AH Belo was previously written up in June, 2010 by styx1003, with a similar thesis to where we are today.   I will not go through the business in too much detail, as styx does a good job walking through it. 

Overview

AH Belo is the publisher of three local daily papers – the Dallas Morning News, The Providence Journal and the Press-Enterprise (Riverside, CA).  Today, roughly 61% of revenues are from advertising, 30% from circulation and about 9% from businesses such as print and distribution of our of region newspapers.  The business obviously has strong secular headwinds, which I do not anticipate will abate. 

With that backdrop, the company is being valued like it will soon go out of business.  AHC is trading at 1.3x this years’ EBITDA, with a 42% FCF yield (taking into account pension liabilities, and backing out cash).   The company has no debt, $61 million in cash at year end, and a portfolio of real estate that is for sale.  I have assumed that the low end of the after-tax sale expectations of the company are met (range given is $21-$33 million), and have capitalized the NPV of the future unfunded pension payments.   Belo also pays a 4% dividend, which it reinstated in June 2011.  Assuming a discount to peers (GCI, NYT, MNI, MEG), given the size and liquidity of the company still yields upside of between 50-100% from current levels.

Business Trends

While advertising remains troubled, especially in California and Providence, circulation revenue has been more resilient.  While subscriber numbers have been falling at a moderate pace, price increases have offset much of the decline in the base.  At the Dallas Morning New, the monthly average seven day rate is up 15% from 2010 – to $33.95.  The company has obviously been working hard on digital initiatives to offset print declines.  Currently, they are offering free digital to seven day print subscribers, and charging between $9.99 and $16.95 for digital only.  They have yet to break out the digital only subscribers, but have said that by March 2012, almost 50% of print subscribers will have authenticated online.  Belo is rolling out digital products in Riverside & Providence during the first half of 2012, which should offer some help with decelerating both circulation and advertising declines.  For reference, Mon-Fri circulation in Dallas (including the Denton Record-Chronicle) is 405k, Providence is 92k and Press-Enterprise is 122k.  Circulation #s in Dallas on an apples to apples basis around down around 1.8% from 2010-2011, but over 7.8% in Providence and 6.5% in Riverside.

After seeing decelerating revenue declines in 2010 and in Q1 2011, Q2 and Q3 2012 saw declines in advertising reaccelerate to down 9% and 12.5% respectively.  The company blamed several factors for the weakening environment, including a continued difficult southern California market where unemployment remains almost 5% above the national average, a continued weak environment in Providence and an ‘aberrational’ month of September in Dallas.  They commented that while the local ad market in Dallas remained pretty consistent; the national business was hurt by several financial institutions and pharmaceutical companies who had large commitments in Q3 2010, but didn’t repeat them in Q3 2011.  Since September, the company commented that they have seen some improvement throughout October.  The company announced in January that advertising declines had attenuated in all three markets and the business was overall actually flat y/y in November.  They guided that for the full 4^th quarter, revenue would be down between 4 and 5% (from 8% in Q3).

The company has been trying to diversify its revenue streams to offset advertising declines.  They have increased the portfolio of print products offered to advertisers, including condensed news publications delivered to homes of non subscribers in key zip codes, and various other niche products targeted at specific demographics including free products as well as Spanish papers.  AHC further diversified its revenue mix through contract printing and distribution, which is made up primarily by commercial printing services for national newspapers that require regional printing such as the Wall Street Journal, New York Times or USA Today.  On top of that, they also they also have corresponding home delivery contracts in its markets.

Expenses:  The Company has been very aggressive targeting cost cuts to offset revenue declines.  They have reduced headcount in the past 5 years from over 4000 to 2300.   Between 2006 and 2010, total opex decreased by 42%and salary and employee expenses dropped by 40%.  In addition, cuts were made around personnel, automation, and production in Q2-Q4, as revenue declines accelerated.  The company will see the full year benefit of these cuts in 2012.  Newsprint costs have been going in the wrong direction, as mill closures and capacity reductions have driven up prices.  The company has also reorganized its sales team into end market verticals, and downsized the sales team considerably.

Real Estate:  AHC owns a significant real estate portfolio which it is in the process of monetizing.  All of the current properties are owned outright, without any mortgages. In addition, certain properties that were once jointly owned with AHC sister company, Belo Corp. in an entity called Belo Investment, LLC were divided at the beginning of 2012.  The company has commented that it will be patient, and not sell its assets at fire sale prices.  Between 2010-2011, about $10 million of proceeds were realized from non-core sales.  The previous sales were on the market for roughly 20 months.  The assets currently for sale are estimated to have market values of between $23 and $37 million, and if sold would generate pre-tax proceeds of $21 t o $33 million.  The properties are in all 3 markets the company operates.  In addition, for certain facilities not for sale, the company is looking at potential subleasing opportunities as well as sale-leaseback transactions.  

AHC also owns a 3.3% ownership stake in Classified Ventures, which is primarily made up of Car.com and Apartments.com.  It receives a dividend annually, ranging from $2 to $3 million.  This is also a non-core asset, although the company is not currently looking to sell it.  Putting an 8x multiple on the cash dividend offers about $1 / share in value.

Pension:  AHC came to an agreement with Belo Corp. in October, 2010 to split the shared retirement pension plan into separately sponsored plans effective January, 2011.  After significant payments during 2011 - $25 million mandatory + an additional $30 million contribution, the payments will ramp down over the next few years.  The company at year end (prior to an updated 3^rd party actuarial valuation) will be unfunded by roughly $95 million.  The schedule of mandatory payments through 2016 has an NPV of $46 million, with a 2012 contribution of $19 million.  The company has left open the possibility of an additional $10 million voluntary contribution which will reduce future payments.  

Cash Flow:  AHC generated $1.67 in FCF before pension contributions in 2011, however because of the $30 million voluntary contribution, FCF post contributions was negative.  In 2012, I am modeling $2.11 in pre-contribution FCF and $1.22 in post contribution FCF.   Backing out the almost $3 in cash at year end the company has, in addition to the nominal interest income generated, the FCF yield post pension contribution for 2012 is 42%, rising to 60% in 2013.  The cash flow generative capacity of the business is pretty strong, especially if overall revenue declines attenuate, combined with recognizing cost cuts. The business is not capex intensive, they spend around $10-$12 million / year in capex.  Mandatory contributions to the pension will fall over the next few years and the company pays minimal cash taxes.  

Uses of Cash:  Management has described three uses of excess cash:  1) Pension Contributions 2) Dividends and 3) Buybacks.  While consolidation in the industry is ripe to happen, AHC has essentially stated that they will not be the acquirer.  Mandatory contributions to the pension program will be made first, with 1 additional potential voluntary contribution of $10 million next year.  In addition the company currently is paying out only about 20% of FCF, and has ample room to increase the dividend.  Lastly, the company could buyback stock. Given the liquidity in the name though, this may not be the first choice.  In conjunction with the dividend policy announced in 2011, the Company amended their revolving credit facility to allow for dividends and share repurchases without restriction as long as there is no outstanding balance on the facility.  

Valuation

AHC, while facing secular headwinds that will not abate any time soon, is grossly undervalued.  The company is trading at a price of $5.82, has 0 debt, almost $3 in cash, another $1 in real estate valued conservatively, and another $1 in non-core assets (Classified Ventures), with about $2 in unfunded pension liabilities. 

The levered peers of AHC, trade at EV/EBITDA multiples ranging from 4-8x, including Gannett, McClatchy, Media General and the New York Times.   FCF yields range from 17-20% for these peers.  Granted these companies are larger, and are more liquid.  Applying a haircut to the low end of these comps still implies huge upside to the stock, strictly on a valuation basis.  At a 3.5x 2012 EV/EBITDA multiple, the stock should be trading 75% higher than current levels.  Similarly, applying discounted FCF yields gets a stock price between 40% and 80% higher than current levels based on 2012 metrics. 

Shareholder Value

There are several ways the company can increase shareholder value.  

 - Increase in dividend – Comapny is currently only paying out 20% of FC Fin 2012 – management has substantial ownership and is incentivized to create shareholder value.

 - Share buyback – The change made to the revolver now allows for stock buybacks, although the company has not authorized one currently.

 - Real Estate sale – The assets have been on the market for about 12 months, and the company could realize between $1 and $2 / share in value, which will be distributed back to shareholders in some form

 - ‘Less bad’ results – Just putting up results that show a decleration of revenue declines have been large enough a catalyst to move some peer stocks

 - Cost cuts lead to margin expansion – The company put through cost cuts late in 2011 that will be reflected in numbers for 2012. On top of this, the company’s margins are substantially lower than its peers

 - Revenue declines decelerate due to company initiatives as well as a slowly improving economy. 

- Industry consolidation - This will likely happen, and the company is most likely a seller, not a buyer.  They would look to sell off their Providence or California assets if a buyer offered an acceptable price.  Dallas seems to be the only real 'core' market. 

Risks:

The newspaper business is in secular decline, the rate of which is hard to determine and can make my projections completely wrong.  This will never be a growth company, but the life cycle of the business can be prolonged through effective management, and a cooperative advertising market.

If the economy turns south again, the company will not be able to cut costs at a fast enough pace to offset margin erosion

Newsprint prices can continue to increase

Technological irrelevancy

Actuarial requirements for the pension plan could increase substantially given the low interest rate and low return environment

There are 2 classes of stock – the directors and management control 52% of the voting power, with only 16% of the economic share.  Series A shares have 1 vote /share, Series B have 10 votes / share.

There is not much liquidity in the name, and the market cap is below $150 million.   ADV is only 81,000 shares.  

Limited sell side coverage.  Gabelli covers it, and thats about it. 

Increase in dividend – only paying out 20% of FC Fin 2012 – management has substantial ownership and is incentivized to create shareholder value.

Share buyback – change to revolver allows for buybacks

Real Estate sale – assets have been on the market, and the company could realize between $1 and $2 / share in value, which will be distributed back to shareholders in some form

‘Less bad’ results – newspaper stocks have had large runs, just by showing results that suck less

Cost cuts lead to margin expansion – The company put through cost cuts late in 2011 that will be reflected in numbers for 2012. On top of this, the company’s margins are substantially lower than its peers

Revenue declines decelerate due to company initiatives as well as a slowly improving economy.