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Don't Stop the Presses: Print Media Still Alive!

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The newspaper industry has been written off for dead more than once. With multi-year declines in print circulation, newspapers have slashed jobs and costs while activist shareholders have demanded further bloodletting or mergers. This year, No. 2 newspaper publisher Knight Ridder (KRI) was bought out by McClatchy (MNI). Speculation about future mergers abounds.

Rather than a harbinger of doom, the current downturn is part of the normal business cycle, says James Peters, publishing analyst at Standard & Poor’s. Some newspaper stocks present buying opportunities, he believes, as their valuations have been hammered down. “When we start to see better revenue growth, these stocks might look like strong value plays,” he says. “With strong cash flow, these are stable companies — they’ve been around a long time.”

Peters doesn’t gloss over the industry’s problems. The biggest is that “major advertising clients are in a cyclical slump,” he says. Meanwhile, costs are rising for paper and energy; proliferating media compete for readers and advertisers; and the Internet forces new forms of production and distribution. This “confluence of factors has created a negative perception of the industry,” Peters observes.

Predicting just when advertising will rebound is “tough,” Peters says. Summer blockbuster movies should bring in promotional dollars — and more post-release ads if the films open well. Year-over-year comparisons should be easier to beat now. Further retail or telecom consolidation, which cuts ad budgets, is unlikely in the near term, although auto advertising may continue to struggle, along with the Big Three carmakers.

Peters projects that when newsprint industries rebound, newspapers, especially those that have cut costs and invested in new products, will enjoy improved operating leverage. “Investors will see that the industry isn’t on an unending, downward march, with low or negative revenue and EPS growth,” Peters says. He believes lasting prosperity can only come from an improvement in business fundamentals and not from share buybacks, which some publishers have been doing.

Measuring the industry’s success is another problem. “The newspaper industry needs to change the perception of the business being based on print circulation to one of readership,” Peters says. “How many eyeballs do you reach?” Because most newspapers serve a local audience with no competitor, they can achieve the high levels of penetration sought by many advertisers. And while circulation is going down, readership is increasing, he says. Still, advertisers have been willing to pay higher rates to reach the differentiated audiences that newspapers can provide, Peters says. “Advertisers put value in newspapers’ significant audience reach and their readers’ undivided attention, which gives newspapers pricing power.”

Operating margins for print newspapers are very high — “around 20%, comparable to oil companies,” Peters notes. Yet as print subscriptions fall, the Internet presents distribution and marketing opportunities that many publishers are just beginning to explore. Web ad sales are growing at an explosive 25% annual rate, and newspapers claim 17% of online ads, Peters says.

Still, most newspaper Web sites are not yet profitable. While incurring costs to build online capabilities, newspapers must also maintain print operations, whose revenues are declining. To compensate, they need to merge back-office operations and find a way to distribute their content across various media platforms, Peters says.

In terms of online franchises, the Wall Street Journal Online has taken an early lead. Launched in 1996, it had attracted 768,000 paid online subscribers by the end of 2005, reports parent company Dow Jones (DJ). “They’re the most successful in terms of augmenting and not cannibalizing their print subscription with online subscriptions,” Peters says. Yet Dow Jones is already one of the most expensive companies in the publishing group.

Another Internet success is ‘TimesSelect’ from the New York Times`A` (NYT). Introduced in 2005, this online service had attracted some 176,000 paid subscribers by April 2006, according to Editor & Publisher. Peters believes, a consumer advice Web site acquired in 2005, is growing revenue rapidly and expanding the Times’s Internet presence. But he expects the significant capital expenditures to depress free cash flow at the company for several years, while a difficult local economy crimps its Boston Globe operations.

Online ads currently represent only 4% to 5% of publishers’ revenues on average, Peters says. Ultimately, the Internet will likely transform the industry, becoming a bigger driver of revenues and earnings growth. Newspapers that don’t develop online businesses could be left behind. But the Internet’s influence “will play out over a longer period of time,” Peters says. Because Standard & Poor’s equity recommendations are based on a 12-month outlook, Peters ranks both Dow Jones and the New York Times as a “Hold.”

Peters’ “Buy” recommendations include Tribune (TRB), where online advertising already accounts for 6% of revenues, even without a subscription product. Within three years, the company aims to make that figure 12% to 15%. Ads contributed about 79% of publishing sales in 2005, and publishing represented 73% of total 2005 revenues. While Peters is “concerned” by Tribune’s slow revenue growth, he likes its focus on cost-cutting and on promising areas like the Internet and the new CW broadcast network. Cost savings include a partnership in California with direct mail company ADVO (AD) and an expected $65 million in savings from layoffs announced in 2005. In late May, the company announced a financial restructuring — including borrowing up to $2.4 billion to buy back stock — intended to bolster its share price.

Gannett (GCI) is taking steps to merge its print and online back-office operations for USA Today, the largest circulation paper in the U.S. This move “lowers the company’s cost base, allows it to distribute the same news across different platforms, and refer readers to those different platforms,” Peters says. Though USA Today is supported largely by advertising and doesn’t yet have an online subscription product, the company appointed a president of digital operations in January. “Gannett is looking for ways to distribute content differently than in the past, getting it into the hands of consumers in whatever format they wish to be engaged,” Peters says. In 2005, 90% of Gannett’s $6.9 billion in revenues came from its newspaper publishing segment, with online and print ads contributing 75% of those revenues, circulation 18%, and commercial printing 7%.

Many publishers – not just newspapers – are confronting the problem of how to move content to varied media to appeal to more readers and advertisers, while investing in digital media. Among them are Reader`s Digest (RDA), which is “just starting on the upswing of a long turnaround,” Peters says. “They are expanding internationally using their brand name, and doing so at low cost, rapidly and profitably, with many potential future markets.” Recently, the company bought cooking Web site, complementing its large stable of food periodicals. Its Internet properties also include its flagship

Others have noticed. Thyra Zerhusen, portfolio manager of ABN AMRO Mid-Cap Fund (CHTTX), has been known for spotting bargains. Reader’s Digest is a top holding in her fund, as is New York Times. Both FMC Strategic Value and Wells Fargo Advantage Mid-Cap Disciplined Fund/Inv (SMCDX) also include Reader’s Digest among their top 10 holdings.

Meredith Corp. (MDP) publications are focusing on “niche growth demographics, like Spanish language, women’s issues, and special interest topics like health,” Peters says, a trend he expects to see copied by newspapers. The company “consistently delivers solid growth,” he says, and its integration of magazine publisher Gruner & Jahr offers a potential to expand its operating margins over time as it improves efficiencies.

Playboy (PLA) is similarly “in the middle of a turnaround,” Peters says. Primed by new business lines and cost-cutting efforts, the company could see fundamental improvement in the second half of 2006. Last October, Playboy began publishing its online magazine in a format that looks like the print publication. The company is “doing a particularly good job at leveraging the brand through licensing, including for casinos, retail outlets and e-commerce,” Peters says.

Playboy’s situation is familiar to many publishers. Its auxiliary businesses are “highly profitable,” Peters says, while the print magazine — the brand and content that generates the profitable lines — loses money. So while the newsgathering business may look like an old gray goose, it keeps laying golden eggs.

Contact Bob Keane with questions or comments at: [email protected].


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