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How to Spot the Media Survivors

Aston/Fairpointe manager Thyra Zerhusen looks for valued content, adaptability to distribution changes, and cost controls in seeking out media winners.

Esther Pak, Assistant Site Editor, 05/31/2011

Thyra Zerhusen is the lead portfolio manager of Aston/Fairpointe Mid Cap CHTTX. She recently answered our questions on the portfolio's meaningful stake in the media sector and how she distinguishes the survivors from stragglers in this fast-changing arena. She also discussed the most misunderstood name in the portfolio and why it merits her continued conviction in the firm's long-term prospects.

Finally, she commented on the multiple holdings in the portfolio that have been acquired by other firms and provided her take on the valuation of small-cap companies.

1. You have several positions in the media sector, which has undergone changes at a rapid pace during the past decade. How do you identify which firms will be the survivors?
We look at content, adaptability to distribution changes (for example, digital), and keeping costs under control to generate strong cash flow. A good example is New York Times NYT. We have seen that the company's newspaper subscribers are willing to pay for content, with long-term print subscribers up from 600,000 to more than 800,000 during the last decade. New York Times also adapted to distribution changes, with 26%-28% of revenues coming from digital. Keep in mind that subscribers of The New York Times pay with their own money. This is not always the case with a newspaper like the Wall Street Journal, which tends to be an office expense. The New York Times has good readership. It owns the International Herald Tribune, and the firm has undergone cost-cutting, reducing annual costs by more than $800 million, a decrease of almost 30% of its cost base since 2006. All of these factors allow New York Times to offer a must-have product.

2. What's your take on New York Times' new premium service for paying subscribers? Do you anticipate that other media outlets will adopt that same model?
New York Times is a leading media company focused on creating and distributing high-quality news. The company tried once before to monetize digital content along with access to its archives. Although it did not initially gain traction as anticipated, management learned from it and came back with a strong offer to monetize electronic distribution of content and digital advertising (which now accounts for 28% of the firm's advertising revenues). A number of other media outlets have or are in the process of adopting a pay model. The Financial Times has a metered model at FT.com, and The Wall Street Journal, via WSJ.com, has had a web-based pay model for many years.

3. What is the most misunderstood name in the portfolio, and what are investors missing? How do you distinguish between value traps and firms experiencing short-term temporary issues but still have significant long-term upside potential?
H&R Block HRB, a provider of tax services, has undergone a number of management changes during the last year. These moves have had the effect of slowing down the turnaround story to realign the company's business model after the company exited the mortgage and brokerage business.

Despite the weak economy, high unemployment rates, and the loss of refund anticipation loans this tax season, Block remains focused on the turnaround. The company's strategic acquisition of 2SS Holdings, an online tax-preparation service, will double the number of digital tax returns for Block to more than 10 million. The stock is attractively valued with a current P/E multiple of 10.8 times, an improved balance sheet, and a 3.8% dividend yield. As far as Block's long-term upside potential, I expect the company will refocus on its fundamental business: taxes. As the economy recovers and employment increases, the demand for expert tax advice will fuel the company's long-term sustainability.

4. A number of your holdings have been acquired by other firms during the past several years. Do you specifically target firms that might be takeover targets, or are acquirers simply looking for many of the same features you are? All takeovers are different, but have you generally been happy with your holdings' buyout prices?
Takeouts tend to be a byproduct of our process. Our disciplined, fundamental bottom-up approach to investing lends itself well to identifying undervalued companies that have the potential to be acquired. We seek to identify companies that are inefficiently priced relative to their earnings-growth outlook and cash-flow generation during the next three to five years. We have a preference for companies whose products make their customers more efficient or profitable and are critical to their success. Because we seek attractively valued, focused companies that enjoy market-leading positions and possess strong balance sheets, we believe that companies with such characteristics are attractive acquisition candidates. Generally, we have been pleased by the acquisition prices of our portfolio investments which have supported our underlying valuation work.

5. You look for mid-cap stocks with market capitalizations between $1 billion and $12 billion, but you've got a significant stake in small-cap firms, as well. Does your valuation research corroborate the view that many other managers have been espousing, which is that small-cap companies are more likely to be fully valued than larger ones these days?
We are stock-pickers and manage concentrated portfolios of 40-45 stocks versus an investment universe of approximately 1,200 stocks in our specified mid-cap space, which we define as companies with market capitalizations between $1 billion-$12 billion. We have two holdings with market caps of less than $1 billion, which represents 3% of the total portfolio. We believe our concentrated portfolios provide adequate market diversification yet allow each investment to have a material impact on the performance of the portfolio. We continue to see our portfolio as attractively priced relative to the overall market.



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