American newspapers are buckling under the internet onslaught. But there are bargains to be had, say James Robinson, media correspondent of The Observer, and fund manager Sven Lorenz
Ever since Bob Woodward and Carl Bernstein uncovered the Watergate break-in, and ultimately brought down President Nixon, American newspapers have been walking with a self-confident swagger. Titles such as The New York Times and The Washington Post consider themselves the best in the world, displaying a healthy self-regard that their critics might prefer to call arrogance. But if the Watergate era marked the peak of power for the US press, the last two years have represented a nadir. American newspapers have suffered a crisis of confidence. Even the most prestigious The New York Times saw its reputation seriously damaged after a young reporter, Jayson Blair, plagiarised stories.
That could happen to any title, but there was also a collective bout of soul-searching about the press's failure to expose the Bush administration's flimsy case for waging war in Iraq. Both have prompted lengthy mea culpas in the pages of American newspapers, displays of self-flagellation that would be comical if the issues involved weren't so serious. However, editorial problems have been accompanied by commercial issues that may finally eclipse those caused by short-term journalistic shortcomings. The newspaper industry has been exposed to competition that could ultimately render it obsolete: they have been struggling to cope with the threat posed by the internet, which is now Americans' main source of news. And where readers go, advertisers follow.
The newspaper sector: competition from the internet
Even Lauren Rich Fine, one of the world's most respected newspaper analysts, and for many years a cheerleader for newspapers, has recently turned gloomy. In 18 years of working as an analyst, she has "never seen these kind of changes before", she has said. Fine was referring to the increased competition newspapers face from the internet as well as cable TV and specialised magazines. New media has been taking a bite out of newspapers' market share for the past six years. For newspapers, local classified advertisements used to be a near-monopoly, the nearest thing imaginable to a licence to print money.
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Today, free internet services such as Craigslist.com are providing formidable competition. Even those newspapers that have responded by selling classified advertisements online have found they get about 30 cents for every $1 they would have got for the print equivalent. Online competition has proved hugely deflationary. More seriously, perhaps, newspapers are not replacing dying readers with new ones. Traditionally, young people started subscribing to a newspaper around the same time that they took out their first mortgage. Today, a good proportion of 20- and 30-somethings are turning to the web. That trend is likely to accelerate as other platforms, including hand-held digital devices and mobile phones, start to offer news and entertainment.
Newspaper sector: activist shareholders
American newspapers face the biggest fight since TV was invented, and many of their Wall Street critics argue their archaic ownership structures mean they are ill-equipped for it. America likes to picture itself as a bastion of shareholder culture and corporate governance, but a surprising number of firms, including Rupert Murdoch's News Corporation, are controlled by their founding families.
The trend is particularly prevalent in newspaper businesses, many of which were founded at the turn of the 19th century. In some senses, that's only to be expected. Newspapers, as every proprietor privately concedes, are different from other businesses. Like landmark hotels or football clubs, they are trophy assets. But they also bring with them political power and a wider influence in the corridors of power that is beyond price. Not surprisingly, the families that inherit them are keen not to relinquish control, particularly as many have greater voting rights than those held by other shareholders.
The Sulzberger family is a case in point: family members own 20% of The New York Times Company, but control it through a separate Class B share, which gives them the right to appoint nine out of 13 board members.
The arrangement isn't unique to the US. In Britain, Daily Mail owner Daily Mail & General Trust (DMGT) is quoted on the London Stock Exchange but controlled by Viscount Rothermere, whose great-grandfather founded the paper. That means it is unlikely ever to fall prey to a prospective buyer. Many argue that this has enabled the group to build strong newspapers by investing heavily in journalism, even when the City would prefer to see it cut costs to meet short-term performance targets.
In the US, that argument currently cuts no ice, and some of these old-fashioned arrangements may not remain in place for long. Shareholder activists, who have already forced change at some of American's largest media companies, including Disney and Time Warner, have begun to turn their sights on the newspaper industry. They are demanding obsolete dual-share structures are dismantled in the name of shareholder value', a familiar Wall Street rallying cry.
Newspaper sector: share price falls
At first glance, these two trends the threat posed by the internet and a sustained attack by activist shareholders seem unrelated. But The New York Times and others would not be facing an investor assault if it were not for the changes the information revolution has unleashed and the catastrophic effect they have had on share prices.
Over the last three years, newspaper shares were bottom of the list when it came to performance. Between January 2004 and April 2006, the newspaper sector of the Russell 3,000 index was down 37.8%, while the S&P 500 index was up 17.6%. Archaic management structures that were tolerated as long as stock prices were rising are now regarded as anathema by fund managers who have watched their investments shrink in recent years.
Recently, the sector has taken yet another beating and the backlash has claimed a prominent victim. Last November, Private Capital Management, weary of the poor performance of Miami Herald owner Knight Ridder, in which it held a 19% stake, forced the group to sell its papers. Under pressure from PCM, Knight Ridder eventually sold its 22 papers to rival McClatchy Newspapers. The $4.5bn auction that preceded it was remarkable; not a single one of the other potential buyers actually posted a bid. The usual line-up of private-equity firms did circle the company, but the prospect of buying into the industry ultimately proved unattractive. It was a dramatic illustration of the low esteem in which Wall Street currently holds the nation's newspaper business.
Knight Ridder's titles ended up in the hands of McClatchy CEO, Gary B. Pruitt, a passionate newspaper boss who firmly believes he bought them at a bargain price. That was two months ago, and analysts say it's still too early to say whether Pruitt's belief is misplaced. McClatchy's share price fell in the aftermath of the deal, but that can be explained in part by the release of yet another set of dire industry figures at around the same time.
Newspaper sector: declining advertising spend
Early in June, industry research firm TNS Media Intelligence reported that advertising spending in local US papers had dropped by 6.1% in the first quarter. That's the biggest decline in more than four years. Advertisers spent $5.55bn on local publications, down from $5.91bn in the first quarter of last year. At the same time, internet advertising jumped by 19% to $2.31bn as large advertisers increased web spending. "It's the perfect storm for local newspapers," said Jon Swallen, senior vice president of TNS.
These figures have set alarm bells ringing in downtown Manhattan, where investment banking giant Morgan Stanley runs its asset-management operations. Funds managed by Morgan Stanley own more than 5.6% of the venerable New York Times Company, a stake they have held since 1995. In the wake of a share-price slide, the bank approached the board demanding changes, including an end to the dual share structure, but it was an ultimatum the board politely ignored. But at a shareholder meeting, 28% of investors voted in favour of Morgan Stanley's demands. There is no immediate threat to family control, but Morgan Stanley hasn't ruled out acquiring more shares. The market capitalisation of the company is now about a third of its enterprise value (the estimated value of its assets).
If the revolution gathers pace, and a revered newspaper dynasty is unseated, it would be the most dramatic example so far of the power the internet wields. But is there a solution to the industry's sluggish performance? Journalists will be heartened to hear that cost-cutting doesn't seem to work. Knight Ridder tried to reduce costs, but still fell victim to worsening margins.
In the UK, Trinity Mirror has adopted a similar strategy and managed to appease shareholders (including several large American investors), but circulation at its major titles, such as the Daily and Sunday Mirror, continues to plummet and their long-term future seems far from secure.
Newspaper sector: huge market share
The competition unleashed by the internet is likely to intensify. But there are some little-known figures that put the general doom and gloom into perspective. Despite the recent decline in readers, 54% of all American adults still read a paper every day, and 60% do so on Sundays. That's 124 million pairs of eyeballs every Sunday. To illustrate just how massive a market share that is: more Americans read a newspaper every Sunday than watch the Super Bowl TV's biggest attraction of the year. The Super Bowl only reaches 90 million Americans, and it does so only once a year, compared to the Sunday papers' 52 weeks per year. Young people may have turned to the web as their premier source for news, but 39% of them still read a newspaper. In a country of 300 million, that's a massive market.
What's more, the web hasn't yet replicated the kind of depth of local coverage, or reader trust, that hometown papers enjoy. Local titles still produce quality content and form strong bonds with their readers; many are franchises that won't vanish overnight, and the sheer size of the country means most don't face serious competition from national titles. It's often easier to buy The New York Times in London than in Waco, Texas or Phoenix, Arizona.
Then there is the overseas market. Overall global newspaper circulation is actually rising with a fall in Western countries offset by a rise in the developing world. In countries such as China and India, literacy rates are improving and the newspaper industry is booming. Some countries are lifting laws banning overseas ownership of media assets. US groups may decide that international expansion is a good way to keep profits rising while domestic conditions remain tough.
Newspaper sector: growing demand for news
Ultimately, tackling the new media conundrum remains the most pressing issue. But even here, the omens aren't all bad. A crucial distinction should be drawn between newspapers, which may struggle to survive, and journalism, which has a bright future. With the demand for news increasing and the number of people able to access it growing, the global desire for information is as insatiable as ever. It's irrelevant how that news is consumed, or which platform is used to deliver it.
Firms that invested hugely in the internet, such as Wall Street Journal owner Dow Jones in the US and Britain's Guardian Media Group, recognised early that the internet revolution meant content had to be made available in several forms. Translating eyeballs into revenue is the challenge they face, but the Journal's web site is now profitable and the Financial Times also claims its internet operation is in the black.
Few predicted the speed with which search engines would grow, or that they would enable us to bypass print. But new technological advances could mean news providers will one day be producing futuristic products that owe a huge debt to the traditional formats of the past. Indeed, some manufacturers are already experimenting with electronic computer screens that are almost as thin and flexible as paper. New content can be downloaded regularly, but the screens can be folded in half, or even rolled up and shoved into a handbag or a back pocket sound familiar?
Two shares to buy before the story hits the papers
Buying at the point of maximum pessimism is a lucrative but tricky strategy. It involves anticipating news and developments before they have been published. A good speculator doesn't always have investment bank reports to back up his views, as he tries to get into a story before investment banks pick it up at all. Being ahead of the crowd is what contrarian investing is about, yet it takes some nerve, as you can't file away newspaper clippings that confirm your view. Those who prefer to wait for such official confirmation often miss the best prices. Are you brave enough to walk off the trodden paths of investment banks' buy ratings?
One story that could make the news sooner rather than later is that of a potential take-over of The New York Times Company (NYSE:NYT). Currently, the consensus view of this firm is negative. Yet that's when a share is worth buying, as long as you see a potential catalyst for change on the horizon. In this case, it's the activities of Morgan Stanley (see story above), as well as the fact that the more the share price slides, the more likely it is that some family members will want to sell out before losing even more. Even in its current dismal state, the NYT has an enterprise value that is one-third above the current market price.
But there's more potential to be realised. A more visionary CEO could start to make use of the NYT as a platform for developing additional revenue-earners, such as mail-order sales of products and services. Also, the NYT could do much better at selling its unique content on the web, using its globally established brand name. The combination of an existing, higher enterprise value on one hand and room for operative improvements on the other, should make this firm a mouth-watering asset for private-equity firms. A bid should lead to a share price well above the enterprise value, as a bidder will have to compensate shareholders for some of that future potential. From today's price, this share has room for 50% capital growth before the end of the year. If it slumps further to $20 or less investors should buy. At such a price, the share would offer an attractive risk/rewards ratio. Buy, with a limit of $20.
Once The New York Times is in play, it won't take long for a wave of speculation to hit the shares of The Dow Jones Company (NYSE:DJ). As in other industries, one key player selling out often sets off a wave of bidding for similar targets. The Bancroft family has seen its main asset shrink in value by half during the past five years and hence looks vulnerable. The Wall Street Journal, equally, is one of the most recognised global brand names in publishing. If the owners of The New York Times sell out at a price that recovers much of the past years' share-price slide, the Bancrofts are likely to get greedy, too. This could lead to a quick collapse of the family voting pool, quite possibly due to younger members of the family choosing to take cash that they can reinvest into more dynamic assets.
Warren Buffett has in the past been said to be interested in purchasing the FT, and given that The Wall Street Journal is published on his home turf, he would most likely be among the bidders for it. Buffett bought into The Washington Post Company (NYSE:WPO) in 1973, when the industry experienced a slump. Just like today, at the time no one predicted a glorious future for newspapers. Yet Buffett turned his investment into a 100 bagger worth 100 times his initial investment on the back of a strong brand name outlasting any industry crisis. Just like the NYT, the Dow Jones Company is trading well below its current enterprise value. The discount to the share's fair value is 20%, even when factoring in the current poor state of affairs. In a bid situation, the shares should eventually rise 20%-30% above the current enterprise value, giving it a total profit potential of about 50%. Given that this share is now at its lowest since the early 1990s, it's a buy.
Recommended further reading:
You can read James Robinson's report on the broadcasting sector here: Television is dying so which broadcasters can survive the entertainment revolution? There is a full list of articles on investing in a variety of sectors, from nuclear energy to gambling in our section on investing in stock market sectors.
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