How Low Can Gannett Go?
The stock price of newspaper giant Gannett (GCI) has resembled a double black diamond ski slope over the past year. Now, this well known publisher of USA Today and many regional daily newspapers is a very highly ranked Magic Formula stock with a dirt cheap P/E ratio of 5.6. Gannett still owns some of the highest circulation papers in the country and generates a ton of free cash flow, as well as paying a meaty 6.7% dividend. Is this a buy?
Only a little over 10 years ago, the newspaper business was one of the best in the entire investing world. Most cities in the U.S. are only large enough to support a single daily newspaper, and even the large cities had one that most considered *the* paper (such as the New York Times over the Post, and the Chicago Tribune over the Sun-Times). This created a bunch of mini-monopolies around the country, where local advertisers had to pay up to the city paper to get their products in front of the widest audience. Additionally, classified ads were a lucrative business. Before eBay (EBAY) and Monster (MNST), local junk slingers and job recruiters relied on the main paper to hawk their wares or recruit new employees. Newspaper production costs are largely fixed expenses (printing 1000 copies costs little more than printing 1), so each additional paper sold over break even was almost pure profit. Great investors like Warren Buffett recognized this, making big investments in newspapers, and the newspaper companies that bought their way into new markets, like Tribune and Washington Post (WPO), saw profits continually rise.
Today, of course, times have changed dramatically. Newspaper publishers have seen the enemy, and it's name is the internet. The internet seems almost the perfect invention for decimating newspapers. For one, it's ubiquitous. No longer does the person selling a used camera have to sell just within his metropolitan area - now he can sell all over the world online. The internet has torn down sales barriers, allowing people from anywhere to easily buy products from any vendor, eliminating the localized markets that used to exist. With the news online, and for free, newspapers have seen their subscription rates plummet, wiping out circulation revenues. The worst for newspapers is the significant competitive advantages internet advertising has over print. When advertising online, vendors can directly target any set of characteristics to target ads to, and immediately get feedback on how successful those ads are from a return-on-investment standpoint, something that is nearly impossible to do accurately through print ads. While newspapers do, arguably, provide a better medium for consuming information, this is not nearly enough to save them from continuing decline as the internet becomes increasingly available through handheld electronic devices like Apple's (AAPL) iPhone or Amazon's (AMZN) Kindle.
Gannett is doing what it has to do, quickly moving their local papers onto the web and focusing on breaking news there, then following in print. Online advertising revenues have been rising in the mid-20% per year range. The company is also buying stakes in social oriented websites like CareerBuilder and Cosi.com - Gannett's ability to get these sites in front of millions of readers is an attractive proposition. The problem with this strategy is two-fold. One, there is no way the internet is going to replace a significant portion of Gannett's newspaper operations, which provide 89% of revenues. There is simply too much competition on the web, from news portals like Yahoo! (YHOO) to cable television properties online (like CNN.com) to blogs. The second problem is that Gannett has a large fixed cost structure for producing newspapers. If they cut back on this cost structure, newspaper revenues could fall dramatically with nothing to pick them up. The company is in a difficult Catch-22 situation that will take years to work themselves out of. Growing revenues in the foreseeable future is going to be tough.
Adding to the black marks on the company is greedy management. The CEO earned 7 million dollars in bonus money in 2007, despite a drop in revenues, tightening margins, a lower return on capital, and a stock price down 30%. Don't you wish you were awarded 7 million for that kind of performance?
Gannett is in a business that will almost surely continue it's decline for some time. Although quite cheap, and with a generous dividend that is safe for now, this one screams "value trap".
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