Gannett Co. Inc.
Gannett is the largest newspaper publisher in the United States, and the second largest in the United Kingdom through it's subsidiary Newsquest. The company publishes USA Today, the largest selling paper in the U.S., in addition to 85 dailies and 900 non-dailies in the US and 17 dailies/300 non-dailies in the UK. Newspapers account for 89% of the company's revenues (74% of this through ads, the rest through subscription fees). The remaining 11% of revenues are earned through broadcasting, where the company owns 23 network-affiliated TV stations. Gannett has purchased several stakes in small, specialized websites including CareerBuilder, ShopLocal.com, Topix.net, and Cosi.com. However, online revenues represent a scant 6% of total sales.
Gannett has little choice but to embrace the internet. The company has been aggressively moving their local papers onto the net, and changing newsrooms to focus on breaking news on the web while following up in print. Multimedia delivery of the news has been another focus, one made possible through the web. Online revenue has been increasing at a 20%+ clip per year for these sites. Gannett has also purchased several stakes in specialized, mostly social oriented websites. This will likely be an ongoing strategy, as the company's wide reach is attractive for social sites that require large volumes of members to operate profitably.
The competition includes other forms of media, such as television, radio, and rival newspapers. Increasingly, Gannett's papers face a very dire competitor in internet advertising. Advertisers prefer the internet to traditional print ads, as the internet allows them to fine tune targeting as well as providing instant feedback on the performance of ad campaigns. Gannett has no real competitive moat that would allow them to charge higher ad rates, or maintain the advertisers they currently have.
The list of challenges facing this company are long and daunting. First, there is internet advertising, whose advantages are explained in the Competitive Position section. In addition to it's advertising advantage, readers viewing the news online do not pay subscription fees, which drives down circulation revenues. Classified Ads, long a highly profitable and wide-moat business, are in a long term death spiral as web sites such as eBay, Craigslist, and Monster.com have become the preferred outlet for home sellers and job seekers. While Gannett has been moving into the online business, the company still must maintain a large fixed-cost publishing structure which will limit profitability. There is just no way for this company to grow revenues and profitability. Focusing on one inevitably will weaken the other. It's a brutal Catch-22 that all newspaper companies are facing.
Craig Dubow took over as president and CEO in 2005. He is a Gannett veteran, with the company in some executive position since 1981. Executive compensations are rather high, and the proxy lists 14 vague factors the compensation committee may or may not use to determine bonuses... meaning there are no real targets that management has to meet. Dubow was awarded nearly 6 million in total bonuses in 2007, despite drops in revenue, operating margin, return on capital, and a stock price that declined over 30%. Pension and termination plans are ridiculously generous as well. Insider ownership is almost laughable at 0.20%. Needless to say, MagicDiligence is not a big fan of Gannett's management.
The newspaper business has long been a profitable one, and Gannett is still clinging to some of the attractive economics. The company still delivers over 40% return on tangible capital, but this figure has declined each of the last 5 years. Operating margins have also contracted each of the last 5 years, and revenue declines in both newspapers and broadcasting are accelerating fast. Compounding the problem is the fact that Gannett holds nearly 4 billion dollars in debt. Interest coverage is still fairly comfortable at 6x earnings, but continued revenue and margin declines could make the debt a dicey problem in a hurry. On the bright side, Gannett is an absolute cash cow, even today producing over a billion dollars of free cash flow with a free cash margin of nearly 15%. The meaty 6.7% dividend appears safe for now, with payout only about 30% of free cash flow.
Looking back at what makes a bad Magic Formula stock, one criteria is "is the company in a declining industry with poor future prospects"? Clearly, Gannett meets this criteria. The internet is wreaking havoc on the newspaper business model, basically eliminating circulation revenues and placing print ad sales at a serious disadvantage. While Gannett can and is moving onto the internet, the giant fixed costs associated with the newspaper business is a real heavy albatross to the company accomplishing anything worthwhile in this venture for some time. One could also argue that the company fails the first test of having reasonable debt and sustainable competitive advantages. There is little reason to consider an investment here. The company is extremely cheap and pays a nice dividend, but this could look expensive and the dividend could disappear if the business continues to deteriorate. Stay away from this one.
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