Knight Ridder: Weaker Than Peers As Buyout Awaits

While Knight Ridder's earnings report was sloppy with weak December trends, I am surprised the shares would trade down 2% given that the investment case is totally controlled by the auction underway for the company. On this front, management led off the call by announcing it would take no questions. One analyst did have the guts to act about recent newspaper reports that the company is promising an additional $140 million in cost savings (significant on and an EBITDA base of $600 million). Management would not comment except to say that you should not believe rumors printed by non-KRI owned newspapers. The attempt at humor was appreciated but, in my opinion, this is a relevant question for current shareholders and should have been more directly addressed....

Reported EPS came in at $1.24 for 4Q05. Management went through an explanation that claimed on a pro forma basis EPS were $1.16 vs. $1.16 a year ago. Another analyst noted that a few of the times that the company is claiming as one-time costs seem like ongoing expenses. This analyst also pointed out that he tax rate was a bit lower than expected and equity income higher than expected, implying that quality of earnings and operating earnings were not up to snuff. It seems this is what is driving the 2% decline in the shares as just in case the auction fails, earnings power on the operating line may not be what was previously expected.

For all of 2005, management noted a pro form EPS figure of $3.35 vs. $3.52 in 2004. Current consensus is for $3.69 in 2006. Management provided some general guidance for the year that makes this figure plausible, forecasting ad revenue up 3-4% and operating income up in the mid to high single digits. KRI has been buying back shares so an operating income of this magnitude could get EPS growth toward up 10%. One thing in support of management's outlook is good expense control, up just 1% in the fourth quarter. Another analyst did note, however, that the newsprint expense increase of 2% seemed awfully low compared to peers who faced increases in the upper single digits. In support of its advertising revenue gains, management said that help wanted and real estate remain strong, while auto and retail which were quite weak in 2005 would at least be less negative due to easier comparisons. Nevertheless, KRI had one of the weaker ad revenue performances in December (along with Tribune).

I am guessing that this is the last conference call for KRI of any importance. The auction should wrap up in March at the latest. A buyout price in the $60s seems likely as lenders and buyers are plentiful. It is possible the deal could reach into the $70s but I'd be surprised if buyers paid up that much given the weal secular fundamentals.

With just 10% or so upside on the buyout, and no guarantee a deal will come to fruition, I am not interested in speculating in KRI shares. Other names in the group are equally cheap, offer greater operating leverage, and are experiencing better current advertising momentum.

Knight Ridder Earnings Preview: Waiting On The Auction

It would be very surprising if anything of substance came from the earnings release and conference for the 4Q05 report by Knight Ridder (KRI). First, the company is in the midst of an auction with presentations being made to a number of interested industry and private equity buyers. This will probably restrict what management can say in its press release and on its conference call. Second, even if management does decide to be chatty, the fact that last week saw earnings reports from New York Times (NYT), Dow Jones (DJ), and Gannett (GCI) means we already have a pretty good picture of what is happening in the newspaper industry. Each of those companies revealed some strengthening in advertising trends in December, particularly in the national category. While each also noted that the seasonally small January was not confirming the trend, all remained confident that March quarter numbers would show improvement. Let's see if KRI confirms this outlook or not....

KRI guided to $1.23 last December and affirmed the figure when it issued a sluggish November revenue report in late December. Thus, there should be no surprises on the headline number. Revenue is projected at $818 million. 1Q06 consensus calls for EPS of 67 cents on revenue of $735 million. For all of 2006, analysts are looking for EPS of $3.69, an increase of 5.7% on a revenue gain of about 2%.

There have been numerous newspaper articles discussing the auction of KRI. Most recently, it appears that KRI has been telling potential suitors that cost cutting could push EBITDA up by at least 20% vs. the current annual run rate of just over $600 million. Apparently, this figure seemed to good to be true as it sent suitors scrambling to re-analyze their own models with the results being a delay in the outcome of the auction until late February or possibly March.

Press reports indicate that a number of suitors have emerged including GCI, McClatchy (MNI), privately held Media News, and all the big names in private equity. Despite the wide interest, KRI shares have stalled in the low $60s as a multiple above 10 times EBITDA does not seem to be in the cards. This would cap the auction at about $70 based on current estimates. The buyer won’t want to give up any of that 20% potential EBITDA boost to current shareholders so the stock did not move up on the news. I suspect though that current shareholders will sue if the company accepts a bid that does not compensate at least partially for the potential EBITDA pop.

The best preparation you can do for KRI's earnings call is to pull up recent news reports on the auction and to review the earnings summaries I did last week for NYT, DJ, and GCI. I don’t plan on getting long KRI under any circumstance short of the collapse of the auction and a sharp decline in the stock.

Knight-Ridder: Receiving Bids But Sale Process Slow

Reuters posted an update on the Knight Ridder (KRI) bidding process. The deal is described as "slow moving," with multiple bidders and a timeline that extends to February. Price talk is the mid $60s to low $70s. The article is well informed, in my opinion.

A deal at that level provides some downside support for newspaper stocks by establishing a private market value near 10 times EBITDA. The valuation would be below prior deal levels in the newspaper industry but moderately above current trading levels for most newspaper stocks.

Knight Ridder Sale Won't Rescue Newspaper Stocks

I don't think Knight-Ridder (KRI) is likely to receive a takeover much more than 10% above the current price. Further, I don't think the current situation surrounding KRI is likely to kick off a round of takeovers in the newspaper industry. Assuming KRI gets a bid, which is not guaranteed, it will provide support for newspaper equities around recent lows but it is also likely to confirm that recently depressed multiples are warranted. Without a sustained uptick in advertising growth, which I don't expect, I believe the stocks will be a value trap even if KRI goes out a price above current trading levels....

Potential Industry Buyers for KRI Are Limited

At 11 times EBITDA, KRI would sell for about $71. Historically, 11 times would be at the low end of newspaper industry deals. However, I think that would be the high end of any current deal for several reasons. First, the industry is severely growth challenged on a secular basis. The Internet is taking direct aim at key newspaper categories such as help wanted, classifieds, real estate and auto advertising. Even if the industry can hold market share, online ads have lower pricing so growth is sure to remain pressured. Second, there aren't many industry buyers out there for KRI. Gannett (GCI) is everyone's first choice and it is in GCI's corporate DNA to look hard at KRI. Beyond GCI, I just don't see who else bids. New York Times (NYT) and Tribune (TRB) are the other likely players and they both have problems of their own. Shareholders in those companies, and probably GCI as well, would react quite negatively to a deal for KRI, particularly at a premium to the current price. If GCI is the sole industry bidder, they have little incentive to pay any further premium.

Private Equity Group Is a Possible Bidder

One group that might bid is private equity. I suspect the KRI institutional shareholders advocating for sale of the company are counting on private equity. Lauren Fine of Merrill Lynch wrote a report several months ago that suggested LBOs of newspaper companies were likely to generate returns of only 10%. Even if she is off target, there doesn't appear to be huge return potential. KRI might be attractive to a private equity buyer with patience to sell off the pieces. This is probably the best chance to ultimately achieve a premium multiple for the company as individual papers probably have more potential buyers than the company as a whole.

KRI Saga May Confirm Currently Depressed Multiples

The bottom line is that if you are long KRI, you ought to take some chips off the table and be very glad that the shares have rallied 20%. If you aren't long KRI, I wouldn't enter at current prices as upside is not high enough relative to the odds of no deal or a long drawn out process that doesn't produce much further upside. If you are long other newspaper stocks and hope that a KRI sale will turn the stocks permanently upward, be prepared for the possibility that the KRI saga serves to confirm the currently depressed multiples rather than prove that the stocks are cheap by historical standards.

Knight-Ridder: Cheap But No Earnings Growth

Knight Ridder (KRI) reported results in line with reduced expectations following management's lower guidance a month ago. Excluding unusual items EPS came in at 67 cents, down 18% from a year ago. Revenue was flat and shares outstanding were down about 10% so the problem in the quarter relative to its industry peers was on the cost side. The following quote from the press release summarizes the quarter quite well:

"When you strip away the complexities associated with our asset sales and acquisitions, the story of the quarter is relatively simple: Excluding the acquired newspapers, total operating revenue was up 1.1% and costs -- in a stark aberration from our normal pattern -- were up 7.0% (or 5.5% if you exclude severance costs of $8.6 million)."

The press release went on to say in relation to costs "that level of cost increase will not be repeated in the fourth quarter." On the conference call, management was emphatic that costs trends would improve dramatically in the fourth quarter, specifically guiding to 1% growth. Guidance for 4QEPS was also specific with management stating that above the year ago $1.16 was a sure thing and that current estimates of $1.25 were "in the ballpark."

KRI has almost all its exposure in major market metro dailies. This leaves the company particularly vulnerable to current industry trends where national, retail, and auto advertising are the worst performing ad categories. Furthermore, KRI's papers in Philadelphia and Kansas City are underperforming. I still don’t fully understand why these papers are lagging although Philadelphia is unusually exposed to the Federated-May merger.

To its credit, KRI management is aggressively buying back stock. Against a 77 million share count earlier this year, the company has promised to complete a 10 million share buyback no later than 1Q06. Over 6 million has already been bought as 5 million was purchased via Goldman Sachs. I think Goldman effectively shorted htose shares so in 4Q both Goldman and the company will be buying stock semeinlgy providing some downside support.

Also to its credit, KRI has been a leader in development of online properties. In 3Q05, online revenue was $1 million, representing 7% of total company advertising revenue. Online revenue grew 54% vs. 2004. Much of this revenue is a mix shift form the paper to the web and with that shift comes lower pricing on a CPM basis. Nevertheless, it is better to maintain advertisers than lose them so management is to be commended for its early focus on the internet.

Among major newspaper stocks, only Tribune (TRB) is cheaper than KRI. However, KRI has always been a cheap stock and trades at a very modest to its long-term historical valuation. So like many other stocks in the group, despite poor performance YTD, KRI is not all that cheap given the secular challenges and near-term cyclical issues faced by the industry. KRI is an attractive takeover candidate without a controlling shareholder and management has been shareholder friendly is terms of share repurchases. For those reasons, KRI is worth keeping an eye on as an alternative if the industry outlook improves.