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Wednesday, October 14, 1998

An Investment Opinion
by Louis Corrigan

Ziff-Davis Crushed by Debt

Initial public offerings (IPOs) generally underperform the market after the initial six-month honeymoon period is over, and new issues have been slaughtered in the recent market turmoil. Still, newly public companies don't normally have the commanding market presence of a Ziff-Davis (NYSE: ZD), the leading publisher of computer magazines, such as the top-ranked PC Magazine, and organizer of the highly successful Comdex computer trade show.

The publisher, which is controlled by Japan's Softbank, which also has major stakes in Yahoo! (Nasdaq: YHOO) and E*Trade (Nasdaq: EGRP), reported $1.15 billion in 1997 revenues. It has also diversified its holdings of late with ZDNet (, the most popular website for technology news, according to recent surveys; the March launch of ZDTV, a 24-hour cable channel; and Yahoo! Internet Life, the nation's fastest-growing technology magazine. If you were looking for a media company well-positioned to benefit from a techno-future, Ziff-Davis would be a leading candidate. So why has the company's stock plunged to around $4 today from the $17 high reached shortly after the company went public in April at $15 1/2?

For starters, business has been not so great. The troubles affecting PC manufacturers and related sectors for most of this year have cut into ad spending. Publishing revenues for the first half of the year dropped 4% to $412 million due to the spin-off of the MacUser and MacWeek magazines into a joint venture. Even adjusting for these shifts, though, publishing revenue grew by just $7 million, or 1.7%. While higher-margin ad revenues at its business publications declined, ad revenues at its consumer publications and at ZDNet increased. In fact, ZDNet second quarter sales jumped 53% to $12.9 million. Still, revenues from its events unit also declined by $4.6 million to $92.9 million due to a drop in exhibition space at the Spring Comdex show, which reflected marketing cost cuts by tech companies.

Even as overall revenues fell by 4.1%, selling, general and administrative expenses rose slightly. Also, the company spent $3.2 million on one-time relocation expenses and reported $4 million in losses related to the launch of new publications. That left Ziff-Davis with an operating loss of $2.6 million for the first six months of 1998 versus an operating profit of $10.5 million for the comparable period of 1997, or a pro forma loss per share of $0.82 versus $0.77. Looking at the EBITDA metric (earnings before interest, taxes, depreciation and amortization) often used to value media companies, we see a decline from $93.8 million last year to just $78.5 million for the first half of 1998.

And the bad news keeps coming. Last Thursday, the company said that third quarter results would be in line with expectations, with revenues coming in at $225 million and EBITDA at $27 million, both up from the third quarter of 1997. However, CFO Tim O'Brien said, "[W]e do not see the previously expected recovery in the fourth quarter." As a result, fourth quarter EBITDA will drop 15% from the year-ago period, due mainly to continued weakness in the publications business. In addition, the company sees the need to tighten its belt and plans to cut 10% of its workforce while discontinuing three publications: Internet Business, Equip, and Windows Pro. The company will take a one-time pre-tax restructuring charge of $50 to $60 million. The moves come on the heels of the firm's reorganization of its international operations, designed to make them more autonomous. In response to the latest news, analysts have slashed their estimates, with some now expecting a loss even for FY99.

Indeed, analysts have even cast doubt on Ziff-Davis's new plan to sell 20% of its ZDNet business to the public. Keith Benjamin, the omnipresent Internet analyst at BancAmerica Robertson Stephens, told the Wall Street Journal that the ZDNet spin-out looked like a sign of "desperation" and that the deal would have worked better a year ago when competitor CNET (Nasdaq: CNWK), operator of the technology news site, went public. However, Ziff-Davis's management thinks ZDNet is being undervalued. CFO O'Brien told Bloomberg that ZDNet alone could be worth $6 to $7 a share.

ZDNet broke even during the second quarter and claims an audience roughly comparable to CNET's. Relevant Knowledge says ZDNet averaged 6.8 million unique visitors during the second quarter, an 8% sequential increase. Average daily page views jumped 89% year-over-year to 5.1 million during the second quarter. Meanwhile Media Metrix ranks ZDNet as the #1 news, information, and entertainment website. For August, it says ZDNet attracted 7.08 million unique visitors compared to 7.015 million for CNET.

The Ziff-Davis stable is full of other thoroughbreds as well. Mediamark Research Inc.'s (MRI) fall study shows that PC Magazine isn't just the top computer publication but the top overall business magazine with a circulation base of 1.175 million and a readership reach of 6 million. Its average issue audience is 22% greater than Business Week's, 52% larger than Forbes', 63% more Fortune's, and 74% higher than the Wall Street Journal's. Moreover, its demographics are first rate. Its average reader is a 39-year-old male with average household income of $75,000. About 82% have attended graduate school and 41% have professional or managerial titles.

The MRI study also shows that Ziff-Davis publishes four of the six leading computer magazines. In addition to PC Magazine, there's PC Computing at #3, Computer Shopper at #4, and the new Yahoo! Internet Life at #6. PC World from International Data Group (IDG) is #2 while CMP Media's (Nasdaq: CMPX) Windows Magazine is #6. Looking to the enterprise newsweeklies directed at corporate information technology purchasers, Ziff-Davis's PC Week leads the field for the fourth year in a row, with a 1.14 million audience reach, up 8.8% for the year, according to the IntelliQuest 1998 Computer Industry Media Study. As significant, PC Week and Ziff-Davis's Inter@ctive Week have been gaining influence while IDG's Computerworld and InfoWorld have reportedly been losing audience and CMP's InformationWeek average issue audience increased just 1.2%.

Nonetheless, it's highly misleading for the Wall Street Journal to talk about the "striking" disparity between CNET's market value (currently about $570 million) and Ziff-Davis's (currently about $400 million). What this comparison ignores is Ziff-Davis's substantial $1.5 billion in long-term debt net of cash. Looking at the enterprise value (which includes debt and cash), we see CNET valued at $529 million and Ziff-Davis at $1.9 billion. Indeed, the company's enormous debt burden means that while the stock has dropped 76% from its high, the company's enterprise value has declined by just 40%. This debt is a concern to Standard & Poor's, which placed Ziff-Davis's BB corporate credit and bank loan ratings and B+ subordinated debt rating on Credit Watch, with negative implications, following the publishing firm's downbeat forecast last week.

It remains true, of course, that Ziff-Davis's annual revenues are about 25 times CNET's, although CNET's alliance with NBC could help narrow that gap by driving its Internet growth with the new Snap! portal site. Assuming that ad spending by tech firms picks up down the road and that financial markets solidify enough for ZDNet to go public, Ziff-Davis could prove a bargain. On the other hand, with many international markets dealing with recession and mixed signals on the tech front in the U.S., the company's ad revenues could remain weak for some time. Meanwhile, Ziff-Davis will have to keep making those hefty interest payments, which amounted to about 13% of revenues in the June quarter and probably just slightly less going forward.