive our fair value estimate of $7.80 (rounded up from $7.78)

Table 3- Forward Earnings Per Share

Discounted Cash Flow Valuation

In addition to the two eps based approaches above, we also calculated a valuation based on a discounted cash flow model of future earnings and the New York Times weighted average cost of capital as discussed earlier in this report. A WACC of 7.83% with a long term return on capital (NYSE:ROC) of 14% yields a price target of $7.95, which supports our earnings based valuation. The sensitivity of the price target for this model based on varying WACC and ROC can be seen in Table 4 below. Table 4 - Return on Capital Vs. Discount rate

Risks to our New York Times short Call:

New York Times is able to restructure and spin off the legacy business and pension costs and have the opportunity to realize higher valuations based on digital media growth.

New York Times is able to make very fortuitous digital media acquisitions and growths its way out of this trap.

New York Times is acquired by higher multiple digital player that desire the New York Times brand cache and pays a significant premium to fair value.

Footnotes on New York Times pension plans from 2015 annual report:

Weighted-average assumptions used in the actuarial computations to determine net periodic pension cost for qualified plans were as follows:

The table below includes the liability for all of these plans.

The funded status of our qualified and non-qualified pension plans as of December 27, 2015, is as follows:

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