Newspaper Industry Outlook

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SAIBUS RESEARCH Market Outlook September 18, 2013

Value Investors Finding Value in Newspapers – Newspaper Industry Outlook

We recently published a two-part series evaluating the updated performance of Warren Buffett’s investments in the newspaper industry through his company Berkshire Hathaway (BRK.B, BRK.A). Buffett had worked as a paperboy delivering The Washington Post when he was a teenager. Buffett purchased 1.7M shares of The Washington Post Company (WPO) for $11M in 1973 and acquired complete ownership of The Buffalo Evening News in 1977. Berkshire also purchased shares in Gannett (GCI) in 1994 and sold out of his position in Q2 2013. What attracted Buffett to the newspaper industry many years ago was that well-run newspaper organizations were able to generate solid levels of free cash flows and good managers could use those cash flows to reward shareholders through dividends, share repurchases or timely acquisitions of higher margin media properties like television broadcasting stations, cable TV properties or even digital media operations.

Source: Morningstar Direct

Value Investors Looking into Newspapers

Ever since Warren Buffett acquired the Omaha World-Herald newspaper in November 2011, investor interest in the newspaper industry has surged as has the share prices of well-known publicly traded newspaper publishing firms. Every major publicly trading newspaper publisher boasts at least one major, well-known value investor amongst its Top 20 shareholders.

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 Lee Enterprises-Berkshire Hathaway owns 20% of Lee’s outstanding debt as well as 88K shares.

 Gatehouse Media-Fortress Investment Group owns nearly 40% of Gatehouse’s outstanding shares

 Journal Communications-Mario Gabelli’s GAMCO Investors owns 9.23% of Journal Communications’ shares

 The Washington Post Company-Berkshire Hathaway owns 23.3% of The Washington Post Company and Southeastern Asset Management owns 7.4%

 The McClatchy Company-Bestinver Gestion SA owns 10.7% of McClatchy’s outstanding shares

 The New York Times Company-Fairpointe Capital owns 10.2% of The New York Times Company and JHL Capital Group owns 6.6%

 Gannett Company-LSV Asset Management owns 3.45% of Gannett and Ariel Investments owns 3.4%

 The E.W. Scripps Company-The Edward W. Scripps Trust owns 44% of E. W. Scripps, Bluemountain Capital owns 6.7% and GAMCO owns 0.94%

 A.H. Belo Corporation-Hodges Capital Management owns 6.7% of A.H. Belo’s shares

Strategic Reorganizations in the Newspaper Industry

The two most notable and recent newspaper transactions were Amazon.com Founder Jeffrey Bezos buying The Washington Post Company’s newspaper publishing operations for $250M and Boston Red Sox Principal Owner John Henry buying The New York Times Company’s New England Media Group for $70M. Last year, Berkshire Hathaway acquired 63 newspaper publications from Media General for $142M and received 4.6M stock warrants at $.01/share by extending the company a $400M term loan. Berkshire also disclosed a 3.2M share position in Lee Enterprises that was the result of Berkshire buying $85M worth of Lee’s 2nd Lien Term Loans as the company was heading towards bankruptcy.

In addition to selling its New England Media Group to John Henry, The New York Times

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Company has also been selling most of its non-core operations in order to redirect its resources and efforts on its flagship The New York Times Media Group operations (which include NYTimes.com). In 2012, it sold off its About Group subsidiary (instructional information websites) for $317M to IAC/InterActiveCorp and it sold its Regional Media Group (community newspapers) to Halifax Media Group for $140M. Gannett acquired BLiNQ Media and Mobestream Media in 2012 in order to grow its digital marketing services offerings and announced a $2.2B acquisition of television broadcaster Belo Corporation (BLC). Journal Communications sold off its Northern Wisconsin community newspaper operations and has purchased three radio stations and a television broadcasting station over the last six quarters. Lee Enterprises also sold two of its newspaper publications (North County Times and The Garden Island) to private owners when then promptly merged the operations of those newspapers with existing newspapers that the new owners already owned.

Operational Issues Newspapers are Facing

Newspaper chains are facing a myriad of issues in order to remain relevant as well as surviving as a going concern. Here are the most notable ongoing operational issues we see as a challenge for the newspaper industry:

Monetizing Digital Assets: The Wall Street Journal and Barron’s were amongst the first newspaper publications to charge its readers for access to its websites. The major, publicly traded general newspaper chains have been steadily pursuing efforts to increase its revenue from digital operations (whether digital subscriptions, paywalls and digital advertising) in order to stem the revenue losses from declining demand for the print editions of its newspapers. All of the publicly traded newspaper chains enjoyed year-over-year digital revenue growth of 5% in its most recent quarter so we see that these firms are gaining some traction with its efforts to monetize its digital assets.

Deleveraging: Most of the publicly traded newspaper chains took on too much debt during the last decade in order to fund acquisitions. Lee Enterprises in particular has been pushing itself towards repaying the $1.46B in debt it took on in 2005 to acquire Pulitzer during the last eight years. Although we can see that the Pulitzer acquisition qualifies as a “Deal-From-Hell Buyout Bust-out”, at least Lee is still able to generate $165M/year in unlevered cash flow and $75M/year in free cash flow. The face value of Lee’s outstanding indebtedness is $873.5M as

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of its most recent fiscal quarter, which at least is less than half of its 2005 peak of $1.79B.

Source: Morningstar Direct

The McClatchy Company found itself in a similar situation at the end of FY 2006 when its debt soared to $3.3B in the wake of its $6.5B acquisition of Knight-Ridder. We think that McClatchy’s stakeholders have been reeling from the news that it had to write down $3B in goodwill and intangible assets in FY2007, which was 18 months after McClatchy acquired Knight-Ridder. At least it reduced its debt from $3.3B in FY 2006 to $1.5B in H1 2013. Gannett took $8B in charges in 2008 but at least it reduced its debt from $5.4B in 2005 to $1.36B in H1 2013. We are aware that Gannett had to slash its dividend by 90% and drastically reduce its share repurchases from 2008 to 2011 but at least it survived and was able to partially restore the dividend and share repurchase programs. We believe that the newspaper chains need to deleveraging its balance sheets since these firms are no longer investment grade and don’t have access to low-cost debt financing.

Declining Advertising Revenues: All of the publicly traded newspaper chains have seen a steady decline in its advertising revenues due in part to the weak economic recovery and also due to other media outlets (particularly digital media and advertising outlets) displacing newspapers as the leading destination for advertising solutions. These declines served as a catalyst for the newspaper chains to look towards setting up digital pay-walls and to emphasize digital subscription packages in order to offset advertising revenue declines with circulation- related revenues.

Non-Newspaper Related Operations: Lee and Gatehouse are the only two companies that have no operations that are not news-oriented or print-oriented. Lee owns 82.5% of a newspaper-oriented Internet service property (TownNews.com), which provides digital

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infrastructure and digital publishing services for nearly 1,500 publications. Lee used to own television stations but it sold them in 2001 in order to focus on the newspaper business. Scripps has 19 television broadcasting stations and revenue performance from this division is influenced by election year political advertising. A.H. Belo owns about 3.3% of Classified Ventures (apartments.com, cars.com and HomeGain.com) and 12.5% in ShopCo Holdings (Findnsave.com). McClatchy owns 15% of CareerBuilder, 25.6% of Classified Ventures and 33.3% of HomeFinder.com.

Journal Communications owns 35 radio stations and 15 TV broadcasting stations and its broadcasting operations account for more than 60% of its revenues. The New York Times Company has sold off its interest in About.com and the Fenway Sports Group (Boston Red Sox professional baseball team’s holding company) but still has 25% of quadrantONE LLC (an online advertising network that sells bundled premium, targeted display advertising onto local newspaper and other Web sites). Gannett has the largest alternative media content in this peer group with 23 TV broadcasting stations, a pending acquisition of Belo Corporation (A.H. Belo’s former TV broadcasting operations) and controlling interests in CareerBuilder, PointRoll, ShopLocal, Reviewed.com, Mobestream Media, BLiNQ Media and Planet Discover.

Newspaper-related expense management: Lee’s FYTD 2013 operating expenses other than unusual, nonrecurring expenses (excluding depreciation) declined by 3.7% year-over-year. The only companies that saw its adjusted newspaper division operating expenses increase year- over-year in the YTD 2013 period were Gannett (+40bp) and Gatehouse (+16bp). Lee’s operating expense reductions were well above the 2.3% average expense decline and the 1.9% median expense decline that its peers enjoyed during the period. E.W. Scripps (4.6%) and The Washington Post Company (-5%) were the only two newspaper publishers that enjoyed greater declines in its adjusted newspaper division expenses than Lee Enterprises. Nearly half of the publicly traded newspaper chains (McClatchy, Gatehouse, Gannett and A.H. Belo) saw its adjusted newspaper division operating revenues decline at a faster rate relative to its expense declines (or increases)

Conclusion

In conclusion, the easy money has been made in the newspaper industry. However, we believe that the financial crisis has forced newspaper companies to confront the “New Normal” industry dynamics. This “New Normal” is forcing newspaper makers to monetize digital assets, diversify

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into non-newspaper operations, deleverage the balance sheet, control costs and find ways to attract the attention of well-heeled deep value investors. This five point plan will enable newspaper companies to survive going forward, to attract a new kind of stakeholder to the industry and even set up a potential exit strategy for the firms looking to shed assets. With the exception of A.H. Belo (3.13%), all of the other companies that will continue on operating newspaper publishing businesses sport free cash flow yields ranging from 8% (The New York Times Company) to 107% (Gatehouse Media). While Gatehouse Media will be seized by Wells Fargo in order to satisfy its $1.2B outstanding term loan, we believe that Lee Enterprises (49% FCF Yield), McClatchy (47% FCF Yield) and Journal Communications offer the best risk/reward opportunity for newspaper industry investors going forward.

Source: Morningstar Direct

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DISCLOSURES

Past performance is not necessarily indicative of future results. All investments involve risk including the loss of principal. This report is confidential and may not be distributed without the express written consent of the original author and does not constitute a recommendation, an offer to sell or a solicitation of an offer to purchase any security or investment product. Any such offer or solicitation may only be made by means of delivery of an approved confidential private offering memorandum.

Investments may currently or in the future buy, sell, cover or otherwise change the form of its investment in the companies discussed in this letter for any reason. The author hereby disclaims any duty to provide any updates or changes to the information contained here including, without limitation, the manner or type of any of the investments.

All of the views expressed in this research report accurately reflect the research analysts’ personal views regarding any and all of the subject securities or issuers. The research analyst is not registered with FINRA, and may not be subject to FINRA rule 2711 restrictions on: communicating with the subject company, public appearances, and trading securities held in the research analysts’ account. No part of the analysts’ compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed in this research report. The analyst responsible for the production of this report certifies that the views expressed herein reflect his or her accurate personal and technical judgment at the moment of publication.

Under no circumstances must this document be considered an offer to buy, sell, subscribe for or trade securities or other instruments.

Disclosure: Analyst(s) covering this company does not own its stock.

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