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Opening Shot

Media’s Bright Spots

The big winner ten years from now will be a company that is tiny today or hasn't even been born yet.

Whatever you think of its editorial line, the New York Times, in the depth, breadth and sophistication of its journalism, is the best newspaper in the world. The Times, however, is rapidly losing readers (circulation was down 7% for the six months ended September 30) and advertisers (revenues in the third quarter fell by nearly one-third compared with the same period in 2008). In 2002, the Class A stock of the New York Times Co. was trading for more than $50 a share; it’s now about $9, giving the firm a market capitalization of $1.2 billion.

That valuation includes not just the New York Times itself, which has a circulation of one million on weekdays and 1.5 million on Sundays, but also the International Herald Tribune, the Boston Globe, 15 small-city daily newspapers and more than 50 Web sites, including NYTimes.com, Boston.com and About.com.

Although Times shares have doubled from their February low, the company is still struggling to survive. Despite a $250-million infusion of cash from Carlos Slim, the richest man in Mexico, the Times has an ugly balance sheet, with a half-billion dollars in debt coming due in the next five years and current liabilities exceeding current assets by one-third. The Value Line Investment Survey gives the Times a below-average ranking for safety and a miserable C++ financial-strength rating.

Stocks for a song. At current prices, you could buy the public stock of the Times Co. (symbol NYT); the Washington Post Co. (WPO); Gannett (GCI), publisher of USA Today and 85 dailies, and owner of 21 TV stations; E.W. Scripps (SSP); McClatchy (MNI); and Media General (MEG) -- plus CBS (CBS) -- for the price of Yahoo (http://tfn.kiplinger.com/index.php?ticker=YHOO&page=stockTipsheet YHOO) alone.

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The devastation among traditional media companies is widespread. Daily newspaper ad revenues are expected to fall to $32 billion this year, compared with $49 billion in 2006. Adjusted for inflation, those figures are at 1965 levels, according to the Columbia Journalism Review, even though the
U.S. population has risen by half since then. Newsstand sales for magazines dropped 12% in the first half of this year, and venerable titles, such as Gourmet, published by privately held Condé Nast, are folding. Vogue is selling one-third fewer ad pages this year than last.

Television is not faring much better. Local stations are suffering, and TV ad revenues at News Corp., the global giant that owns the Fox network (as well as Dow Jones, publisher of the Wall Street Journal), have dropped 27% in the year that ended June 30.

The media business has been hit by a double whammy: the declining economy and changing technology. Newspaper publishing used to be what Warren Buffett enthusiastically called a franchise business, positioned to skim off profits like a tollkeeper on an economic highway. “Even a poor newspaper is a bargain to most citizens simply because of its ‘bulletin board’ value,” he wrote in the 1984 letter to shareholders of his holding company, Berkshire Hathaway, which owns a large chunk of Washington Post stock.

The Internet changed all that. Free services, such as Craigslist and Facebook, are now far more effective bulletin boards than newspapers ever were. Partly as a result, the Tribune Co., owner of what were classic franchise papers and TV stations in such huge markets as New York City, Los Angeles and Chicago, filed for bankruptcy in December 2008, and the stock of Journal Communications (JRN), which owns, among other things, Milwaukee’s monopoly newspaper franchise and the NBC affiliate there, traded in March for 39 cents a share (it closed at $3.89 on October 29). Media executives have seen the current disaster approaching, like an oncoming train in a tunnel, for the past two decades, but they have been practically frozen in their tracks.

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They had two main responses. First, they started online versions of their newspapers. In nearly all cases, those Internet editions have proved to be expensive flops (in fact, even Internet ad sales have dropped -- by 5% in the second quarter of 2009). Second, the brass hacked away at costs, an activity that has only accelerated the death spiral: Reduced editorial investment hurts quality, chasing away more readers and leading to lower profits. That brings more editorial cuts, hurting quality further and chasing away still more readers, and on and on.

The question for investors is whether newspaper stocks -- and media stocks more broadly -- are down so far that they have nowhere to go but up. A recent headline on TheStreet.com suggested that the answer was yes. “Restart the Presses: Newspapers Not Dead Yet,” it said.

Maybe. Consider Media General, which publishes 21 daily newspapers, including the Tampa Tribune, and more than 200 weeklies, and also owns 18 TV stations. Its market value is just $200 million, or about $10 million per TV station, with everything else tossed in for free. Between 2004 and 2006, Media General’s net profits averaged more than $70 million a year.

Value Line expects the company to eke out a profit of $4 million this year; but if the company can get earnings back to half the level of the mid 2000s, then today’s market cap will represent just six times earnings. To put it another way, Media General today trades at one and a half times its 2006 cash flow per share.

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On the other hand, Media General has an appalling balance sheet, highlighted by $6 million in cash and $711 million in debt. Still, the company generated a profit of $21 million in the second quarter (including a $7-million capital gain), and its cash flow is easily covering interest payments. If the U.S. economy expands 3% or so in 2010, as most economists expect, then Media General and the others may be able to keep their heads above water. But they still need to overcome the systemic problem: too much competition from new media for both readers and advertisers.

Media stocks were essentially left for dead this summer. Gannett, the leading newspaper publisher, dropped to $3.17 a share on July 9 -- a price that was well below its annual per-share earnings in every year from 2002 to 2007. Because of glimmers of hope, a cost-cutting fest and the stock market’s broad recovery, Gannett’s shares have nearly quadrupled, to $11. Yet that’s still 85% below the stock’s all-time high, set five years ago.

Crystal-ball failure. As someone who has spent 40 years as an editor, publisher and writer, I am not optimistic about the future of conventional-media stocks. When the Internet emerged as a commercial tool, I told friends, “When I ran a magazine, our three biggest expenses were printing, paper and mailing. The Internet eliminates all three!”

Yes, but what I didn’t take into account was that the Internet would sharply curtail circulation and ad revenues as well. Can anyone solve this problem? No one has yet. You can buy a cheap stock and hope that a solution may be found, but my guess is that the incumbents won’t find the answer. Professor Clayton Christensen, of the Harvard Business School, argued in his 1997 book, The Innovator’s Dilemma, that new, “disruptive” technology is resisted by established firms and typically developed by small, new companies that start by serving niche markets.

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In media, some of those companies are already here, although they are no longer small. Half of all online ad sales are generated not by newspaper sites but by search engines, such as Google (GOOG). My guess is that the big breakthrough is still to come, but I would place my bet on Google
or Yahoo to accomplish it rather than on the New York Times or Gannett.

Who else? One possibility is the Washington Post Co., which derives most of its revenue from its Kaplan education division. Maybe the Kaplan folks can tutor the newspaper folks. Other candidates are solid, diversified entertainment companies, such as Walt Disney (DIS), which owns the ABC and ESPN networks.

More likely, the big winner in media ten years from now will be a company that is tiny today or hasn’t even been born yet. In the case of media, it’s better to go with a quirky or unknown quantity than with incumbents that have proved, in the face of change, to be powerless or clueless.

James K. Glassman is executive director of the George W. Bush Institute,
in Dallas. His next investing book, to be published next year by Crown, is titled
The Comeback.