June Quarter Media Earnings Recap

Every quarter most of the major companies and most of Northlake’s individual stock positions all report during the same week. This occurred during the week just ending. It is a crazy time of conference calls, research reports, volatile stocks, more conference calls, and even more conference calls! There is a benefit to all this as we get to hear from all the leading companies at the same time so we can compare and contrast and get a pretty good idea of what investors are concerned about. This quarter the intensity was upped a few notches as the week also saw the end of two major mergers, Fox/Time Warner and Sprint/TMobile. There was a newly announced merger in TV broadcasting and newspapers between E.W. Scripps and Journal Communications. Gannett also made a major acquisition of Cars.com and announced it was splitting off its newspaper operations.

Amid all this activity investors were focused on TV advertising trends, M&A activity, and the outlook for continued growth in TV production and content sales. Ad trends definitely disappointed even on lower expectations. There seems to some loss of dollars to online advertising as well as hesitancy of major advertisers due to uncertainty about the economy and geopolitical fears. The good news is that growth should pick up in the second half with the return of political ads and the NFL. The NFL draw most ad categories including autos and beverages. The takeaway on M&A is that it appears there may not be more big deals. Fox made it quite clear that it would not being dong any large deals after giving up on Time Warner. CBS massively increased it share repurchase program and indicated there would be no future deal that would be large enough to sidetrack the buybacks. TV production continues on fire as more and more outlets look for original programming. There is some fear of a bubble and that traditional markets for syndicated programming could be undercut.

Media stocks have performed poorly this year. Only Disney has clearly outperformed the market, while Comcast has about kept up. Most of the rest of the stocks are down from 1% to 5%. The worries mentioned above crystallized this quarter amid a clear slowing in TV advertising growth. I am hopeful that sentiment toward the3 stock and expectations of 2014 growth may have bottomed. I think this is especially the case for Northlake’s media holdings including CBS, Liberty Global (LBTYK), Liberty Media (LMCA), and Discovery Communications (DISCK). Below please find brief comments on the latest results from each company along with Disney (DIS) and Comcast (CMCSK).

LBTYK had its second consecutive quarter of accelerating growth in operating cash flow. I believe this is a start of good run of faster growth for LBTYK as the company begins to reap the rewards of its high level of acquisition activity in the European cable market. The company is awaiting approval of its acquisition of the leading cable company in the Netherlands which would be paired with LBTYK’s #2 entry. Think Comcast and Time Warner Cable. While the regulatory review is pending LBTYK’s massive buyback program is on hold and that is providing a headwind to the shares. A yearend rally should be in order after acquisition approval.

DIS had another great quarter driven by the incredible success of Frozen. There was also upside at theme parks, consumer products, the rest of the movie studio, and ABC. ESPN had some challenges due to timing of programming and license fee increases. One of my favorite analysts, Michael Nathanson at MoffettNathanson, points out the 2014-2016 is shaping up comparable to 2005-2007 when Disney last enjoyed an extended content winning streak. Back then Disney earnings and stock price consistently performed to the upside. I buy this thesis.

CMCSK reported the prior week and had another solid quarter on the financial and subscriber front. However, all eyes are on the regulatory review of the attempted acquisition of Time Warner Cable. Closing early next year is the current consensus. CMCSK has been a decent stock this year as investors recognize the power of company as in terms of free cash flow growth. Time Warner Cable makes the story even better.

LMCA has been in limbo this year as it aborted its purchase of the half of Sirius XM it doesn’t already own and then decided to split off its ownership stake in Charter Communications. Sirius had a good quarter putting some of the bearish sentiment about is competitive position to bed. The creation of Liberty Broadband (holding the 27% stake in Charter) could take place this quarter. I believe this will provide a catalyst for LMCA share as its discount to net asset value narrows and the next step to realize full value of the Sirius XM majority interest becomes clearer.

CBS reported results well below what was expected three months ago but in line with more recent estimates that had been lowered due to the weak TV advertising market. Management was extremely optimistic and confident that ad trends would improve markedly in the second half. The bigger news was an even larger than expected share buyback plan that could retire 20% of the share over the next 18 months. This should provide support for the shares and set up a sharp rebound if the ad market does improve as management expects.

DISCK completed a 2 for 1 split and reported one of the better advertising growth rates among cable TV network peers. The bull case is that the financial benefits of the acquisition binge in Europe will be revealed over the next few quarters amid a pickup in domestic advertising growth. DISCK shares have shed most of their premium valuation this year which should allow for a rebound if the company canhit its current guidance.

LBTYK, DIS, LMCK, DISCK, CBS, and CMCSK are widely held by clients of Northlake Capital Management, LLC, including in Steve Birenberg’s personal accounts. Steve is sole proprietor of Northlake, a registered investment advisor. Northlake regulatory filings can be found at www.sec.gov. LBTYK, DIS, LMCA, CBS, and CMCSK are net long positions in the Entermedia Funds purely as a hedge. Entermedia is a long/short equity hedge fund focused on media, communications, leisure, and related technologies. Steve Birenberg is the portfolio manager of Entermedia, has personal monies invested in the funds, and controls Entermedia’s General Partners.

Newspapers Final 2007 Data As Ugly As Expected

Last Friday, the Newspaper Association of America released its 4Q07 and full year 2007 advertising expenditure data. Not surprisingly, the NAA titled its press release, "Online Advertising Jumps 19 percent in 2007." The only problem with headline is that online advertising represented just 7.5% of all newspapers ads last year. Print advertising, which represents the other 92.5%, fell 9.4% last year, bringing total newspaper advertising to a decline of 7.9%.

Among the major ad categories, retail, the largest category representing half of print ads, faired the best, falling 5%. National ads, about 17% of total ads, fell 6.7%. The big damage was in classified advertising, largely a local business, which had a massive decline of 16.5%.

Classified advertising is composed of automotive, real estate, help wanted, and other. The news is the first three categories is terrible. Auto fell 18.3%, real estate fell 22.6%, and help wanted fell 19.8%. Auto fell for the fourth straight year with each year's decline larger than the last. This category clearly is facing secular challenges. Real estate had been a strong growth category prior to the subprime mess so while it also faces secular share loss tot the internet, it should return to growth when real estate markets improve. Help wanted also has a significant cyclical element although the secular challenge is real. 2007 marked the second straight year of declining help wanted advertising.

Quarterly trends show little hope....

.... Auto might be bottoming as its rate of decline moderated from 20% in 1Q07 to 16% in 4Q07. However, the rate of decline in real estate and help wanted accelerated as the year passed.

Newspaper stocks have been absolutely decimated. Gannett, the acknowledged best in the business, saw its stock cut in half in 2007. The shares now trade at on-third of their 2004 price. McClatchy, which doubled down by buying Knight Ridder in a leveraged transaction is trading at $10, down form over $40 at the start of 2007 and over $70 in 2005. New York Times fell by just 30% last year but trades at about one-third of its 2004 high. Takeover speculation allowed NYT shares to hold up a bit better in 2007.

Among these three stocks, the only one worth worrying about as a potential long is Gannett. The stock looks cheap at 7 times 2008 earnings estimates and a 5.5% current yield. However, it won’t stop falling until estimates stabilize and in the last 90 days the 2006 estimate has fallen from $4.46 to $4.16. Consensus is calling a 7% decline in 2008 earnings followed by a 4% drop in 2009. I think Gannett will stage a tradable rally from the long side once the momentum of advertising declines reverses. Not growth but a significant lessening of the decline. No reason to own it now worth putting on your screen and monitoring the monthly ad trends that the company and industry reports.

NY Times Shares at 20 Year Low!

New York Times shares traded below $20 yesterday for the first time since April 1997. As recently as June, NYT was over $26. The stock was over $30 almost two years ago exactly. In 2002, NYT shares briefly traded over $50.

NYT's fall yesterday was matched by new lows for McClatchy and Lee Enterprises. Gannett held just above the multi-year low it made in early August. The culprit for yesterday's action was a downgrade to sell for NYT, MNI, and LEE from Merrill Lynch analyst Karl Choi. The impetus behind the downgrades was a lowering of Merrill's 2007, 2008, and long-term newspaper advertising growth rates. For 2007, the forecast now calls for a 7% decline vs. a 4% decline previously. The 2008 forecast is now -5%, down from a decline of under 1%. While Merrill looks for a slight rebound in 2009, the long-term forecast is now for an annual drop of 1% in newspaper advertising. These forecasts include the benefit of growth in the industry's online advertising revenue.

Massive market share loss in classified advertising to the internet is the secular headwind that is killing newspapers. In 2007, total newspaper advertising is expected to be about $46 billion. Classified represents about $11 billion, with real estate and help wanted around $4 billion each and automotive around $3 billion....

....Newspaper auto advertising has been falling since 2004 with the rate of decline accelerating each year. This year, Merrill Lynch is forecasting a 19% decline with 2008 moderating to a 12% fall.

Help wanted is also declining and while the decline may have a greater cyclical component, secular share loss is a significant part of the problem. Employment advertising turned negative in 2Q06 and the decline has steadily worsened, ending in a 2007 forecast of -16%. Next year, Merrill is forecasting -14%.

The real killer, now and for the foreseeable future, is the downturn in real estate ads. Again, the problem may be more cyclical than secular but like automotive and help wanted there is an unmistakable trend toward online ads. In 2005 and 2006, real estate ads grew by 10-11%. The downturn began in 4Q06 and the deterioration was so rapid that 2007 may see a decline of 20%. With no housing upturn in sight, a forecast of another 20% decline in 2008 seems plausible.

Add it up and roughly 25% of the newspaper industry's advertising revenue is declining by 15-20% in 2007 and 2008. The multi-year secular decline in auto advertising is probably a harbinger of what is coming for real estate. In other words, classified advertising is likely to fall beyond 2008, making Merrill's forecast of -1% annual advertising growth long-term seem pretty realistic.

With newspaper stocks trading at 6-7 times Merrill's below consensus 2008 EBITDA estimates, I still don’t think they are cheap enough to bottom despite the fact that what you have just read has quickly become conventional wisdom. Negative revenue growth means declining margins and pressure on free cash flow. There has been lots of chatter on this site about financial stocks as a value trap. Look no further than newspapers for a value trap that is not open to debate.

No SIgns of Upturn at Gannett

Gannett (GCI) reported another poor quarter as expected. There was nothing in the numbers to signal less pressure on revenues was around the corner. In addition, management provided no commentary on fundamentals or use of cash flow and the balance sheet that would reassure investors. As a result, I see no reason to be bullish off these numbers and still predict that GCI sees the $40s before it sees the $50s.

For 2Q07, GCI reported adjusted EPS of $1.24 on revenues of $1.93 billion. EPS were a few pennies ahead of consensus while revenues fell just short of expectations. Management and analysts noted a few non-operating items that impacted EPS which suggest that operating results were actually a little light.

GCI's problems remain centered on the top line....

Newspapers and Broadcasting both saw revenue declines but it is the much larger newspaper segment that is causing most of the trouble. During the quarter, newspaper revenues fell 5.3% with the U.S. papers falling 7.7%. Classified advertising remains very weak with Real Estate down 13.6% in June and Automotive down 14.7%. Real estate has a tough comp against mid-teens growth a year ago but the decline in auto is on top of a similar decline a year ago indicating that this area is in secular decline. Management noted the real estate weakness is much more pronounced in California, Florida, Nevada, and Arizona. More importantly, management noted that weak real estate advertising is spilling over into other categories, especially retail.

The good news is that GCI continues to control expenses very well. In the newspaper segment, pro forma operating expenses fell 3% benefiting from a 7.8% decline in newsprint expenses. The newsprint savings were mostly volume related although pricing was down a small amount. Corporate expenses fell 8.1% but this is a volatile line item on a quarterly basis.

Other good news is in the UK where the cyclical aspects of the decline in real estate are moderating and revenue growth is almost in a positive territory. Profit growth resumed in the UK which management noted was a positive sign indicating that "when" revenue growth returns in the US there will be plenty of operating leverage to drive profits.

The big question for GCI and the rest of the newspaper industry is whether the recovery is a "when" or an "if." If I had to fault GCI management if would be that their planning seems to assume the problems are more cyclical than secular. Of course, there is not that much management can do about secular issues.

McClatchy, New York Times, Tribune, and Dow Jones all report in the next week. GCI didn’t provide much hope.

McClatchy Sells Minneapolis Newspaper for Peanuts

McClatchy (MNI) announced it was selling the Minneapolis Star Tribune to a private equity outfit for $530 million. MNI will also receive a $160 million tax benefit on the sale. The Star Tribune is the 14th largest daily newspaper in the country by circulation.

MNI is selling the paper as the final major step in realigning itself following the acquisition of Knight-Ridder earlier this year. Proceeds from the sale will be used to reduce debt. MNI is comfortable with its new financial profile and believes it has flexibility to invest its remaining newspaper, particularly to develop digital initiatives.

Based on the assumption that the Star Tribune earns an operating margin slightly below the corporate average (a decent assumption likely based on the unionized workforce in Minneapolis), Goldman Sachs calculates the $530 million purchase price equates to 7.4 times 2006 estimated EBITDA. Merrill Lynch assumes higher margins and an even lower multiple of under 7 times EBITDA. MNI would no doubt include the tax benefit of $160 million in its calculation of the multiple. Using Goldman's assumptions, incorporating the tax benefit would raise the multiple to 9.6 times. For Merrill, the multiple rise to around 8.5 times....

The tax benefit is the result of the fact that MNI purchased the Star Tribune in 1998 for $1.2 billion. Even if MNI overpaid at the time, it is a telling commentary on the current outlook for the newspaper business that MNI is taking a 55% loss on its original investment.

Furthermore, the multiple excluding the tax benefit is the correct comparable for most other newspaper assets and newspaper stocks as there are not that many other assets that are held at inflated, late 1990s values for tax purposes.

Given that most newspaper stocks trade at 7-8 times current 2007 estimated EBITDA, it is probably fair to draw the conclusion that private market values are not at a significant premium to public equity values. Tribune (TRB) management and shareholders have learned this lesson in the past six months.

With valuation constrained by weak private market values and poor fundamentals, I would continue to avoid newspaper stocks. And I would use any strength related to deal announcements or speculation or signs that advertising and circulation comparisons are improving to sell current holdings or establish short positions. That would include industry bellwethers like Gannett (GCI) and New York Times (NYT) along with MNI.

Google Throws A Lifeline to the Newspaper Industry

The launch of a newspaper industry ad buying marketplace by Google (GOOG) is an interesting development. Studies have shown that newspapers only reach a fraction of the potential advertisers within their geography. I read one study that said it was as low of 20% of potential advertisers. Most of the advertisers that aren’t using newspapers are small businesses. The idea behind the GOOG-newspaper industry trial is that by making it easier to buy newspaper advertising, the base of advertisers will grow. I am not that well versed in all things GOOG but I am under the impression that it is smaller businesses that are the primary users of Google search. So in theory, this is a good match.

Another potential benefit to the newspaper industry could be a lower cost structure to reach advertisers. An efficient, easy-to-sue, online ordering system could lead to lower cost of sales as advertising sales forces are slimmed down and administrative expenses are reduced.

One potential problem I see.....

.....is that GOOG's auction bidding model is quite efficient. Certainly it is a lot more efficient than calling the newspaper and buying an ad. Market theory says improved efficiency should drive down prices. Consequently, a risk I see in this initiative is that smaller advertisers will be buying excess inventory at a discount to what the newspaper industry's major advertisers are paying. This could serve to drive down pricing across the industry such that lost pricing more than offsets the increased volume from a simplified ad sales process.

Overall, this is a worthwhile idea. It is easy to create a scenario where newspapers are doomed, slowly losing readers and advertising revenue, and effectively becoming liquidating trusts with a very long tail. The industry should be willing to try to new ideas, even if they come with risks. Status quo is unacceptable.

Diversification toward digital media is underway and revenue contribution across the industry is in the upper single digits and rising. Other uses of digital technology, such as the GOOG initiative, also have to part of the solution. If there is one.

Newspaper Industry Outlook Remains Bleak

Newspaper industry fundamentals continue to look pretty bleak. According to Citigroup, August was the worst month so far this year for advertising growth with industrywide year over year declines averaging 1% against an easy comp. In fact, Citigroup states that the ad revenue growth in August was the worst since 2002.

Help Wanted advertising continues to decelerate, with August recording a decline of almost 9%. In 4Q05, help wanted was growing 8-10% so comps stiffen looking out to 4Q06. Real Estate classifieds have also finally rolled over with growth decelerating from 15-20% for the past year to 12% in August. Analysts expect real estate gains to continue to moderate, especially in 1Q07 when they will be comping against 2-30% gains.

Against this backdrop it is not surprising that Merrill Lynch and Morgan Stanley lowered 2006 and 2007 estimates across the board. Morgan went to ad growth of 1% and 1.4% in 2006 and 2007, respectively. Merrill Lynch analyst Lauren Fine, who was below consensus already dropped her ad growth estimates to 0% and -1.5%, respectively. It is worth noting that those estimates include online advertising which is growing at least inthemid-teens at most companies and represents 5-10% of revenues....

Lauren slashed her 2007 earnings estimates by an average of 7% and now sits 10% or more below consensus on most companies. Her estimates for Dow Jones (DJ) and New York Times (NYT) fell by 13-14%, while most other companies saw estimates cuts of 5-8%.

With estimates cuts that deep, the stocks aren’t getting any cheaper even as investors look out to 2007 and in spite of pretty sharp declines for most of the stocks, which all trade close to 52 week lows. The contrarian in me says I should look for opportunity in the stocks when the street finally throws in the towel but I see fundamentals as bleak and don’t believe private equity will be a savoir at big premiums. On Lauren’s news estimates, the stocks are trading at over 8 times 2007 EBITDA. I have a hard time seeing financial buyers developing spreadsheets that support good returns at any significant premium to that multiple. Further, what exactly is the exit strategy once a newspaper company is taken private. You could pretty easily make the case that the terminal multiple should be quite a bit below the takeout multiple.

I remain on the sidelines while keeping a close eye on the developments at Tribune (TRB), which is effectively for sale. E.W.Scripps (SSP), which ahs effectively diversified away from newspapers, and DJ, which has unique content more easily suited to the web, are the two stocks I would be most likely to buy if I decided to enter the group.

Newspapers In The News

There were some interesting developments in the newspaper industry yesterday.

First, Nelson Peltz has filed with the SEC indicating he has an ownership stake in Tribune (TRB) of 1% of the outstanding shares. The amount is small and there is no way of knowing his intentions but it is probably fair to deduce that the Chandler family has a new ally. Investors must agree as TRB shares rose 5% on the news.

Second, TRB and New York Times (NYT) both provided monthly revenue reports yesterday and the news remains bleak. NYT had a lousy July with its News Media group incurring a -5.3% decline in advertising revenues. This group includes the company’s New York, New England and Regional newspapers. New England has been terrible for awhile and had another double digit decline but the worse than expected results were due to weaker than expected performance in NY and the smaller regional papers. Digital revenues included in the News Media group were up 27% so the decline in print advertising is even worse than the headline numbers. Help Wanted, Automotive, and Studio advertising categories were noted as particularly weak.

TRB’s monthly revenue report wasn’t nearly as bad as NYT’s but it is hardly encouraging. Advertising revenues for TRB’s publishing properties fell 1.4% in July with similar underlyng trends to NYT. TRB’s results appear more in line with the weak industry trends in July so NYT clearly is underperforming.

Finally, Google (GOOG) announced a plan to offer online coupons via its Google Maps in conjunction with its Local Business Center. The always helpful Lauren Fine of Merrill Lynch noted that based on Newspaper Association of America data, coupon related revenue to the newspaper industry totaled $1.1 billion in 2005. In an email exchange, Lauren explained that roughly $250 million would be distribution fees that the companies which produce coupon inserts pay to newspapers for distribution. Other coupon revenue sources could be other types of coupon inserts and regular ads with coupons.

GOOG’s initiative is local in nature allowing anyone who has a business registered with GOOG to offer a coupon. This should provide plenty of near-term protection for the newspapers which get most of their coupon revenue from national advertisers. However, it is another headwind and if the local coupon idea takes off it represents another advertising alternative for local advertisers and the potential for further loss of market share.

Mid-Year Updates Provide Little Cheer For Newspaper Stocks

Newspapers companies presented to analysts last week in the annual mid-year review. I did not attend the meetings or listen in on any webcasts but I did review several summary reports prepared by analysts including Lauren Fine of Merrill Lynch and Mark Fenton of Citigroup.

Overall, the presentations gave little hope for the short-term other than a contrarian call based on lower interest in the group (as measured by lower than usual attendance) and continued pessimism on near-term fundamentals. Analysts did note that relative to recent conference calls and presentations managements were more subdued and more accepting the bearish outlook toward newspaper print advertising held by the street. This is potentially another sign that we could be closer to a bottom than current fundamentals and sentiment would suggest.

Unfortunately, any bullishness is tempered by continued weakness in advertising trends and stocks that are not unusually cheap by historical standards. Conseqeunty, I see little reason to be in any stocks in the group unless you are hoping to hit the lottery with a premium takeover bid.

Getting back the management presentations....

the big news is that strength that appeared in May advertising numbers has not been sustained in June. Only Dow Jones (DJ) indicated a good month was in place continuing a trend of outperforming the industry this year. However, be aware that DJ had a very easy comparison in June, continues to benefit from the extra Saturday edition of the Journal when none existed a year ago, and has not been able to translate better ad trends to earnings due to mix issues.

The dominant theme of the mid-year review was digital/online properties. Presently, online revenues account for about 6% of total industry revenues. Consequently, even with 25% growth rates for online advertising, total revenue growth is not able to break out of plus or minus 0% growth rate. Many managements, especially online leaders DJ and New York Times (NYT), noted that their goal is to raise online revenues to 15-20% of revenues over the next three to five years. At that level, assuming online revenues were still growing in the solid double digits, the industry would return to mid-single digit or better overall growth.

One issue with online revenue is that is not clear how much is incremental and whether the portion that is substitution for print carries similar margins. Print advertising had a high fixed cost base and online pricing is not anywhere near par with print so the mix and margin issue is real.

Looking at individual companies, as mentioned, DJ had the most optimistic presentation. The company has 761,000 subscribers to WSJ.com which makes it the equivalent of a very large metropolitan newspaper. On the Weekend Edition, management did note that in September when comparisons lapped the initial editions from 2005, overall growth rates would be worse than many due to a surge in advertising from the first few Saturday editions.

NYT noted that its TimesSelect effort which charges subscribers for premium content at NYTimes.com is off to strong start with over 500,000 subscribers (including yours truly). Management indicated that it wants to keep 95% of its content free but was looking at additional subscription products. Coming out the meeting estimates went up slightly for NYT but only because management guided to a lower tax rate.

Tribune (TRB) presented but took no questions because of its dutch tender. Management did say that June looks like a down month. The conflict with the Chandler's was discussed with the company stating that the dispute is really over taxes and valuation of certain assets held in the partnership between TRB and the family. TRB shares have given back portion of their gains since the Chandler family dispute became public news. The shares remain a good place to hide if you are bearish on the market as it still seems possible that an trigger event beyond the dutch tender could occur.

Finally, Gannett (GCI) said that 2Q estimates look OK but the quarter was not in the bag. I guess this means that if June is poor, estimates could be high. GCI also updated its full year assumptions with the only major change being a shift to negative revenue growth outlook for its UK properties. This came as no surprise to analysts and did not lead to any meaningful estimate changes.

Newspaper companies are among the first to report each quarter so we will be hearing again from them soon. Based on the mid-year review it doesn’t appear that we should be holding our breadth in anticipation of bullish news.

Newspaper Industry Earnings Wrap-Up

Newspaper companies are among the first to report each quarter. As of today, most of the companies have reported. In the "Continue Reading" section linked below, I have posted a series of notes beginning with a preview and including summaries of the reports from Gannett, New York Times, Tribune, and Dow Jones.

I entered the earnings period looking for a bullish trade in the group. My thought was that everyone hates the group and the stocks have been going steadily down. If earnings were no worse than expected and the outlook for the balance of 2006 did not deteriorate further, a trading oppoortunity might exist. I don't own newspaper stocks so taking the unpopular stance seemed like the right idea. As it turned out, results didn't warrant getting long. I remain onthe sidelines but I think my bullish thesis still could work out if 2Q trends show stability. For that reason, it might be worth your time to wade through the lengthy post and get more familiar with what is happening in the newspaper industry.

Earnings Preview

Heading into 1Q06 earnings season for the newspaper companies, earnings estimates continue under pressure virtually across the board. As recently as late March, industry leader Gannett (GCI) told analysts that earnings would come in at the low end of range for 1Q, citing ongoing weakness in automotive and national advertising. While GCI also continues to feel pressure from its UK operations, the problems with automotive and national advertising are plaguing the entire industry. Retail advertising and subscriber losses are also hurting industry growth rates.

The newspaper industry problems run deep. Some are cyclical, others are structural. As earnings reports begin to come in this week, here are some things to keep an eye on:

Automotive advertising, a major category for the industry has been dropping at double digit rates. In this case, the problems appear to be cyclical and structural. Clearly, there is a trend toward the internet for auto advertising. However, weak auto sales and scaled back incentives also are exerting cyclical pressure. Advertising Age recently noted that Ford (F) would have flat to lower ad expenditures this year and a greater proportion of the spending was headed online.

National advertising, another major category, has also been weak. Telecom has been a big culprit but I believe this is largely due to recent mergers, particularly among wireless carriers. The wireless industry has been a big newspaper advertiser but mergers have taken AT&T Wireless and Nextel out of the picture over the past two years, allowing the acquirers, AT&T (T) and Sprint (S) to gain economies in the advertising budget. Thus, this factor would seem to be cyclical and as the mergers are lapped on a year-over-basis and new branding comes from T, the recent pressure on this category could dissipate and growth might return.

Mergers have also caused a problem in retail advertising. As Federated Department Stores (FD) has bulked up, it has meant loss of advertising in key markets where the company formerly competed with Marshall Field's or May Department Stores. Since FD is switching from a regional to a national branding strategy by putting the Macy's nameplate on hundreds of stores, the impact on newspapers is structural. FD will now spend much more of its ad budget on the most effective national ad platforms like TV.

Another structural issue the industry faces is loss of subscribers. Until about a year ago, the decline was steady but modest. However, the losses accelerated last year. At least part of the problem came from subscriber restatements as newly audited figures revealed many instances of overstatement. These losses will soon be mitigated in year-over-year measurements but I have to believe that some small part of the acceleration in subscriber losses is due to what appears to be round 2 of the internet wave, this time driven by broadband connections.

One other thing to consider as newspaper companies begin to report is that in general, advertising and circulation trends have been worse in larger markets. There have been some signs recently that smaller markets are beginning to succumb. Lee Enterprises (LEE) is a smaller market operator that has recently seen its ad trends revert toward the industry mean. The Ottaway division of Dow Jones (DJ) has also had weak numbers. Nevertheless, the problems are worse at large daily metros and it is earnings reports from GCI< New York Times (NYT) and Tribune that will set the tone for investor sentiment toward the industry.

Turning the current setup in the newspaper stocks, nothing I have written should come as any surprise. The demise of the newspaper industry has been widely discussed and is conventional wisdom. The recent sale of Knight Ridder (KRI) to McClatchy (MNI) at a modest multiple was a convenient excuse for pundits to dump on the industry so sentiment is currently about as bad as it has ever been. Newspaper stock prices which have declined steadily for the last few years and valuations, commonly judged on enterprise value to EBITDA, are slightly below long-term historical averages at around 8 times 2006 estimates.

Of course, one could argue that given the challenges the industry faces "slightly" cheap on a historical basis is not saying much. The same thing could be said about valuations relative to other media sectors. Multiple compression in entertainment and cable has been worse so the discount for newspapers has actually shrunk significantly. Maybe the other sectors were even more overvalued and are now responding to their own set of challenges. However, intra-sector relative valuation is a headwind for newspaper stocks.

Despite lousy fundamentals, with sentiment poor and conventional wisdom well entrenched, I am actually entering this earnings season looking for a reason to become bullish. As mentioned, some of the problems are cyclical. Comparisons on advertising and subscribers will begin to ease in 2Q06. Newspaper management teams have kept a tight lid on controllable costs with many companies keeping costs close to flat on a year-over-year basis.

Consider these questions. If cyclical trends stop declining, might we be at the point where estimates stabilize? Could success in monetizing internet traffic to local newspaper websites provide a growth engine? Have recent internet acquisitions provided the opportunity develop large, growing business units that can move the needle on the top and bottom lines? Is sentiment poor enough and are valuations cheap enough to ignite a tradable rally in the group?

Since I am not long any newspaper stocks beyond an odd lot holding of TRB, I plan to enter earnings season looking for affirmative answers to these questions. I've got nothing to lose and at this point I think the any investment opportunity in the group lies on the opposite side of the deeply entrenched conventional wisdom.

Gannett's Results

Gannett (GCI) shares are trading flat as the conference call discussing the company's 1Q06 earnings wraps up, rebounding from a decline of more 1% as the call began. The earnings were pretty close to analyst estimates, which is no surprise, given that the company lowered guidance less than a month ago. EPS of 99 cents matched analyst estimates as did revenue of $1.88 billion. The operating figures underlying these results show absolutely no momentum as pro forma revenues were down less than 1%. Based on what I know so far, I don’t think GCI supports my trading rally thesis but there are a lot more newspaper earnings coming in the near future.

Looking more closely at the segments, overall newspapers saw revenues decline 1.8%. This figure was penalized by foreign currency but the bigger drag was the continuing poor results out of the company's UK operations. On the call, management noted that March revenues in the UK were down about 8% and stated that trends were "very soft." UK results were a focus of Q&A on the call and my impression is that estimates in this business will be going lower.

Newspaper results in the U.S were better. The press release stated that 1Q06 newspaper in the U.S.-only were up 1.5%. Smaller papers outperformed larger papers and USA Today was a big drag with a revenue decline of over 4%. Simultaneous with the earnings release, the company released its March Revenue Report. This report indicated that department stores, auto, and telecom continue to be weak categories. One of things I am looking for is flattening growth in these categories as comparisons ease. Based on what I read and heard today, I'd have to say I am less hopeful this will be the case in 2Q06.

The other are of focus on the conference call was how GCI would manage its balance sheet and cash flow. The company currently carries $5.2 billion in debt, mostly in commercial paper. Interest expense was up sharply year-over-year to $65 million from $45 million due to rising short-term interest rates and higher debt levels due to share repurchase. In response to a question, management said that they might be terming out some of the debt soon. I wonder why they have not already given the uptrend in short-term interest rates has been so obvious. One reason maybe because free cash flow not dedicated to acquisitions could be used to paydown debt. Analysts pressed for share repurchase but I got the impression management was non-committal. They seem to prefer acquisitions and stated that while no large deals are out there, the pipeline is strong for deals less than $1 billion in digital media, broadcasting, and newspapers. Given the lack of growth in newspapers and TV and secular challenges, investors would prefer GCI to buyback shares.

While the easier comparisons are ahead in newspapers and broadcasting pacings are already getting less negative, I fear that rising interest expense and worse-than-expected IK results could keep modest pressure on estimates. The bull thesis is that stabilization of estimates leads to share price relief. GCI might not be a good indicator as its debt and UK situations are not mirrored throughout the industry. However, I am not ready to call things for the bull case without hearing from other domestically dominated newspaper companies.

New York Times Recap

New York Times (NYT) reported 1Q06 earnings in line with estimates. EPS of 28 cents was a penny better than expected on in line revenues of $8.32 billion. The New York Times Group and the Regional Newspaper group had positive advertising revenue growth but the New England Media Group (primarily the Boston Globe) continued to struggle with negative growth. The publishing websites were a bright spot with revenue up 23%. In response to a question from Lauren Fine of Merrill Lynch, management admitted that revenue growth at all the publishing operations would have been negative if the internet revenue was excluded. Easter timing also was a benefit so underlying print growth is still clearly declining. About.com was a star in the quarter with revenues rising 98% to $19 million. This acquisition seems to be working out well for NYT. Management stated that they'd rather do "more About.com's than buyback stock."

While the EPS and revenue numbers were inline, it is worth noting that cost controls at NYT are not quite as tight as reported by peers Gannett (GCI) and Tribune (TRB). NYT's expenses were up 3.2% in the quarter vs. flat to lower at GCI and TRB. The press release quantified the increase as coming more or less equally form distribution and printing costs, raw materials, and promotions. Newsprint expense rose 5.9%.

Q&A had a few revealing items. First, like TRB, NYT said that telecom advertising was growing again. This is a good sign as one of the cyclical challenges appears to have turned favorably. Hotels were also mentioned as a strong category along with real estate. Also like TRB, entertainment was noted as a laggard, falling more than 10% in the case of NYT. I missed the entire comment but management said that this category was 14% of ad revenue. That seems high, so I am guessing that what I missed was that this was just at the NY Times. Shorter runs for movies and small films nominated for Oscars were the reason for the lousy entertainment numbers.

Second, the dominant area of interest to analysts was the NYT's internet revenues. Analyst seemed impressed by the numbers and pressed management on sustainability and margins. The company responded positively and appears very confident in their assets and strategies in this area. As noted above, management would like to acquire more internet assets but at current prices, I have to wonder how the street would greet any reasonably sized deal.

I didn’t come away from the call with a lot of enthusiasm for going long NYT shares. So far, I think TRB is the best bet in the group because it is the cheapest stock and its fundamental underperformance relative to its peers seems to be moderating. If I had to build a bull case for NYT, it would be based on their growing internet operations. On a percentage basis, NYT is not generating any more in revenues from the net than its peers. However, the assets are easier to understand and appreciate given the national, even global, brand that is the New York Times. Additionally, About.com is a standalone business that investors can understand. The bull case would be that the stock deserves a premium to the group because its internet assets increase the likelihood that growth returns to the entire company.

Tribune Results

Tribune (TRB) reported slightly better than expected 1Q06 earnings after adjusting for one-time items. The company reported 38 cents adjusted vs. consensus of 35 cents. Revenues came in as expected at $1.3 billion. The upside appears to emanate from tight cost controls and equity income. Based on commentary on the conference call, it sounds like both of these things could recur over the balance of 2006. Consequently, if revenue trends don’t get worse, EPS estimates for TREB ought to stabilize or even inch up slightly.

While this is important to generating a bull case for TRB, I think the real upside comes from improved performance relative to its newspaper and broadcasting peers. I think the 1Q06 numbers support a relative improvement. Circulation trends are stabilizing as most weakness is now isolated to bulk and other sales. Advertising revenue trends remain anemic but they aren’t really any worse than their peers. TRB shares trade at a 10-15% to the group so if investors appreciate that the many self-inflicted problems the company has faced over the past year are fading, the shares could have some upside. For now that is my operating thesis for TRB shares but I'd like to read some analyst commentary to confirm.

In the quarter, TRB had flat newspaper revenues. The big drags were movie advertising at the LA Times, which fell 8%, and continued pressures at Newsday resulting from the circulation issues. In reality, flat overstates the results because interactive, up 30%, is included in publishing revenue, and the company stated that the Easter shift helped March results. National and retail advertising remain the weak areas. Besides movies, national auto remains weak. Interestingly, TRB noted that national telecom/wireless spending was up and that the company felt it had largely cycled the merger induced weakness. Local ad trends were better as classified categories like help wanted and real estate continued to grow strongly offsetting continuing weakness in auto. Management noted that homes were selling more slowly in Florida and this was actually boosting advertising spend.

The real story in publishing was in cost controls. Cash expense fell 2% on a 5% reduction in staff. Management felt these trends would continue and pointed out that savings from cost reductions at Newsday would kick in later this year.

On the broadcast side, management spoke optimistically despite the fact that revenues fell 2%. This is a better performance than occurred at any time in 2005 and trends at the company's Fox affiliates are quite strong. Cash expenses in broadcasting are also under tight control. Management believes the shift from the WB to the CW Network later this year will provide a boost to revenues. This transaction also accounted for some of the surprise in equity income as TRB is no longer reporting losses from the WB.

As expected, Q&A had numerous inquiries about share repurchases. Analysts seem disappointed by the recent pace of repurchases and management was not particularly firm about future plans. Potential acquisitions were mentioned but with the stock at under 7 times EBITDA, investors aren’t interested in adding businesses which would certainly be acquired at a premium.

Overall, I'd have to say TRB's report support my bullish trading theses for the industry and for TRB uniquely. There are signs of stabilization in revenue and cost controls remain tight. Growth will remain challenging but all I am looking for is stability in estimates. I think that is in the cards at TRB.

Dow Jones Recap

Dow Jones (DJ) shares are down sharply following the company's 1Q06 earnings report and conference call this morning. The company reported an adjusted EPS number of 14 cents on revenues of $452 million. These figures compared to estimates of 15 cents and $445 million. 2Q06 guidance was also provided, with EPS estimated in the low to mid 30 cent ranges against a current consensus estimate of 38 cents. Revenue growth in 2Q06 looks a little better than current analyst estimates. This data above suggest that operating expenses are higher than expected. Management attributed this to advertising mix, newsprint, the Community newspapers, and equity income.

Revenue growth clearly seems to be on the rebound. Even excluding Weekend Edition, growth is in the upper single digits and management seems confident that it will hold at that level for the balance of 2006. This is partially due to easy comparisons but management noted that all categories are contributing (I continue to think that online growth could be stronger – up 15% in 1Q at DJ, while NYT reported a 23% gain). Mix is an issue, however, as classified real estate is showing unusually strong growth. Unfortunately, this is a low margin category. Newsprint also continues to rise in price and pressure margins. Management isolates newsprint expense but clearly this is a recurring area of operating expense. Community newspapers (less than 20% of revenue) are also feeling pressure as advertising revenue growth remains elusive.

Overall, the shares are succumbing to the worse than expected guidance. I think the negative reaction is worse than warranted. However, sentiment toward the group is terrible and DJ trades a big premium. Furthermore, DJ shares had enjoyed solid gains so far this year, up about 8% prior to today. The bar was set high for a turnaround and investors are not willing to tolerate a shortfall.

That said, I think investors are willing to pay for growth, so I believe that weakness in DJ shares may be limited to the damage today. Solid downside support exists due to the operating turnaround (1Q EPS rose 27% year over year), takeover potential, and the highest online exposure in the newspaper group. Key for the shares is for revenue gains to continue in 2007 when comparisons stiffen. This will require a cyclical turn for the industry, something that few investors are predicting or willing to pay for.

If I were going invest in newspaper stocks, which I do not currently plan, I would use a combination of DJ and Tribune (TRB). DJ offers the best potential growth, while TRB is the cheapest stock in the group and the fundamentals are o longer any worse than its peers.

Summary and Wrap-Up

Based on the first round of earnings from newspaper companies, I don’t think my thesis of a bull trade off of stabilization in estimates seems likely to occur in the near-term. Results did show signs of stability and some negative cyclical factors such as telecom mergers are reversing. However, there is no sign whatsoever of growth in print advertising, so despite generally good cost controls, there is no sign of operative leverage or operating income growth. Share repurchase activity does create a little growth in EPS, but the bottom line is that investors are unlikely to get interested in the group in the immediate future.

To get the group moving again requires a return to top line growth. I still believe that as 2005 troubles from mergers and circulation restatements get put in the past, it is possible that print advertising could start growing again in the low single digits. And that just might be enough to drive total revenue growth into the mid-single digits because online advertising at newspaper companies is beginning to grow large enough to make a difference.

I mentioned on last week's New York Times (NYT) earnings coverage that analysts were very focused on the company's online activities. NYT generated 7.5% of its revenue in 1Q06 from online services. Tribune (TRB) reported a similar 6.5% of revenue from online sources. At NYT, online revenues grew in excess of 30% including the 98% gain from About.com. Core online revenues grew by 23%. NYT is projected to generate $3.5 billion in total revenue this year, so we are talking real money here (at least $250 million in 2006).

With print advertising and circulation revenue barely growing, it seems plausible that online revenue could be 8-9% of total revenue generated by NYT or TRB in 2006. If so, and if in 2007 that revenue stream grew by 25%, online would generate at least 2% top line growth next year all by itself, even if all other traditional revenue sources endured another flat year.

If all other revenue sources began to grow again, even modestly, the idea that certain newspaper companies could generate mid-single digit revenue growth in 2007 is not far fetched. As mentioned, some of the things that have been pressuring revenue are cyclical in nature. If cost controls remain tight and operating expenses are held to very low single digit growth, operating income could grow in the upper single digits, ongoing share repurchase could turn that into double digit EPS growth.

I don’t sense investors are willing to pay for this potential yet. After all, it is just potential, and it is hard to have confidence in a rebound in traditional revenue sources. However, conventional wisdom seems aligned virtually 100% against investing in the industry. To me, that is time to do your homework and look at what might go right.

Newspapers Flounder As Web Ads Flourish

So far the positive news out of Dow Jones (DJ) that 4Q05 guidance was being raised has done little to rally the newspaper group. I think several factors are at work that reflect the unique mix of businesses at DJ vs. its newspaper peers:

# DJ has very heavy exposure to B2B advertising from technology and financial firms. These categories were extremely depressed for the past year and a small improvement has allowed double-digit declines to turn into positive growth.

# DJ also has less exposure to help-wanted advertising. This has hurt the company relative to its peers over the past year but the year-over-year gains in help wanted are moderating so DJ looks better.

# Finally, DJ has less exposure to auto advertising. Auto is a big category for local media including newspapers and TV stations....

Web Ads for Cars Are Hot

A recent article on AdAge.com noted that the auto companies have already purchased 80% of the inventory available in 2006 at the major independent auto web sites. A year ago the sell-out rate was just 50%. The web sites are dramatically raising prices in the face of strong demand with CPMs (cost per thousand impressions) up 20%-30% at many sites. Ford (F) is leading the way in the shift to online advertising.

AdAge.com quoted a Ford executive as saying that the company will sharply increase its online ad budget but its overall budget will be flat. By definition, this means the traditional ad budget is down. An ad buyer from British media company WPP notes that he is advising auto clients to shift 10% of their ad budget to the web this year. It is thus not surprising that Merrill Lynch media analyst Jessica Reif is looking for a down year in auto advertising, something that has occurred only once in the last decade.

Online Research Attracts Car Buyers

Most of the other automakers are planning a similar approach in 2006 with big increases in web advertising and a decline in traditional media. The auto companies are finally responding aggressively to studies that show more than 70% of the people who buy a car conduct online research first. Another interesting tidbit from the AdAge.com article is that despite tight inventory and rising CPMs at the web sites, the auto companies are not shifting ad purchases back to traditional media. Instead, they are bidding up prices of online inventory further.

Meanwhile, Newspapers Annoy Advertisers

While auto advertising may be the most significant headwind for newspapers this year, there are a few other problems. The latest circulation survey for the six months ending Sept. 30 showed a decline of 2.6%, the largest drop since 1991. I think a big part of that is the cleaning up of bulk subscriptions, so the trendline of circulation drops may not be steepening as much as perceived. However, I find it surprising that coming off these numbers and the bad publicity and advertiser anger they elicited, newspapers plan to increase ad rates between 3% and 6% in 2006 (DJ is an exception as it is trying to broaden its advertiser base to consumer companies). I suppose managements don't have much choice, but this seems like a risky way to reach for higher revenue.

Bid for KRI Could Spark a Rally

The Knight-Ridder (KRI) sale could be the salvation of the stocks if a fancy price is paid. CSFB is reporting that presentations to the KRI board will begin next week and final bids are due at the end of February. The group currently trades at around 8.5 times 2006 estimated EBITDA. A $70 price for KRI equates to 10 times EBITDA. I think that would protect against further downside in the stocks but I'd note that Comcast (CMCSK/A) trades at under 7 times EBITDA with better growth prospects, albeit much higher capital spending requirements.

Bottom-Line: What's Good for Online Media Is Bad for Print Media

The outlook for newspaper stocks in 2006 is drab, since the fundamentals remain challenging and valuations are not cheap enough yet. An upturn in advertising can be better played elsewhere, and waiting on takeovers is pure luck if it works in your favor. Meanwhile, investors in online media have secular winds at their back and would still benefit from an upturn in ad spending. These are some of the reasons that I have recently purchased shares of Yahoo! (YHOO) for myself and Northlake clients.

Extra, Extra: Newspaper Stocks Face Long-Term Challenges

Quick Summary:

Earnings estimates have come down steadily all year and several companies have pre-announced earnings misses for 3Q05.

The stocks should be trading well below historical multiples even if you believe that certain issues are cyclical.

It is still too soon to take long positions in the group even though most of the stocks are trading close to 52 week lows

Newspaper companies are among the first to report quarterly earnings. This week I will be listening to conference calls from Gannett (GCI), Tribune (TRB), E.W. Scripps (SSP) and Knight Ridder (KRI)....

Earnings Estimates Have Declined Steadily All Year

I have written extensively about my negative outlook for the industry and third-quarter earnings will present a bleak picture. Earnings estimates have come down steadily all year and several companies have already pre-announced earnings misses for 3Q05 while others have issued monthly revenue reports that show continued anemic growth in advertising revenue. As an example of the weakness in the upcoming reports, Merrill Lynch analyst Lauren Fine expects EPS growth in the group to range from -9% to -30% and revenues to grow just 2%. SSP might eke out a positive comparison but that company is really no longer a newspaper company.

Most Newspaper Stocks Are Close to 52-Week Lows

Year to date, the newspaper stocks have performed poorly with most stocks down between 15% and 20%. In fact, most newspaper stocks are trading quite close to 52-week lows. Despite the poor stock performance, valuations are not cheap by historical standards or relative to other struggling media industries. Based upon consensus 2006 estimates, the group is trading about 8.5 times EBITDA, which is actually in line with the average multiple on forward EBITDA since 1989. Additionally, relative to current fundamental trends, 2006 estimates still look high with consensus EPS estimates looking for upper-single-digit growth. To reach these estimates would require mid-single-digit revenue growth vs. recent trends in the 2% range.

Newspapers Discount To Other Media Stocks Has Narrowed

Other media stocks have actually seen greater multiple compression as they have shown better EBITDA growth this year. Consequently, the newspaper industry, arguably the most challenged of traditional media industries, actually trades at less of a discount to the broader media universe than usual despite the very poor stock price performance so far in 2006.

Challenges Are Long-Term

Among the many problems faced by the newspaper industry are: (1) weak auto advertising; (2) weak retail advertising; (3) sluggish national ad trends led by travel, entertainment, and wireless ad spending; (4) circulation restatements and weak circulation growth off lower base figures; and (5) a shift of traditional print advertisers towards newspaper Web sites where reach-based pricing is cheaper.

Stocks Should Be Trading Well Below Historical Multiples

Unfortunately, many of these problems are the results of long-term challenges due to the rise of the Internet and younger demographic groups not reading newspapers. Mega mergers in retail and wireless, two of the most important ad categories, are also long-term issues. This suggests to me the stocks should be trading well below historical multiples even if you believe that certain issues are cyclical and current estimates do not account for the possibility of cyclical operating leverage.

Here is a brief overview of what to expect for each of the calls we will be covering this week:

Tribune (TRB) faces all sorts of problems well beyond the success of the Cubs' cross-town rival White Sox. EPS for 3Q05 are expected to be -5% before any additional problems due to two TV affiliates in New Orleans. TRB has faced some of the worst circulation restatements but management has encouraged the Street to look for better fourth-quarter trends. The company recently lost a big tax case which slightly reduces financial flexibility. TRB owns lots of assets, including major market TV station and newspapers. It seems like value exists but management is cautious and will not likely move aggressively to alter its strategy.

E.W. Scripps (SSP) now gets over half its EBITDA from its cable networks, which are the driver of valuation for the shares and will be the focus of the earnings call. SSP has reported big positive surprises in recent quarters but I fear that growth may slow over the coming quarters and years as HGTV and Food Network have matured. Management has done a good job investing in additional cable networks but I worry that the economics for Great American Country, DIY, Fine Living, and Shop At Home will never approach those of the first- and second-generation cable networks. If I am correct, when the Street realizes it, multiples on cable networks will contract limiting upside in SSP despite the superior results and strategies executed by the management team. I think the cable network issues could become a hot topic in 1H06.

Knight-Ridder (KRI) announced very disappointing third-quarter trends but also has a very aggressive stock buyback in place. KRI is one of the cheaper newspaper stocks and with no major insider ownership, is potentially a good acquisition target if M&A would return to the industry. KRI also offers good operating leverage if its big-city dailies return to revenue growth. I hope to heer something positive on the call that might make me want to act on this bullish bias but I doubt that will happen. Surprising cost growth in the third quarter and among the industries worst top-line trends likely will be the story.

Posted by Steve Birenberg at 01:22 PM