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Regional newspaper publisher McClatchy (NYSE: MNI ) has struggled to turn its core business around. It has been hurt by a population that continues to ditch its newspaper subscriptions, as evidenced by another decline in average daily circulation for the nation's newspapers in 2013, according to the Alliance for Audited Media. While McClatchy remains the self-described leading source of news and information in most of its markets, the rise of alternative information mediums has siphoned advertising revenue away from the company. This has led to a multiyear drop in revenue and operating profit.
Yet, against this backdrop, McClatchy's shares have risen sharply. This includes a double-digit pop in early March that was caused by the announcement of the sale of Apartments.com, in which it owns a major stake through its Classified Ventures partnership. On Tuesday, the stock rose 3% on news of its sale of the Anchorage Daily News. So, should investors bet on more upside ahead for McClatchy?
What's the value?
McClatchy is the No. 3 domestic newspaper publisher, operating a portfolio of 30 newspapers in mostly second-tier markets, including Sacramento, Calif. and Kansas City, Mo. Unlike competitors that have bailed on the newspaper business, like former Washington Post owner Graham Holdings, McClatchy has stuck with the medium, hoping to keep its readership and corresponding value intact by building digital versions of its newspapers. The efforts have limited erosion of McClatchy's overall subscriber base. The lower relative pricing of digital advertising compared to traditional advertising, however, has significantly eroded the company's operating profitability over the past few years.
In fiscal year 2013, McClatchy's results trended negative once again. This was highlighted by a 5.1% top-line decline that was primarily a function of lower across-the-board advertising sales, led by a 10.9% decline in the retail category.
The company's circulation revenue was a bright spot, registering a year-over-year increase thanks to continued success in the digital-subscription arena. The gain, however, was more than offset by weak advertising pricing and sales volumes, the source of more than two-thirds of McClatchy's total revenue. As a result, McClatchy generated a double-digit decline in operating income, hurting its ability to fund growing investments in its digital initiatives.
What's going on?
McClatchy shares have been on fire lately, no doubt due to investors' expectations of a profit windfall from realized and potential asset sales. Its higher valuation, however, seems to be unwarranted given limited traction in the company's underlying publishing business. In addition, the one-time proceeds seem unlikely to end up directly in investors' pockets, as management has indicated a desire to reduce the company's sizable debt load.
Certainly, a de-leveraging of McClatchy's balance sheet would appear to be prudent, given the declining ability of newspaper empires to support a highly leveraged business model. The strategy also has precedence, as iconic newspaper publisher The New York Times (NYSE: NYT ) has followed a similar blueprint over the past few years.
The New York Times' asset sales, including the high-profile sale of its interest in Fenway Sports Group, have greatly improved its overall liquidity, putting it into a positive net cash position as of December. It has also allowed the company to focus on its publishing operations as it tries to create value by convincing a growing number of customers to pay for digital content.
A better way to go
Given McClatchy's inability to stem multiyear profitability declines in its core publishing business, investors looking for publishing exposure should probably consider more diversified operators in the space, like Gannett (NYSE: GCI ) . The publisher of a large assortment of newspapers, including USA Today, has been subject to the same negative margin trends as its competitors. It, however, has chosen a different strategic tack, choosing to bulk up its high-margin broadcasting operations.
Case in point is the recent blockbuster acquisition of local broadcaster Belo, a transaction that nearly doubled Gannett's portfolio of broadcasting properties. More important, the transaction lowered Gannett's reliance on the declining publishing business, which will likely improve its growth prospects and lead to rising shareholder value in the future.
The bottom line
McClatchy's stock price has been moving in the right direction, but it is hard to see how the momentum will continue given negative trends in its underlying fundamentals. As such, prudent investors should probably avoid this speculative name in favor of Gannett, a competitor that has seen the writing on the wall and is wisely diversifying its business mix into related areas that are less susceptible to profit erosion.
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