Thursday, October 27, 2011

Gannett Cash Flow Offers Opportunity

Gannett owns newspapers (such as USA today) and tv stations, mostly in the US. These industries are much hated by investors today, as revenues are generally in decline; advertising dollars are migrating online as circulation and viewership of traditional media continues to decline. But for value investors, this negativity can create an opportunity.

Gannett trades for just $2.8 billion despite having generated free cash flow of about $800 million in each of the last three years. So far this year, that trend looks set to continue or even improve, as through six months the company has generated some $400 million in free cash flow.

But as is the case with many companies in this industry, a potential risk to shareholders is a rather large debt burden. To the company's credit, however, this debt burden has been on the decline. In early 2008 it was over $4 billion; today, it is likely under $2 billion! This speaks volumes about Gannett's ability to generate cash: it was able to pay off $2 billion worth of debt in 3.5 years, while at the same time investing enough in its business to maintain current cash flows.

If the company can maintain this level of cash flow for a few more years, shareholders who buy in at this price will make a fortune. The question of course is whether the company will be able to do that, as Mr. Market seems to believe otherwise. Debt levels have a way of looming large over companies in declining industries, as fixed debt payments have to be serviced by lower revenue in-take. Nevertheless, for those who believe the rate of demise of these industries is over-exaggerated, Gannett may be an attractive investment.

The question investors should ask themselves is whether they are comfortable with the company's debt level. While it would only take 3-4 years to pay down completely at the company's current rate of cash generation, if advertising spend accelerates away from Gannett's newspapers and tv stations, it could take much longer.

Buying a company in a declining industry can be done successfully. But the investor should be sure to understand the risks of such an investment, particularly when they are magnified by a significant debt balance.

Disclosure: No position


Poor Charlie said...

I looked at this investment during 2008/2009 and missed a wonderful opportunity. Mr Market had discounted the price to astonishingly low levels. I also bought Yellow Pages in Canada thinking the same trend would occur here. I thought the business was being penalized for the US Yellow Pages. Be careful, the goodwill can disappear very quickly.

Sjoerd said...


I always read your articles with great interest, including this one. Keep up the good work!

This is a very interesting opportunity. I actually made the investment in GCI in 2008 (for $4) and this worked out very well. It is very important though that GCI continues to use their strong FCF to deleverage. Until now they have done this well and if they continu they will be basically debt free in about 2 years. This will also increase FCF as their interest payments will decline as well.

Interesting that Poor Charlie names YLO.TO here as I currently have a position in this company as well. In the preferred share though (series C&D). The company's FCF covers the interest for the preferred's many times over and they are cumulative as well. With the divestment of Trader they now have about 1.8 billion in debt and about $400 million in FCF.

Another interesting one is USMO. This company (still) delivers paging services, mainly to the healthcare industry. They recently bought a software company specialized in messaging services (unfortunately for 14x EBITDA), but this company's management is certainly very capable of slashing cost harder than the decline in earnings and so keeping the FCF of about $85 million/year constant. You can buy this company now for 3x times FCF and in the meantime you get an annual 7% return of capital.

All of the above companies are pronounced dead by the investment community, but are clearly very alive...

Disclosure: I have a position in USMO and YLO preferred C & D



Poor Charlie said...

Sjoerd and other readers, interested to hear your thoughts on YLO. Did you average down? Is FCF enough to justify a long position? I've read a variety of opinions on this one, but I think they can pull off this transition to the digital world. The rest of the world is betting against it based on the stock price.

I've spent some time reviewing USMO. Definitely outside my circle of competence but I like the fundamentals. Interesting they've been more profitable with less revenue (2010 vs 2007). Is there a catalyst to expand revenue? Growth story here or simply an oversold stock?

Sjoerd said...

Poor Charlie

Regarding USMO: In my position they have positioned themselves in a nice niche: critical communication in the medical/university sector. Traditionally this critical communications was handled solely by pagers that work on a separate infrastructure that guarantees maximum uptime and signal receiptance throughout the entire premises of the client. Now pagers is a dying form of communicating, but still has this advantage over GSM/ WIFI, etc. that it is relatively cheap and very reliable. That is why you see that especially in the medical sector there will be pagers for quite some time and basically USMO operates this sector as a monopolist.
With their (way too expensive) purchase of AMCOM they are now building on their position by providing alternative forms of communicating through tablets, phones, etc. AMCOM has a very strong position here as they can provide the most comprehensive solution (for now) and they service the biggest hospitals in the US. The benefit of software is that you can service the established base with maintenance and support at about 15-20% annual fee (against original purchase or list price), which has a huge margin. Once this software is established in the IT infrastructure of a client, switching cost are very high as well as people's willingness to switch as they like what they're used too. All in all USMO is nicely positioned to continue generating huge cash flows that benefit the shareholders as mgt has shown for the last years.

Regarding YLO. This company has always operated more or less as a monopolist and they have established the attitude that comes with it. Now in the 'new world' they have to adopt or go extinct (very much Darwin). They finally have seen the light (as they were forced by the bank to look into the light) and are now deleveraging.
That said they still make substantial free cash flow on their directories and are increasing the revenue on their online initiatives. You see that the margins on online are only a fraction of their the margin on their directories so over time this company will generates substantially less FCF than they used to. In the meantime they will experience decreased FCF from directories, but in my opinion this will eventually slow down as all the companies not willing to place adverts in YLO's directories anymore have already stopped. As a consequence YLO will be left with the more stickier customers, less willing to stop advertising in YLO's directories.
One of the interesting things of humans (as very clearly laid out by Charlie Munger) is the tendency to extrapolate past events out in the future. This extrapolation then equates to something like: 'So YLO experienced huge declines in its directories revenue in the past few years so this will continue at the same rate as in the past, hence the directories revenue will be zero in 4 years'.
In my opinion directories revenue will go down to zero at one point, but this will take much longer than now widely assumed as you will first shed customer very eager to run to alternatives and be left with a much more stickier base of customers (see USMO).
YLO is now forced to pay down debt and can do this with a $700 million cash inflow from the sell of Trader. As their debt is traded as huge discounts to face value, this $700 million can buy back a much larger amount of debt. If in addition the mgt. stops buying online companies 'left and right' and focus their attention on using FCF to lower debt and lower their cost base by adopting a frugal mentality they can generate huge amounts of FCF for years to come.
In my opinion they can generate more FCF that the combination of their current mrk cap and (current market value of their )debt combined. All in all an investment with a very interesting risk/reward distribution


Disclosure: long position USMO and YLO. PR.C & YLO.PR.D

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