FOOL ON THE HILL
An Investment Opinion
The Dow vs. TheStreet Louis Corrigan (TMF Seymor) (TMF Seymor)
August 9, 1999
It was hardly surprising this weekend to see Barron's curmudgeon columnist Alan Abelson declare with all seriousness that "we can't see anybody making real money out of the Internet -- except by selling stock." I mean, that's been his mantra since America Online (NYSE: AOL) was still in diapers, back, oh, six years ago, long before the online behemoth sported a market capitalization 20x that of Abelson's century-old employer Dow Jones & Co. (NYSE: DJ).
It also wasn't surprising to see Abelson describe James Cramer of TheStreet.com (Nasdaq: TSCM) as "the logorrheic proprietor of an online financial rag." After all, Cramer has feuded with Dow Jones and Abelson plenty in the past. And truth be told, Abelson is understandably jealous of anyone who can afford to be even more logorrheic than he is. Fact is, Dow Jones may buy ink by the barrel, allowing Abelson to indulge his dot.bomb habit, but TheStreet doesn't have to.
And that's what I want to talk about today. While you hear a lot about the potential competitive advantages enjoyed by Internet e-tailers relative to brick 'n' mortar retailers, the comparison is potentially even more apt for purely information-based businesses like, say, financial journalism. For example, the attractive cash flow dynamics of Amazon.com (Nasdaq: AMZN) follow from the fact that a customer pays for an order at the time of purchase, but Amazon itself doesn't pay its suppliers until a month or so after it ships the product to the customer. That lag time creates a cash "float" that essentially means suppliers pay for Amazon's working capital needs.
OK, Internet investors should know this backwards and forwards by now. Part of the recent anxiety about Amazon, in fact, is that this once mostly "virtual" company with very light inventories is now building massive new distribution centers and taking on increasing amounts of inventory to turn around customer orders more quickly. Yet, assuming Amazon's customer order tracking system is as good as billed, the company should still manage to operate with much lighter inventories and capital expenses than your average retailer. Thus, it should also be more profitable, even with fairly modest net margins. But there's no arguing with the fact that Amazon is laying some serious brick 'n' mortar as a foundation to its virtual empire.
Compare Amazon with a financial rag, offline or on. First, both a Barron's and Street.com rely a lot on subscription sales, usually annual subscriptions. Barron's now runs $145 per year while TheStreet is $99.95. Imagine how sweet this is for the publisher. You, the reader, are paying these guys -- in full -- months before they're going to satisfy their end of the bargain. That creates an inherently appealing cash flow dynamic, one that's potentially much more attractive than Amazon's since, at best, that online merchant gets to play around with your cash for 45 days before it must pay the book man.
But traditional newspaper and magazine publishers screw up this theoretically sublime business model. Their entire distribution system is designed around massive cash suckage. Can you say printing presses? Can you say fish wrap, eh, newsprint? Can you say distribution centers, postage, delivery boy? Let's assume that Abelson is creating phenomenal value for Dow Jones. Investors love his mellifluous prose, his hauteur, his money-making insights. But the process of getting his deep thoughts into the hands of consumers is one now ruled by relatively expensive middle persons all dipping their hands into the coffers.
Say what you will about TheStreet, but it just doesn't have the same problem. And it probably never will. Think of the company (and other Web-centric upstarts) as a financial news e-tailer, but one that doesn't need to spend hundreds of millions of dollars on distribution infrastructure the way either Amazon or Dow Jones currently must. Make no mistake, news organizations that can build their franchises on the Web's open system without simultaneously being weighed down by a capital-intensive offline empire of brick 'n' mortar printing presses or proprietary networks have a long-term competitive advantage over their old world counterparts, no matter how well-branded.
Let's take a closer look at Dow Jones. The company is now divided into three operating units. Its print publishing division includes The Wall Street Journal, Barron's, Smart Money -- owned jointly with Hearst (NYSE: HTV) -- and television revenues from a U.S. news licensing deal with General Electric's (NYSE: GE) CNBC. This unit accounted for 63.5% of revenues for the first six months of FY99. Next, there's the electronic publishing unit, which includes the mainstay Dow Jones Newswires (52% of this division's sales), Dow Jones Interactive Publishing (Dow Jones Interactive, WSJ Interactive Edition, and Dow Jones radio), and fees from licensing the Dow brand for stock indexes. This division generated 20.2% of revenues year-to-date. Finally, there's the Ottaway Newspapers, which operates 19 community newspapers. It's accounted for 16.3% of FY99 revenues.
Dow Jones has done a good job of taking its core products onto the Web. For instance, subscriptions to the online edition of the Journal have soared, increasing from 50,000 at the end of 1996, to 172,000 at the end of 1997, to 266,000 at the end of 1998, to more than 304,000 today. That's despite a November 1998 price hike from $49 a year to $59. Dow Jones has also been pushing corporate sales of Dow Jones Interactive, which provides customers with now mostly Web-based access to a news library of over 6,000 publications, including the WSJ, the 50 largest U.S. newspapers, top business magazines, and 1,500 non-U.S. sources. In FY98, the number of users swelled 56% to 600,000.
The growth in online distribution helps compensate for and even explain the fact that circulation of the print Journal has stalled in recent years, even puttering for a 1.6% loss last year to 1.77 million. Meanwhile, the circulation of Barron's has been equally sclerotic, simply holding steady around last year's 296,000. Both publications have seen a recent pickup in readers, but the broader trend suggests these gains should be viewed with caution. Meanwhile, the Journal's advertising rates have increased slightly but ad linage has gyrated with market sentiment, rising 6.9% year-to-date after declining 1.1% for all of FY98 due to a terrible second half.
Frankly, Dow Jones shareowners should be heartened by what looks like a consumer transition from print news sources to Web news sources. Unfortunately, as the above stats attest, roughly 80% of Dow Jones' revenues comes from print publications. That's why Dow consumed a stunning 278,000 metric tons of newsprint last year. That's why year-to-date, newsprint and delivery expenses have run $133.1 million (13.7% of sales) despite a drop in the price of newsprint. Last year, Dow Jones spent $278.8 million on newsprint, second class postage and carrier delivery. In terms of the company's main product (news, data, and commentary), these are necessary but relatively unproductive expenses.
Still, operating expenses only begin to tell the story. Consider that Dow Jones is now in the middle of a three-year plan to expand the Journal's print capacity from 80 pages to 96 per edition and to boost color capacity from 8 pages to 24 pages. Total cost: an unbelievable $232 million! Now, this investment is no doubt expected to boost ad revenues both on a linage and rate basis -- assuming advertiser demand remains strong. Yet, a Web-centric company could increase its daily page output and colors while spending just about nothing on new equipment. Moreover, a company that can avoid such expenses also reduces the risk that such capital expenditures won't pay off.
This is not an immaterial concern. In Q4 1998, Dow Jones took a $17.3 million charge related mainly to the write-off of its Global News Management System. The company started building this system in 1993 with hopes it would "provide state-of-the-art electronic news writing and editing to support the company's print publishing operations." Unfortunately, the system never worked as planned. So while Dow Jones implements a new off-the-shelf technology solution, it has transferred staffers back to the old system. Money wasted.
Of course, this doesn't compare to what happened with Telerate, the real-time data provider that Dow Jones acquired for around $1.6 billion earlier this decade. Telerate offered a proprietary system that Dow Jones thought it could use to compete against Bloomberg in serving the information needs of professional traders. After years of getting slaughtered by Bloomberg, though, Dow Jones, in 1997, decided to take a $979.5 million restructuring charge, mostly to write down the value of Telerate. Dow finally sold Telerate to Bridge Information Systems last year for $360 million in cash plus $150 million in convertible preferred stock. It booked an additional $150.3 million loss on this sale, making Telerate a $1 billion plus disaster. That makes losses at most Internet companies look trivial.
Given such massive destruction of shareowner value, it's no surprise that Dow Jones stockholders have suffered through a decade in which the stock (unadjusted for reinvested dividends) has produced a truly dismal 2.5% compound annual gain. Thankfully for those shareowners, Dow Jones appears to be managing its business a little better now, based on recently reported Q2 earnings.
Still, in comparing the giant Dow Jones to the upstart Street.com, I'm struck by a couple of things. First, TheStreet exhibits ambitions of being a global financial news provider, meaning it will probably tackle every medium in time. For example, it recently launched a weekly television show in association with News Corp.'s (NYSE: NWS) Fox News. Still, as a Web-centric operation, it doesn't suffer from the baggage of print or TV operations. It's a content company, pure and simple. And its losses to date have been completely understandable, related to brand-building and a ramp in staffing. Though its varied electronic distribution costs gets buried in lines like sales and marketing, I don't think it's ever going to lose 14% of its revenues to unproductive print distribution costs.
Second, because of its light Web-distribution model, TheStreet is not likely to incur huge capital expenditures for equipment and operations, some of which don't pan out as planned. Even granting the David and Goliath nature of this comparison, one stat sums this up. At the end of March, Dow Jones' plant and property assets net of amortization amounted to $629.1 million. That's more than 400 times TheStreet's measly $1.5 million in net plant and property at the end of June. If you understand that such hard assets are actually liabilities of a sort, then you understand why it's amusing to see Abelson's repeated diatribes against Internet companies.