Description

One of the cheapest large cap global media companies can be found hidden in a holding company, called Groupe Bruxelles Lambert (“GBL”), listed on the Brussels Exchange. GBL holds positions in Total SA, Suez, Imerys Group, all of which trade publicly on the Paris Exchange. The fourth holding, Bertelsmann, is a private company, 75% owned by the Mohn family in Germany. By going long Groupe Bruxelle Lambert (1 unit GBL BB) in Brussels and shorting the publicly traded pieces of Total SA (0.17 units FP FP), and of Suez (0.678 units SZE FP), and Imerys Group (0.12 unit of NK FP) in Paris, an investor can take a position in Bertelsmann stub. What makes the investment so compelling is the low valuation of this collection of world class media assets. Bertelsmann is grouped into six divisions: RTL Group, Direct Group, Bertelsmann Music Group, Gruner + Jahr, Random House, and Arvato. The company generated €17.0 billion in revenues and operating earnings of €1.4 billion in 2004. The company reports its financial statements in accordance with IFRS accounting standards and offers disclosure similar to publicly reported companies.

Thesis and Valuation:
I recently visited the management of Bertelsmann at their headquarters in Gutersloh, Germany. We went over the outlook and opportunities for each group division and finished by detailing overall strategy. The implied valuation is approximately 0.8 times 2006 revenues, 6.1 times 2006 EBITDA, and 8.7 times 2006 operating income. This implied private market value is a substantial discount to the large cap media public market valuations. The biggest contributor to Bertelsmann is the RTL Group, which represent its television and radio holdings in Germany, France, UK, Spain, the Benelux, and Eastern Europe. The company’s strategy is to create larger station groups increasing regional market share and to invest in digital television, starting in the UK, Europe’s largest advertising market. The Direct Group is a book membership club with 32.0 million worldwide members. The division generates over €2.0 billion but less than €100mm EBIT. Bertelsmann is working to improve margins and grow in Eastern Europe and China. Bertelsmann Music Group has improved its operating earnings despite the difficulties of the global music industry. It created a 50/50 joint venture with Sony Music in the recorded music catalog business generating greater scale in recording and distribution. Together they are the second largest music company in the industry. Further cost cuts and a reduction in the artist roster from 150 to 60 will improve margins in 2005. Gruner + Jahr is Europe’s largest magazine group with major magazine titles such as GEO, Mens Health, and Tele 2 Semaines (television guides in France). Bertelsmann is targeting 10% return on sales and increased revenues through small acquisitions and portfolio title reviews. Random House is the world class book publisher. The focus of this group is to continue to take out more costs and expand into Asia. Finally, Arvato is a company which acts as an outsourcer to other companies in need of Bertelsmann’s core competencies in IT and distribution. For example, Lufthansa has outsourced all aspects of its frequent flyer program to Bertelsmann. This unit generated return on sales of 8.3% with outsourced clients representing approximately 80% of the revenues of the unit.

Bertelsmann has been restructuring and positioning for the last five years. Each year has been an improvement over the prior year. The company has a strong balance sheet, having paid down most of its straight debt, leaving it with pension provisions and profit participation certificates (PPC) as its only liabilities. As a result, Bertelsmann has approximately €2.0 billion to €3.0 billion in debt capacity to maintain an investment grade rating and to make small-to-mid size acquisitions enhancing its portfolio of businesses.

Catalyst

Groupe Bruxelle Lambert has the right to take its Bertelsmann stake public through an initial public offering beginning in May 2006. If this were to occur, GBL would then hold only publicly traded equities making valuation of the group much simpler. It would also close the valuation gap between the implied valuation and its global media comps. Taken all together, Bertelsmann has the combined elements of a low valuation, a restructuring, and an exit strategy making it a compelling investment.