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Newspaper Publishers
Transferring coverage: tough
times for metro dailies
David T. Clark, CFA
Research Analyst
(1) 212 250 3523
david-t.clark@db.com
Changing three ratings, lowering estimates across the board
We are transferring coverage of the newspaper industry, including five stocks. We
keep our Hold rating on two of the names, EW Scripps (SSP) and Gannett (GCI),
but raise New York Times (NYT) from a Sell to a Hold, lower McClatchy (MNI) from
a Hold to a Sell, and lower Lee Enterprises (LEE) from a Buy to a Hold. We
discontinue coverage of two names, Media General (MEG) and Washington Post
(WPO). Our overall thesis on the industry remains bearish, as the newspapers
attempt to make a difficult transition to digital with one arm tied by the economy.
Deutsche Bank Securities Inc.
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DISCLOSURES AND ANALYST CERTIFICATIONS ARE LOCATED IN APPENDIX 1
Transferring Coverage
Top picks
McClatchy Company (MNI.N),USD7.25 Sell
Companies featured
Gannett (GCI.N),USD21.79 Hold
McClatchy Company (MNI.N),USD7.25 Sell
New York Times (NYT.N),USD15.81 Hold
E. W. Scripps (SSP.N),USD42.79 Hold
Lee Enterprises (LEE.N),USD4.63 Hold
Global Markets Research Company
Metros in the most danger, nationals/smaller papers in better LT position
Life won’t be much fun for any of the newspapers over the next 3-5 years, but we
believe the most viable business models are at the top and the bottom of the size
scale, with the middle in the weakest position. The national newspapers (Wall
Street Journal, New York Times, USA Today) skim the best print demographic
nationwide and have the strongest online prospects and exposure. Small/midsized
papers can still dominate their markets as the only resource for deep local
information and news. Large market metros, however, will likely continue to
struggle mightily against a wide range of aggressive competitors and the bleeding
edge of usage and advertising trends.
Tough situation for McClatchy: too many metros, too much leverage
Despite being one of the best operators in the business, MNI mis-timed its
purchase of Knight Ridder, and is now highly leveraged at the precisely the wrong
moment. Their metro market papers and high FL/CA exposure put them in the
worst position both structurally and cyclically, compounded by their leverage
situation. They would probably like to go private, but can’t due to the leverage, and
falling private market multiples will make it difficult to sell assets and de-lever. If
the economic downturn worsens or persists for longer than expected, we foresee
real trouble for MNI.
Newspaper valuations are full given revenue uncertainty
The newspaper group is trading at about a 6.2x FY08E EV/EBITDA multiple. We
think that is a generous for medium-term EBITDA declines and long-term
uncertainty. DCF and ROIC analyses also suggest a full valuation. We continue to
see more downside than upside risk to multiples and estimates. Key upside risks
to our bearish sector view include a strong online reacceleration due to the Yahoo!
collaboration and other aggressive initiatives, a reversal in newsprint price trends,
a stabilizing economy, an increase in consumer confidence, and a return to job
growth.
Table of Contents
Investment thesis .............................................................................. 4
Estimates and valuation.................................................................... 6
DB sector view................................................................................. 10
Companies in coverage................................................................... 14
Macro driver forecasts/trends........................................................ 29
General advertising trends ............................................................. 30
Retail/Local advertising .................................................................. 34
Classified advertising...................................................................... 37
National advertising ........................................................................ 45
Online ............................................................................................... 47
Circulation........................................................................................ 53
EBITDA margins/costs .................................................................... 58
Financial leverage............................................................................ 62
Appendix .......................................................................................... 63
Circulation data ............................................................................... 64
Newspaper Deals............................................................................. 72
Company models............................................................................. 73
Investment thesis
Outlook: 2H unlikely to bring relief, long-term looks rough for
metro dailies; nationals and small markets have a fighting chance
Despite easing comps in the back half of the year, we think newspaper advertising trends will
likely remain very weak in 2H08. Across the category spectrum we see more difficulty, and
few positive catalysts, other than the rollout of important industry digital initiatives. The
classified verticals, facing cyclical and structural headwinds, will likely remain the toughest
category for the newspapers. Retail, typically a less volatile category, nonetheless has also
shown dramatic deterioration as the economy has slowed. National, a small but not
inconsequential category particularly for metro dailies, has seen accelerating declines as
brand advertisers may have started to reduce or delay budgets. On the positive side, we
think the newspapers have finally started to get the interactive strategy right, and we look
forward to seeing what the new Yahoo!-newspaper alliance can do to accelerate online
revenue growth starting this Fall. Given the highly uncertain economic and advertising
environment, we remain cautious on the group.
Our theses on the five newspaper names under coverage:
McClatchy Co. (ticker MNI, Sell rating, $5 target price)
McClatchy has been among the hardest hit newspaper companies over the last 12 months,
as their substantial exposure to Florida and California compound meaningful structural decline
in their predominantly metro markets. While MNI is a very well run company, they had the
misfortune of levering up to buy Knight Ridder right before the current advertising recession,
and now must deal with rapidly falling EBITDA while trying to pay down $2.4B of debt.
Despite recently obtaining covenant relief from their lenders (in exchange for 50-75bp higher
interest), we think investors’ concerns about MNI’s leverage will persist, simply because the
terrible revenue/EBITDA trends will make it very difficult to reduce their debt/EBITDA ratio in
the foreseeable future. Another round of covenant relief is a distinct possibility next year. Our
estimates have them again approaching the minimum EBITDA threshold by mid-to-late 2009.
MNI would probably like to go private, but leverage seems to prevent them from doing so.
Structural, cyclical and leverage issues are conspiring to put MNI in a crisis.
New York Times Co. (ticker NYT, Hold rating, $15 target price)
The New York Times flagship is one of the premier news brands in all of media, and we
believe that long-term the strong national newspapers should be able to survive and perhaps
thrive once we get past the current cyclical issues, as they skim an elite demographic
nationwide, and are well ahead of the curve in terms of the digital transition. Though we think
the Harbinger/Firebrand activism is correct in principle (ie, focus on core brand and digital,
divest everything else), we are skeptical the activists will be able to compel management to
sell Boston or the regionals. At current private market valuations, selling now may not be the
right strategy anyway. NYT deserves a premium to the group, but we think the current
multiple fully captures it. In the near-term we’re concerned about a meaningful 2H slowdown
in national advertising, which accounts for over half of NYT’s newspaper ad revenue.
Gannett Co.(ticker GCI, Hold rating, $22 target price)
GCI is the newspaper industry bell-weather, as the largest and most liquid name in the group.
Though GCI has exposure to large metros and a national paper (not to mention the UK), the
vast majority of its newspapers are small/mid-sized papers, which should give them a fighting
chance to stabilize revenue in the long-run. We expect GCI to weather the rough seas for the
next couple of years, aided by relatively low leverage and a solid (and growing) portfolio of
top-shelf digital assets (CareerBuilder, cars.com, QuadrantONE, PointRoll, Planet Discovery,
ShopLocal, topix.net). For now we think GCI is fairly valued, despite a group-low FY08
EV/EBITDA multiple (5.6x), given the uncertain ad market and lack of catalysts on the horizon.
E.W. Scripps Co. (ticker SSP, Hold rating , $46 target price)
We assume coverage of SSP just a day before a separation transaction announced last fall is
completed (July 1). The spin co, Scripps Networks Interactive (SNI), takes the cable nets and
online price comparison businesses, leaving the local media businesses (newspapers and TV)
and licensing business (Peanuts, Dilbert) to the remaining company. Our sum of the parts
suggests the pre-spin company is fully valued. We value the local media stub at $5 to $6 per
share, well above the SSP “when-issued” security, trading at $3.40 (6/24), which derives a
sub-4x FY08 EV/EBITDA. While that valuation strikes us a much too low on the fundamentals,
we’re wary of the SSP-WI shares, as 1) most current SSP shareholders only want the SNI
shares post-spin, 2) most newspaper companies are currently hard to short due to a dearth of
available shares, and SSP will be “new meat,” and 3) they have a 25% exposure to FL/CA,
which means another year of harrowing revenue drops and bad news flow. We believe SSP’s
small and mid-sized market exposure is a positive for the long-term, as is their low leverage,
but we would need to see signs that the company’s structural print decline is really in the
low-to-mid single digits to get more positive on the name.
Lee Enterprises (ticker LEE, Hold rating, $6 target price)
LEE has a favorable small market profile, and an aggressive sales culture that is uncommon
among newspapers, but like McClatchy is shackled by the bad timing of a major leveraged
acquisition from a couple of years ago. We think Lee will continue to meaningfully
outperform the industry in terms of revenue growth, and will likely be among the first
companies to stabilize revenue and EBITDA. But high leverage will be an overhang on the
stock until that stabilization comes. In the near-term, falling EBITDA will prevent them from
lowering their debt/EBITDA ratio, thus the specter of needing to seek debt covenant relief
looms. The market assumes they will have to take de-leveraging steps, such as suspending
the dividend and selling assets. We like their profile long-term, but would wait for signs that
EBITDA can be stabilized before getting more constructive.
Valuations are realistic given near-term growth profile
We value the newspapers based on three (or sometimes four) methods: 1) Our DCF analysis
uses a 4.2% risk-free rate, a 5.0% equity risk premium, and a long-term growth rate of 1.75%
(2.25% for SSP). 2) Our ROIC analysis projects an expected trading range based on historical
asset multiples (EV/NCI) relative to ROIC/WACC. We believe the newspapers are currently
moving toward a lower trading range, and therefore consider both the average and the lower
end of the range when setting our targets. 3) We look at several relevant relative valuation
multiples in our analysis, focusing especially on EV/EBITDA. 4) For several of the hybrid
newspaper stocks we use a sum-of-the-parts analysis, which allows us to identify when parts
of their business are likely being undervalued. The companies for which we employ SOTP are
SSP and NYT. The newspapers are trading at 6.2x 2008E EV/EBITDA on average, well below
the 8.3x they traded at in 1H07, but a fair or even generous multiple for an industry with
declining EBITDA over the next several of years.
Upside and downside risks
Downside risks for the sector include 1) faster migration of advertisers and readers to the
internet, 2) below-expectation job growth and retail sales, 3) accelerating circulation volume
declines, 4) fast-rising newsprint prices and 5) rapidly falling margins as companies struggle
to scale costs to tumbling revenue. Conversely, upside risks to our neutral call include 1)
higher-than-expected job growth, 2) stabilizing newsprint prices, 3) a rapid acceleration in
online revenue growth, augmented by implementation of key facets of the Yahoo-newspaper
consortium deal, and 4) stronger-than-expected online advertising pricing.
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