The Market's Most Overvalued Stocks
The newspaper business is in terminal decline.
The newspaper business is in terminal decline.
Newspaper stocks have been decimated over the past year, as the Internet continues to steal readers and ad revenue from traditional print media. We think the stocks have further room to fall, as declining revenues and negative operating leverage combine to create a downward spiral for this moribund industry.
The chart below shows the performance of five newspaper stocks over the past year. Such sharp price declines (including a 52% drop for Gannett (GCI) an 82% dive for McClatchy , and a 94% loss for rural/suburban publisher GateHouse ), coupled with what may be perceived as currently cheap valuation ratios, could be tempting to value-minded investors, but we say "Look out below!"
Black, White, and Red All Over: Newspapers Drop
Newspapers have high fixed costs, like journalists' salaries for reporting. It costs the same to produce a newspaper's content whether it has a readership of 1 person or 1 million people. That gives newspapers a high degree of operating leverage: As revenues grow, operating profit grows even faster. Unfortunately, the reverse also holds true. As we expect newspaper revenues to steadily shrink in the coming years, these businesses should feel a disproportionate effect on their bottom lines.
The Internet is stealing readership and ad market share from newspapers at an accelerating pace, thanks to the Web's numerous advantages. Online news is updated as it happens. Most Internet content is provided for free. Content can be dynamic and interactive. The reader's hands aren't stained by newsprint. Advertisers prefer the Internet's younger audience and real-time feedback from click-through data. Finally, the Internet allows advertisers a low-cost way to target specific populations. We don't anticipate these trends to reverse and consider the newspaper industry unattractive as a whole.
Below, we highlight five newspaper stocks trading at significant premiums to our fair value estimates.
Gannett (GCI)
Economic Moat: None
FV Uncertainty: Medium
P/FV: 1.61
Gannett, publisher of USA Today, is the nation's largest newspaper company. Despite its efforts to expand into other media, newspapers represent 85% of the company's operating income. Gannett's online properties continue to show impressive growth (usatoday.com sees 43 million visitors each month), but it has not been sufficient to make up for the decline in the core business. We expect revenues to fall at a 5% annual clip during the next five years, and operating income to average 14% annual declines.
The New York Times Company (NYT)
Economic Moat: Narrow
FV Uncertainty: Medium
P/FV: 1.27
The New York Times benefits from an upscale readership, which recognizes the quality of the paper's premium content and is willing to pay for it. In our opinion, the Times is better positioned than most in the current environment. Of the company's revenue, 30% comes from circulation fees, which helps insulate the company from declining ad revenue. The Times also enjoys a relatively high concentration of national ads, rather than retail and classified ads that have been under greater competitive pressure from the Internet.
Lee Enterprises (LEE)
Economic Moat: None
FV Uncertainty: Medium
P/FV: 1.63
Lee's portfolio of small-town newspapers faces relatively little competition in providing local news, which has helped the company outperform many of its peers. However, the company is by no means immune to the broader trends affecting the newspaper industry. For every dollar Lee lost in print ad and circulation revenue in 2007, its online business only made up $0.84. We expect Lee to see 2.7% annual revenue declines and 12.9% operating income declines over the next five years.
McClatchy Company
Economic Moat: None
FV Uncertainty: High
P/FV: 1.95
McClatchy doubled down its bet on the future of newspapers with the $4.6 billion acquisition of Knight Ridder in 2006. The $2.5 billion in extra debt assumed in the deal only exacerbated McClatchy's shaky financial footing. Barely a year passed before McClatchy had to write down $3 billion of the acquisition's purchase price. Another problem in the current environment is McClatchy's outsize exposure to California and Florida, with their floundering housing markets. We expect McClatchy to see 4.7% annual revenue declines over the next five years and only irregular profitability.
GateHouse Media
Economic Moat: None
FV Uncertainty: High
P/FV: N/A (FV = $0)
We are most pessimistic about GateHouse Media, a publisher of low-circulation papers in rural and suburban communities. We think GateHouse's equity is worthless. The company has been an aggressive acquirer, which resulted in an unmanageable debt load. The company spent more than $1 billion last year to buy 70 small newspapers and a phone book publisher. We expect GateHouse's cash flows to decline in the coming years, but the company is already unable to meet its obligations. For the first quarter of this year, it did not earn enough to cover its interest expense, even before depreciation and amortization.
Morningstar Equity Analyst Tom Corbett contributed to this article.
P/FV calculated using closing prices on August 13, 2008.
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