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By Jason Stipp | 09-14-2010 01:38 PM

A Bond Pick That Could Deliver

Washington Post's bonds could get a boost once some of the murkiness hanging over for-profit education and its Kaplan unit is cleared up.

Jason Stipp: I am Jason Stipp for Morningstar. Given the secular changes we've seen over the last decade or so, a media company with connections to newspapers may not be the first place that a bond picker would look. But Morningstar's Joscelyn MacKay, a securities analyst, has some interesting ideas about Washington Post bonds.

She is here to tell us what she found. Thanks for joining Joscelyn.

Joscelyn MacKay: Thanks for having me.

Stipp: First question for you: Even in good times the newspaper business could be a tough one given the cyclicality in ad spending, but now we've also seen a lot of media outlets competing for attention, new technologies. How is Washington Post really set up to work in this new environment for publishing?

MacKay: Washington post may have its roots in media, but the firm's for-profit education unit Kaplan actually generates the majority of revenue and profits.

Stipp: So, there is actually much more going on than just newspapers there. So I know that for-profit is one of the big areas where Washington Post might be playing. There is recently some happenings in Washington about for-profit education, some more scrutiny about the loans that students receive and the recruiting that's going on there. Is this a problem for Kaplan, should we be worried about this legislation?

MacKay: Yes, Kaplan is definitely at risk. That said, we think there are many flaws in the Department of Education's proposal and that its data may not actually be accurate. There is no guarantee that the Department of Education will change its stance, but it's our opinion that once more accurate data is available, the Department of Education may decide to revisit this proposal.

Stipp: So, certainly right now it's somewhat of an overhang over the stock, but might be overblown in our opinion.

So, if we're looking then just at the balance sheet of Washington Post, if we were just maybe taking the for-profit education away for a moment, what does it look like, what's their debt situation look like? I know back in 2006 and 2007, a lot on newspapers took on a lot of debt to do some acquisitions. What's Washington Post looking like today?

MacKay: Washington Post's balance sheet is very conservative. They've got enough cash on hand to cover their debt by two times. Debt to EBITDA is about one times, and even when incorporating the firm's operating leases, you only have about 2.3 times leverage. In 2009, the firm also restructured its balance sheet a little bit, so they've got no near-term debt maturities now.

Stipp: Okay. So, when we are looking at how Morningstar's rating the debt or the credit quality of Washington Post, and how some of the rating agencies are, where does it fall in that spectrum?

MacKay: We currently assign Washington Post a credit rating of A, which is about where the rating agencies are. The S&P is the same at A, and Moody's is a touch higher at A1.

Stipp: Okay. And where are the bonds trading, given that rating? Are they trading about in line with what you would expect?

MacKay: No, the bonds are trading much wider than we would expect from a typical A-rated company. They are trading about 214 basis points over, which is about 100 basis points wider than an A-rated company.

Stipp: So, do you think that this legislative overhang on the for-profit education is one of the reasons that we are seeing that difference? Or what would you characterize as the major risks or why the market is demanding that extra protection to invest in these bonds?

MacKay: I definitely think the market is hanging on this uncertainty surrounding the Title IV issue and that once some of that murkiness gets cleared up, we are going to see those bonds tighten.

Stipp: Great, well, certainly sounds like an interesting idea to dig into. Thanks so much for joining me, Joscelyn.

MacKay: Thanks for having me.

Stipp: For Morningstar, I am Jason Stipp. Thanks for watching.

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