FOOL ON THE HILL
An Investment Opinion
The Value of Value Line Louis Corrigan (TMF Seymor) (TMF Seymor)
August 4, 1999
As you know, average Americans are taking control of their own investments like never before. The long-running bull market has helped make investing seem simple, fun, and highly profitable. Then there's the Internet, which makes it extremely easy for individual investors to research stocks and monitor their portfolios all by themselves.
From a certain perspective, these ought to be the best of times for Value Line (Nasdaq: VALU), publisher of The Value Line Investment Survey and related periodicals. Indeed, Value Line (VL) bills itself as the world's largest publisher of investment periodicals based on number of paid subscribers, annual revenues, and number of equity analysts employed. These are substantial metrics, weightier than "impressions," "unique users," and the rest of the new lingo that defines performance for Web companies offering financial news, analysis, and data.
In addition, VL already has a trusted brand that doesn't require loads of marketing to be recognized. The mainstay VL Investment Survey covers 1,700 companies, offering regular updates with historical financial results, a detailed chart, nice-to-know information like institutional ownership, and some brief commentary from VL's analysts. Perhaps best of all, VL uses its own system to rank stocks 1 to 5 for timeliness and safety. Thousands of investors follow these rankings. They even feed into the model portfolios hatched in the Foolish Workshop.
Probably all but the youngest, most Net-centric Fools have at some point bought a subscription to the VL Survey (now $570 a year), or thought about doing so after spending hours combing through the dog-eared pages of the local library's copy. For years, Value Line was one of the best and only research tools a self-motivated individual investor had at her disposal.
If you're waiting for the "but," it's coming, just not yet. That's because Value Line is still an awesomely profitable company, as last Friday's FY99 earnings report reveals.
Value Line has two related but distinct businesses: publishing investment periodicals and managing money, mainly via its family of 15 Value Line no-load mutual funds ($5.1 billion in total assets as of April). Research generated by the publication wing guides the asset management side of the business, but the revenue streams are distinct, with publications generating $62.2 million in sales in FY99 and investment management fees and services amounting to $33.1 million.
Add these revenue streams, then subtract overall operating expenses, and we get operating earnings, which is the line to focus on here. What I'm bracketing is "income from securities transactions," which distorts reported earnings. Value Line has substantial cash, most of which is invested in its mutual funds. As those funds distribute capital gains, Value Line reports those gains as taxable income.
But the distribution of those gains varies year by year, and need not reflect the accumulating paper profits. Indeed, mutual funds should generally avoid distributing capital gains for as long as possible. That's what's been happening of late. Value Line recorded $36.9 million in income from securities transactions in FY97, $18.3 million in FY98, and $5.2 million for FY99. This variation is the main reason FY99 reported net earnings declined to $27.2 million ($2.72 per share) from $35.2 million ($3.53 per share) the year before.
However, fourth quarter operating income of $11.1 million rose 37.6% versus the year-ago period and amounted to 45.6% of the company's $24.2 million in Q4 revenues. For the year, operating income after backing out a one-time gain from the sale of a facility was $38.9 million, or 40.8% of adjusted FY99 revenues of $95.3 million. Operating profits in dollars were down just 1.2% year-over-year. If we apply a 39.1% corporate tax rate, we get net profits from operations of about $24 million, or $2.41 per share for the year. So Value Line's net profit margin is 25%. That's terrific. At the recent price of $37 5/8, the shares now trade for about 15.6 times these adjusted earnings per share.
But more adjustments must be made for Value Line's sterling balance sheet. The company has $55.8 million in cash and short-term investment securities plus another $168.6 million in long-term securities, or essentially $224.4 million in cash. Meanwhile, Value Line has just $10.8 million in current liabilities and no long-term debt. Its major long-term obligations come in the form of $22.3 million in deferred income taxes and $43.1 million in unearned revenues thanks to the lovely business of pocketing cash from subscribers long before it delivers a product.
With 9.98 million outstanding shares, Value Line has a current market value of $375.4 million. So it trades for 2.25 times its nearly $166.9 million book value, most of which is backed by cash since the company's high-margin business doesn't require much in the way of fixed resources. McGraw-Hill (NYSE: MHP) isn't a great comparison due to the fact that it's a much larger and more diversified media company. Still, it does publish Standard & Poor's stock reports, a product that's directly comparable to the VL Survey. As the Fool snapshot shows, McGraw-Hill currently sports a trailing net profit margin of 9.5% (a third of VL's) but trades at 7.9x its book value, which is backed with little cash.
Given Value Line's cash trove, it makes sense to check the company's enterprise value, which I'll conservatively put at $222.3 million (market cap of $375.4 million minus $224.4 million in cash plus $71.1 million in total long-term obligations), or $22.25 per share. So the adjusted P/E on after-tax operating profits would be 9.2.
So is the stock a bargain? Asset managers easily trade for double that earnings multiple. And companies providing high quality financial data to individual investors can easily trade at 25 times often unprofitable sales if they operate mainly on the Internet. Market Guide (Nasdaq: MARG), a leading financial data provider being acquired by Multex (Nasdaq: MLTX), is well off its highs yet still trades at about 53 times its high-margin earnings.
The real difference, though, is that Value Line looks in serious danger of being left behind by the Internet and the rush of new players seeking to serve data-hungry investors. Remember, we've seen an explosion in consumer demand for exactly what Value Line offers. And yet, the company's overall revenues have stalled: $95.3 million in FY99 operating revenues versus $93.6 million in FY98 versus $91.8 million in FY97.
What's worse, even this meager revenue growth has come solely from the asset management side of the business, where growth in assets under management has lagged the industry, partly due to the mixed performance of Value Line's funds in recent years. Sales of Value Line's core product, its periodicals, have flatlined: $62.2 million for FY99, $61.2 million in FY98 and $62.4 million in FY97. New research products generated $1.7 million in additional revenues last year, but that means other products saw revenue declines.
That wouldn't necessarily be bad if Value Line were aggressively weaning customers from the high-cost paper versions of its periodicals to the more timely, versatile, and ultimately lower-cost electronic versions either on CD-ROM, or even better, the Internet. But that doesn't appear to be the case. One year of the monthly CD-ROM version of the basic VL survey runs $595, even more expensive than the print version. Or, print subscribers can add it for an extra $195. Such pricing discourages customers from going digital.
After adjusting for an unusual FY98 expense, distribution costs did decline in FY99 by nearly 7%, or half a million dollars, to $7.5 million. Given the additional "expenses for software and Internet development and maintenance," that's a bit better than it seems. After all, management claims that the company has spent the last year adopting its products for Internet distribution. Still, it's not clear how much money Value Line has spent developing its website. Not enough, it would seem, in light of the market opportunity.
Value Line ought to be an exciting Internet story, but it's not. And that must have something to do with Chair/CEO Jean Bernhard Buttner, who now controls the company through Arnold Bernhard & Co. (ABC). Value Line's board paid shareowners a special $15 per share dividend (imagine that!) in January 1997 so that Jean could buy out her brother's interest in ABC, which controls 80.6% of Value Line. But as columnist Christopher Byron recently noted, Buttner currently seems preoccupied with getting revenge on her critics (allegedly Value Line employees) who have excoriated her in posts to Yahoo!'s (Nasdaq: YHOO) message board.
It's almost never good news for shareholders when management chooses to counterpunch its critics rather than make the company critic-proof. Of course, Value Line shareowners also suffer from the fact that Buttner can run the company like her private fiefdom since no one can mount a takeover battle.
That's a shame because this cash machine could be worth a whole lot more with an aggressive management team. Buttner did say in last Friday's press release that "we are very close to introducing a new Value Line website which will bring more information to subscribers and prospective subscribers in real time." In theory, that could be a real boost for a company that already looks cheap. Yet, given Value Line's tardy embrace of the Net and its related lack of revenue growth, I'm skeptical. And with its paltry average daily trading volume of 4,000 shares, Value Line probably isn't liquid enough to attract even otherwise interested investors.