It’s Debt Is Rated Deep Junk, It’s Shares Hit A Low Of 55 Cents This Week, And Yet McClatchy Still Boasts A Cash Flow Margin Of More Than 20%

Philip M. Stone February 12, 2009

Its Q4 reporting was doom and gloom -- revenues down 42% over the previous year, further savings announced to cut another $100 million or so -- but buried in the analyst conference call later was the gem that for all of that, McClatchy newspapers last year had cash flow margin of more than 20%.

Most businesses would kill today for that kind of cash flow, and it shows that newspapers – print and online -- can still be a very good business even during these economic hard times. The reality, of course, is that advertising revenues are way down and that means costs have been cut accordingly, but assuming one accepts that McClatchy still puts out decent products – perhaps not as decent as in the good old days, but still decent – then there certainly seems to be truth to the rumor that print is not yet dead.

During his telephone conversation with analysts, McClatchy CEO and Chairman Gary Pruitt let loose, “It’s worth noting that our cash flow margin was over 20% last year.”

And that is for a company that has just had its junk debt downgraded even more by the ratings agencies. The explanation from Standard & Poors, “The rating actions reflect our belief that McClatchy is likely to violate the total leverage covenant in its credit facilities at the end of 2009.”

And, of course, that’s the real problem going on here. While McClatchy has done the cost cutting it needs to do to keep the cash flow coming in at more than 20%, that resulting lower revenue is not enough these days to pay off the debt, run the company at a profit, pay dividends and so on as it used to in the, well, good old days.

Remember this is the McClatchy that borrowed in 2006 to buy the 32 Knight-Ridder newspapers for the equivalent of $67.25 a share, in a mixture of $40 cash and the rest in shares for a total of about $4.5 billion. It then sold 12 of the 32 papers so its total debt on the deal ended up around $3 billion.

Things weren’t exactly great then – perhaps McClatchy’s management might have given more thought at the time to why it was the only company bidding for all of Knight Ridder – and, of course, since then things have truly tanked.

If things had gone as normal, those 20 Knight Ridder newspapers McClatchy kept would have produced enough cash flow to pay off the debt, operate the newspapers, and put some loot in the company bank account, but when the bottom fell out that plan went awry, yet the debt payments still have  to be made as if nothing had changed.

McClatchy has done what it can to reduce the debt load – last June it bought some $300 million of its debt at heavily discounted pricing with the debt holders probably thinking a bird in the hand is worth two in the bush; it has also renegotiated its leverage ratio of debts to cash flow that were originally at a 4.5 limit, but now stand at 6.25 (and now that is in danger). 

Getting that leverage change didn’t come cheap – the lenders got a 0.25% interest increase on the loans that will cost McClatchy an additional $2.8 million a year, its line of credit was reduced under certain circumstances, and there were severe limits placed on dividend payments which is why it cut its dividend in half and has now announced its next dividend payout on April 1 will be the last for the foreseeable future as it needs to conserve cash. Overall it managed to reduce its debt by $433 million last year.

McClatchy’s shares closed Wednesday at 57 cents on the New York Stock Exchange and if its shares don’t get above and remain at least $1 within the next six months they’ll be delisted. And this for a company whose shares stood at $54.24 on March 10, 2006, the day it announced the Knight Ridder buy!

What is really sad about all this is that if you put all of the above to one side, McClatchy is doing a lot of things right in running newspapers in this economic climate.  Pruitt explained on the analyst’s call that the online side of the business is really doing quite well. “Our focus on becoming a hybrid print/online company has been in place for some time and we’re seeing some good results. Average monthly uniques were up 25% in Q4, and up 33% for the full year. Online advertising remains the fastest growing segment of our business.” That last sentence perhaps doesn’t really mean all that much considering what does he have to compare it with – print?

But there is a trend with the online sales that other newspapers companies would love to emulate. Pruitt said that about half of McClatchy’s online advertising revenue comes from pure Internet sales – not connected to a print sale, and on that he feels very good. “It shows an independent stream of business that is not dependent on print up-sells. This has been increasing over time.” That means it’s not just a matter of offering the Web at a discount for a print ad – there are new advertisers for the Web only and that business is growing and that is what newspapers everywhere need to achieve.

Pruitt continues to believe that Web news should remain free and advertising supported but he does say the company will experiment with paid content online.  But he claims, “Most experiments show that you lose more online revenue than you gain per subscriber.”

What’ is really needed is what ftm has been proposing for some time now – a hybrid Web service in which some  news (local) is behind lock and key with advertising, too, while the national and international news is solely advertising supported. One blogger recently suggested that newspapers in a coordinated manner should turn off free news on the Internet for one week as the first step in getting people to pay for news online. Interesting concept. Why not?

McClatchy is fighting hard to avoid death by debt strangulation. The company says it will get through this but with $100 million in cutbacks still to come at what price of quality product remaining?