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Would You Invest In An Industry That Forecasts Flat Revenue Growth For Each Of The Next Five Years? That’s What Tribune Newspapers Are Projecting, So Perhaps It’s No Surprise That McClatchy, Since Gobbling Knight-Ridder, Sees Its Shares Hitting An Eight-Year Low

Philip M. Stone April 30, 2007

We all know what Wall Street thinks of newspaper shares, but how do newspapers themselves see the long-term future? Usually, if you’re lucky public companies give a one quarter outlook, but Tribune’s legal documents accompanying its share buyback program to go private gives an insight for the next five years which should make most newspaper investors cringe.

Would you care to predict how much newspapers will earn in the next five years?

According to the Tribune documents management believes that newspaper revenue from 2006 to 2011 will be flat. The broadcast group doesn’t do much better – a 2% annual revenue increase. The company forecast operating cash flow growing by 2% because of investments in CareerBuilder (42.5%) and the Food Network TV (33%). Without those investments overall cash flow would be increase 1.2% annually with publishing cash flow flat.

Those numbers sound awfully conservative – they were the numbers used to “entice” buyers for the company during the six-month period before Sam Zell put in the winning offer – and perhaps they were intentionally low because management really didn’t want to encourage an outside “buyout” and favored doing things internally – but if one goes by this year’s Q1 results then perhaps one could make the argument they were actually too optimistic.

Tribune in Q1 issued its first loss in five years, and cash flow was down a whopping 12%.  Perhaps some of that needs to be taken with a grain of salt since when companies are changing ownership – in this case going from public to private -- they get rid of as much financial baggage as possible during the process, but be that as it may those outlook numbers are really pretty scary.

If Tribune, with properties like the Los Angeles Times, Chicago Tribune, Newsday, Baltimore Sun and others can’t make decent print profits then what is there to make one think that other companies will do much better? It’s not that Tribune management are dummies – they are very savvy – and yet with every quarter comes declining revenue announcements and more job cuts (300 as of the first quarter results).

It all makes one refer back to the thoughts of Warren Buffett when it comes to investing in newspapers. In his annual Berkshire Hathaway shareholder newsletter this year he said that as far back as 1991 he warned that the insulated world of newspapers was changing, not that any publisher listened to him then. “Newspaper properties, moreover, continued to sell as if they were indestructible slot machines. In fact many intelligent newspaper executives who regularly chronicled and analyzed important worldwide events were either blind or indifferent to what was going on under their nose.” Could he there be thinking of the New York Times Company’s purchase of the Boston Globe in 1993 for $1.4 billion, and on which the Times Company wrote down its value this year to around $600 million, or McClatchy’s purchase of the Minneapolis Star Tribune in 1998 for $1.2 billion which it sold in December, 2006 for $530 million plus $200 million in tax credits, or even McClatchy’s buy of Knight-Ridder last year?

It does seem that Gary Pruitt, McClatchy’s CEO is paying the penalty for not taking Buffett’s advice to steer away from buying newspapers. It used to be that no matter what was happening elsewhere one could always depend on McClatchy to turn in sparkling quarterly reports, and its share price reflected that. But since last August when the Knight-Ridder deal was completed McClatchy’s stock has dropped a whopping 44% (from $42.29 to its close Friday at $29.29) when the Dow Jones Averages rose some 18% for the same period. At one point Friday McClatchy’s shares hit $28.80 -- the lowest since 1999.

McClatchy’s Q1 earnings report contains a fistful of information that newspaper investors should study closely. Assuming at the beginning of 2006 that McClatchy had owned the 20 Knight-Ridder newspapers that it kept, then a year-on-year comparison showed continuing operations down 5%, advertising revenues down 5.3% and circulation revenue down 3.6%. A major reason it was still able to show a quarterly profit was because of strong cost reduction programs that cut cash expenses by 6.3%.

And the company offered fascinating figures on how it says it benefitted from the Knight Ridder purchase and the Star Tribune sale. If the company had not bought the Knight Ridder papers in August nor sold the Minneapolis newspaper In December, then its original portfolio performance would have shown a 16.3% reduction in operating cash flow since last August (when Knight Ridder closed). Had it bought the Knight Ridder papers and not sold Minneapolis the cash flow reduction would have been down much less—5.2%; but by making the acquisition and getting rid of the 12 Knight Ridder papers it didn’t want plus Minneapolis the cash flow was down just 0.3%. In other words Pruitt says he and his management team did the right things at the right time.

“Our performance was much better for having acquired Knight-Ridder and selling the 13 papers,” Pruitt said. With our portfolio of newspapers and digital assets in growth markets, new alliances with technology companies, and changes we are making in our cost structure, we approach the future with optimism.”

That release came out April 24. In the three days that followed when the market as a whole rose 2.4% McClatchy’s shares fell 5% -- Wall Street simply wasn’t buying into it. The only really good news that Pruitt had was that because of various additional tax benefits the Star Tribune sale is estimated to be worth $731 million rather than the previously stated $690 million.

Look how he sees just the next three months, “We expect continued declines in real estate advertising, particularly in the California and Florida newspapers, and do not see a significant rebound as yet in other classified advertising categories. So we expect second quarter advertising results to be similar to the first quarter.

And there’s no talk whatsoever of more print investment, Pruitt is now looking digital, having made a deal for Yahoo! to run so some copy and blogs from some McClatchy foreign correspondents, but more important the Yahoo! online classified deal that McClatchy joined in with 11 other newspapers. “This partnership presents opportunities for McClatchy and other newspaper companies to grow online by boosting traffic, bolstering search efforts and creating a state-of-the-art online ad network. We examined many alternatives (Tribune and Gannett, its partners in CareerBuilder tried unsuccessfully to have McClatchy do something with them instead) in determining this was the right deal with the right partners, at the right time. The partnership has emerged as the newspaper industry’s preferred solution, and as more companies join, we expect that gravitational pull will become even stronger.”

Which brings us back to Tribune again. It, too, is looking for a major boost in digital revenues to replace revenues lost to print but even that outlook isn’t looking great. The industry trend is that digital revenues are still climbing, but have slowed off the pace of the past couple of years. Newspapers that had expected 30% increases in digital revenues this year will now likely see something in the low 20s.

So if publishing revenues are forecast to be flat for the each of the next five years – and to achieve that there is going to have to be more cost cutting – and broadcast revenues are looking for an average 2% increase – Olympic and political election years much stronger than those years without and overall that figure could be very conservative – and if digital doesn’t pick up as much slack as once forecast, there really isn’t very much room in there for Tribune to slip in its cash generation to meet its obligations in paying off its $13 billion debt.

There really is no light at the end of the tunnel and Tribune is now offering buyouts at some properties. It may just be the smart employee who takes advantage.

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