Newspaper publisher Lee Enterprises (NYSE:LEE) has remained focused on the newspaper business, despite a decline in overall readership, believing that the company can remain a key source of news in its markets through either physical or digital products. Lee almost sank itself with its acquisition of publishing icon Pulitzer in 2005, a transaction that added a hefty debt load to its balance sheet, creating a leveraged financial profile that isn't supported by the industry's current fundamentals.
Fortunately, Lee found a friend in Warren Buffett, whose Berkshire Hathaway holding company helped it to refinance debt in 2013 while taking a minor equity position. So, should investors follow the Oracle of Omaha into Lee?
What's the value?
Lee has been in downsizing mode since its bankruptcy filing in late 2011, selling off non-core papers and reducing the size of its corporate back-office operations. The moves have left the company with 50 daily and 300 weekly papers, which are predominantly located in state capitals and university towns that enjoy stable population bases. Lee has also been enhancing its papers' digital assets, a growing source of revenue for the company.
In FY 2013, Lee's revenue continued to follow the downward trajectory of the past five years, dropping 4.6% due to lower advertising revenue and reduced average daily circulation for its papers. However, the company continued to get mileage from both lower newsprint prices and its business restructuring activities, reporting an uptick in its adjusted operating profitability. The net result was stable operating cash flow during the period, which allowed it to continue slowly improving its balance sheet.
While Lee has used a greater online presence to maintain a sizable reach with its underlying population base, estimated at 65% across its markets, its advertising revenue has continued to decline, a result that management attributes to a rise in the power of online advertising exchanges. The power shift has led competitors to increasingly abandon the publishing space, including Graham Holdings' (NYSE:GHC) surprising decision to sell its iconic The Washington Post paper to Amazon.com founder Jeff Bezos in August.
Graham Holdings, a company that immeasurably benefited from its close association with Warren Buffett, had been shifting away from publishing for a number of years, with the segment only accounting for 14% of its overall revenue in its latest fiscal year. Instead of reinvesting in its publishing assets, Graham has built a major force in the for-profit education business, primarily through its Kaplan brand, while more recently also diversifying into other areas, likes health care and industrial supply. Despite the current regulatory troubles of the for-profit education sector, Graham likely sees much better long-run profit growth for the sector relative to the publishing business.
Finding an investment angle in publishing
Given the changing dynamics of the advertising business, evidenced by the rise of exchanges run by tech titans like Google and AOL, investors should probably steer clear of advertising-supported publishers. Instead, they should focus on operators that can charge subscribers for their unique content, such as The New York Times (NYSE:NYT). Despite multiyear declines in its advertising revenue, the company has been able to shore up its overall revenue base by focusing on subscriptions, an area that accounts for roughly half of its sales.
In FY 2013, The New York Times has managed to post a small top-line gain, thanks in part to a 28% increase in its digital-only subscription base. More importantly, the company's adjusted operating income has risen sharply, due to the effects of lower newsprint prices as well as benefits from its strategic review process, which has seen The New York Times sell off non-core properties, like online information provider About Group. The asset sales, in particular, have put The New York Times in a positive net cash position, a source of strength that provides the company with a modicum of financial flexibility to pursue business development opportunities, unlike indebted peers like Lee.
The bottom line
Given Buffett's general affinity for the newspaper business, evidenced by Berkshire's purchase of a portfolio of community papers from Media General in 2012, it is not surprising that he found enough value at Lee to warrant an extension of secured credit. However, given Lee's still-leveraged financial position and uncertain growth prospects, most investors should let this opportunity sail on by, sticking instead with unlevered players developing unique content, like The New York Times.