I am recommending a short position in Axel Springer AG (SPR GY).  SPR is the largest print publisher in Germany with the leading newspaper – Bild, as well as several other newspaper properties, magazines, an international JV for print in Eastern European countries, as well as a portfolio of digital assets.  Germany has been a laggard in seeing dramatic print declines, as has been seen in the US, and much of the rest of Europe like the UK.  Over the past several years, SPR has been buying up digital properties at an aggressive rate, often taking only majority stakes in the assets.  They have done a solid job managing expenses on the print side, as declines of low single digits in circulation and print have manifested themselves.  Largely, they have been able to keep the top line (fully consolidating digital assets) stable, as print declines are offset by their M&A spree. 

There are two tenants to the short thesis: 

1)  The secular decline of print will accelerate, which is not forecast into street estimates, and this will disproportionately impact 100% owned German print EBITDA – where ad sales have 80+% EBITDA flow through.  Consensus is actually forecasting that both circulation and advertising declines will remain flat to improve over the next few years, from 3-4% declines in 2012. 

2)  The acquisition strategy that the company has embarked upon, while necessary, has been expensive and is being valued at a premium to comparable digital assets.  While on a reported basis, almost 45% of company EBITDA is from digital.  However, on a proportionate basis, that number is closer to 35%.  The company seems to focus its M&A strategy only improving on its ‘reported’ Revenues & EBITDA, and largely ignores the minority interest impact on EPS.  Also, limiting the impact of minority interest, is that much of the leverage sits on the balance sheets of the majority owned companies and JV partnerships – so minority interest paid out is much less, EPS is higher than it would otherwise be, despite consolidating all the EBITDA.  The company commented during its Q3 call that they finance their acquisitions within their digital classified JV with 4x leverage before putting in equity.  

Some Background:

• From 2003-2012, print ad market share in Germany has fallen from 58% to 45% (31% newspaper & 13% magazine), while in the UK it has fallen from 55% to 25% (19% newspaper, 6% magazine) over the same time period
  • German internet advertising is behind in ad market share gains – representing only 22% of total ad revenues.  TV represents 24%
  • UK internet ad spend represents 37%, with TV representing 26%. 

• National Print
  • Bild – the most popular and influential newspaper in Germany is a tabloid similar to the NY Post w national circulation and more credibility than the Post.  Sold on a newsstand basis
    • Circulation is 3 mm, with 12 mm readership – reaches more people than the most popular German TV show
    • Bild am Sonntag (on Sunday) à The two make up ~70% of circulation revenues in national newspaper division
    • SPR increased Bild prices from .60 to .70 in Q2 2011 for about 40% of the population (causing a drop of 6.5% in circulation), in November 2012 for 16% of the population giving the company a tailwind for circulation comps in 1H 2012 and into 2013.  The company has discussed its intent to increase prices on the 44% that it has not done in 2H 2013.  They have said that they don’t see impediments for future price increases. 
  • Die Welt à higher quality newspaper, sold primarily on subscription basis
  • Regional newspapers à Berliner Morgenpost, Hamburger Abendblatt
  • National print revs are split 51%/46%/3% in circulation, advertising and other
    • Digital versions of the newspaper are not included in this segment – instead are included in digital.
  • SPR has been slow to move to a revenue generating digital model, as has the entire German market.  At its analyst day in December, they laid out their plans for 2013 regarding pay walls.  
    • A metered pay wall for Welt.de was launched in mid-December, and allows access to 20 articles per month, with the option to purchase unlimited access for €6.99 for web and smartphones, and €12.99 per month for smartphones and tablets. 
      • A few problems or concerns with deploying this model à access via search engines will remain unlimited and free.  Springer has said that 50% of Welt.de users do not use more than 20 articles per month.  Lastly – the company will need to protect its 4.9 mm monthly active users and the attraction to advertisers. 
      • Bild will deploy a freemium model to its 10mm current monthly users.  It will launch premium content, which it will sell access to late in 2013.  This content will include short VoD clips of Bundesliga games.  Little else has been communicated about the strategy here
      • The company has both iOS and Android apps for their print properties- but has had limited traction in selling them – describing the revenue as irrelevant. 
  • Expenses à The company has done a pretty good job of cutting costs within their domestic newspaper  segment, but given the high flow through of ad revenues, there is only so much they can do.  Since 2008, Revenue has declined by €144 mm, while EBITDA has dropped €85 mm, implying they have been able to cut .40 of costs for every $1 of revenue.  However, since 2009 they have been much more aggressive controlling costs.  They have done several things including consolidating editorial offices, cutting headcount and newsprint costs have obviously dropped with circulation.  However, EBITDA contraction will continue, and the opportunity to cut fixed costs will diminish over time.  Current margins of 23% are also significantly higher than other newspaper publishers in the rest of Europe
  • Q3 saw trends weaken, albeit against difficult comps in 2011.  Ad revs were down 12%, with circulation down 4%. 
• National Magazines
  • The magazine segment is composed of many speciatlty magazines, many attached to the Bild brand:  Autobild, ComputerBild, SportBild, Bildd der Frau in addition to some other titles and various TV guides. 
    • Largest competition in magazine segment is from Gruner & Jahr & Bauer Media
  • SPR has done a tremendous job over the past 4 years cutting costs out of this business segment.  While revenues have declined €141 million, costs have actually decreased €156 mm.   Much of this has been from closing down underperforming titles, and while margins currently are near peak levels, the rapid declines they are seeing in the ad revenue is beginning to eclipse any additional cost cutting they can do.  There may be some additional editorial cost cutting to do, however variable  costs consisting of paper are only about 15% of the expense base. 
  • Q3 saw advertising revenues decline 8%, and circulation down 5%. 

International Print

• The international print business has been a huge lag on group results over the past few years.  The company has continue to cut costs in the face of continued weakness on the revenue side, however  EBITDA  margins have continued to contract.  There should be some rebound in Q4 as higher restructuring costs were included in Q3 results. 
• Much of the international print business is included in a 50/50 Joint Venture w Swiss Ringier AG in Eastern Europe – Serbia, Slovakia and Czech Republic, which SPR fully consolidates.  In addition, the company has wholly owned subsidiaries in Switzerland, Hungary & Russia.
  • EBITDA Breakdown
    • ~55% Ringier JV
    • 20% Hungary
    • 20% Switzerland
  • 25% holding in DoganTV, Turkish Media Group à book value of €352mm.  Large uncertainty in the asset around a tax dispute with the Turkish government

• Internet Portfolio  
  • The internet portfolio is broken down into 3 broader segments – each with various subsidiaries and many have only fractional ownership of the subsidiaries
    • Axel Springer Digital Classifieds
      • Announced on 3/6/2012 that they were selling General Atlantic Partners a 30% stake in this business for an implied valuation of €1.25bn and a valuation of 10-11x EBITDA on the three assets contributed at the time – SeLoger, Immonet & Stepstone.  The rationale for doing so, was a) to have a partner that would have M&A and digital asset experience b) To have more capacity for a large transaction and c) to place a valuation on its existing assets.  The JV has €460 mm of debt, that is issued by SPR and pays a ‘market’ interest rate.
      • Assets include: 
        • SeLoger – Largest property listing site in France.  Originally acquired for a rich multiple of about 15x EBITDA.
        • Immonet – Leading German property listing site
        • Immoweb.be – Acquired 80% of the shares post the JV - leading Belgian online property portal for 12x EBITDA
        • Stepstone – leading online recruitment site in Europe, competes w Monster
        • TotalJobs – Acquired post JV – leading UK digital jobs board
        • Meinestadt.de – Acquired post the JV - German regional digital classified business in 11,000 towns (mostly jobs)
  • Performance Marketing
    • This segment consists mainly of zanox – the largest affiliate network in Europe.  The direct comp to this business is publicly traded tradedoubler, traded in Sweden.  This is largely a crappy, commoditized, low margin business with intense price competition.  Tradedoubler has been lowering prices aggressively, while still losing market share to Zanox.  Growth has been sequentially slowing, with margins falling.  In Q3 – the business grew 4.6% on the top line but EBITDA contracted 14%. 
  • Content Portals & other digital media
    • The largest segment in this business is the online business of the German newspapers. 
    • AuFeminin – the largest female content portal based in France
    • Idealo – a price comparison site
    • Onet – the largest Polish portal.  The company acquired 75% of this through their Ringier JV (50% owned)

• While many of these businesses, especially in the Digital Classified segment are high quality, most were acquired for dilutive multiples and are facing growth headwinds.  The real estate portals especially – stand out as high quality assets with attractive margins and growth prospects.  That being said, while SeLoger has been putting up solid numbers, they commented at the SPR analyst day in December that the macro environment was catching up to them.  With French housing market resales down 20% in 2012 to a low of 700k, they believe the 2013 environment will remain difficult.  While they expect to see continued growth, the business if far more penetrated now (>80% of all real estate professionals, builders & developers pay SeLoger now) than it was in 2008/9, and they should grow faster than the 3% they put up in 2009. 
• The GA JV has significant exposure (about 1/3 of EBITDA) related to traditional job boards – StepStone & TotalJobs.  Monster just reported continued revenue declines in its int’l segment (falling 15% in Q4), citing Eurpoean macro weakness.  While Stepstone has remained on a growth path, partly due to market share gains vs. Monster, it remains questionable whether they can continue to remain on that trajectory.  Comments out of Europe’s largest HR exhibition last September, suggested that various companies such as Stepstone, Monster & Careerbuilder saw weakening environment in Q4, and expressed concerns about the German market in particular in 2013.  Also - while the company negates the competitiveness of companies like LinkedIn or Xing in Germany – citing a different culture and the trust factor of looking for or posting jobs on Stepstone, its seems very narrow sighted.  There may be a lag (similar to online adoption) to utilizing tools such as Linked-In – but it does appear that’s the way that large corporations see their recruiting moving. 
• Other businesses like Zanox & Idealo operate with troubled business models.  For zanox , affiliate marketing is secularly challenged, competitively intense and R&D heavy.  It also has risks from DoNotTrack initiatives in the EU as well as e-privacy directives requiring website owners to seek ‘explicit consent’ from users before they use cookies to track behavior.  The company has announced that they are replacing the CEO of Zanox in 2013, when his contract is up.  Idealo – which is a European comparison shopping site faces very low barriers to entry, significant cyclicality, competition from the likes of Google and the potential for margins to get squeezed.
• One of the biggest issues surrounding the company as mentioned earlier, is the obsessive focus on top line and EBITDA growth rates, which are inclusive of all acquisitions.  The company lacks any transparency within its digital segment so trying to figure out underlying growth rates in their internet businesses is next to impossible. 
• This company needs to be valued on a proportionate sum of the parts basis – as looking at aggregate multiples ascribes way too much value to the digital business given the partial ownership and the drastic differential in the multiples of the underlying assets. 
• The sell side, has ascribed enormous multiples to some of the internet properties:
  • Between 10-14x for Stepstone & Total Jobs, while Monster trades at 4x
  • Idealo – comparison shopping at multiples between 8-14x
  • Zanox - affiliate marketing at 7.5x while Tradedoubler at <6x
  • Onet which saw essentially flat revenue growth in 2012 at 10.5x
  • AuFeminin which is publicly traded and has a public multiple of 6.5x, is given a value between 9-12x
• While the bull argument has been that digital growth (or acquisition) continues to make up for print losses – over the last three quarters, overall digital growth has decelerated.  The digital transformation story will run out of air, when print declines outweigh digital gains.  

• • On a standalone basis, assuming the print declines are encompassed in the low multiple ascribed to the print business (which I would disagree with), simply putting more appropriate valuations on overvalued digital assets, would offer 18% downside to the stock price.  However, layer upon that – the secular declines of the print business, and the stock should be materially lower. 
  • This is not a one quarter story – as it is almost impossible to predict when the steeper declines in the print business will take hold.  However, trading at a multiple of 7x 2013 EBITDA for a business that has 65% of its EBITDA tied to print, in a country where print has not yet seen the massive secular declines which are almost inevitable, the stock is overvalued. 
  • The stock has rallied on hopes of a big transaction that will transform the company further away from being a print business.  It was reported that the company was looking at acquiring Scout – the digital classified business of Deutsche Telekom.  However, the DT’s CEO commented today that they were not talking to Springer about selling the business to them.  The sale was rumored to be around €1.5 bn, which would push SPR to their self imposed leverage limit.  The stock popped from €32 to €34 the day the report of a potential deal emerged in mid January, but has only moved higher. 
  • It was also rumored that SPR would be interested in buying KKR/Permira’s stake in ProSieben – the largest broadcaster in Germany – however this was also disproved when KKR/Permira sold their entire preferred shares (with no votes) and committed to converting all preferred shares to voting common shares. 
  • Risks
    • Quarters are lumpy, and guidance is vague so there is some volatility around quarterly calls.  They report next week, and have guided that Q4 ad revenues will be down >5%, while my expectations for digital is further deceleration
    • The company has done a solid job cutting costs in light of the secularly declining business – and could continue to find ways to prop up margins
    • The stock has a 4.7% dividend yield – which is secure. 
    • It may take a few quarters to see the thesis around secularly accelerating declines to play out
    • Large M&A of digital assets may transform the company further away from their publishing business