Why Aren’t Aggressive Buyers Out There Buying Small Market Newspapers When Prices Have Dropped So Much?

Philip M. Stone May 14, 2008

There are newspaper bargains a plenty out there in the small market arena but major groups are still sitting on their hands. How come?

According to newspaper broker Larry Grimes, President of W.B. Grimes & Company,  the problem is that “Wall Street and the mainstream media are grouping all newspapers together in their analysis of the industry – which is a flawed strategy. They are not comparing apples to apples. And that, in fact, there are many, many newspapers out there doing just fine,, especially the weeklies and smaller town dailies.”

That’s a view supported by GateHouse Media CEO Michael Reed who told analysts this week that  “my belief is that the valuation declines we’ve seen in the general newspaper sector over the last year have spilled too far into the small market newspaper industry and that in fact small market newspapers right now have been hit too hard with regard to valuation declines.

“So what that means is there’s a fantastic buying opportunity in that space, so we will continue to evaluate the opportunities that are out there because valuation has been hit harder than it should be and if we can find the right acquisitions at the right price in this market that will be very accretive and great for shareholders in the long-term, we would hope to execute on those.”

Having said that, Reed said that Gatehouse is looking more at using some of its free cash flow on buying back shares. The company has more than 100 small market dailies but reported an increased Q1 loss. It is carrying long-term debt of $1.2 billion.

Reed doesn’t believe the current credit crunch is affecting the number of deals being made, but, yes, the prices are down. “We see a consistent deal flow that is consistent with what we’ve seen over the past decade. What we are seeing is better value in that deal flow.”

He is confident that advertising will pick up again. “Extensive conversations with our leading advertisers support our belief that almost all of the slowdown in ad spend is related to the current economic environment and that it will return when economic conditions improve. Advertisers continually tell us that print advertising works for them. We are confident that revenues will grow and that our strategy with regard to dominant, small market media businesses paves the way for that growth.”

Newspaper broker Grime admits  that many small newspapers are having a mediocre year, “but that is purely due to the lousy economy and slow retail environment. He agrees with Reed that “opportunity abounds for aggressive buyers.”

That the major groups aren’t making any moves is a real disappointment to Grimes. “It is very discouraging to me that so many of the major groups are sitting on the acquisition sidelines at a time when they should be buying. They are going to wake up a couple of years from now and wonder why on earth they did not seize the moment.”

The problem for the publicly-quoted companies is that their shares are languishing near 52-week lows and as Grimes said its investors don’t distinguish between buying small healthy newspapers as opposed to sick larger metropolitan newspapers. After all, a newspaper is a newspaper, those investors believe, and in an environment where Gannett, for instance, has just offered buyouts for 160 staff in New Jersey just how do you convince shareholders that buying more newspapers is a good thing, and not see the share price sink on the news?

But there is huge monster lurking out there that can really give pause to those who may be thinking of jumping in to buy in the smaller markets -- $4 a gallon gas. The average across the US now is $3.72 but already in places like Westchester County, New York, regular unleaded has topped $4 and in Nashville high octane is at $4.01. So why does a high gas price spell added doom and gloom?

Most economists believe that $4 a gallon is the benchmark that will force Americans to change their spending and travel habits, and that in turn could well mean a catastrophe for media advertising revenues. If people won’t take the car out so often to go shopping, and they have less money in their pockets anyway to buy something because they need more for gas, then that results in lower retail sales. And with the credit crunch affecting money on hand to buy and/or fix up houses then all of that non-spending trickles down to what the retail trade has on hand to spend on advertising.

Newspaper valuations have really shifted downwards in the past couple of years. Newspapers that were selling for 10 to 12 times cash flow are now going for 6 to 7 times cash flow. Newsday, bought by Cablevision, went for about seven times cash flow.

Also possibly frightening people off are the kind of statements like that this week from McClatchy chairman and CEO Gary Pruitt at his shareholder meeting. When a shareholder asked him when the current revenue debacle would come to an end he replied he just didn’t know. In other words, bad as things are now, there’s nothing out there to indicate they are going to get better any time soon and indeed the likelihood is that if anything it will get worse.

And to give just one example of how newspaper valuations are sinking, McClatchy inherited a 49.5% stake in the Seattle Times, admittedly a big metropolitan newspaper,  when it took over Knight Ridder and that investment had a valuation at the end of 2006 of $102.2 million. By June last year it was down to $89.9 million, in December it was slashed to $19.3 million and last week McClatchy took the knife out again, valuing its half share at just $12.06 million. That means within 17 months a half share of a major newspaper  that had been valued at $102 million is now carried on the McClatchy books at just $12 million.

As for that Newsday sale at $618 million – around seven times cash flow -- what does newspaper broker Grimes think of that price?. “I think that was a bargain,” he told ftm.