Description

Positives

1 Very strong newspaper monopoly: ECP controls the Indianapolis and Phoenix markets with approximately 50% penetration in each market. This represents 88% of their revenue and they are essentially the only daily papers in both markets.

2 Free cash flow: The franchise gives them the ability to generate very high and stable free cash flows. This equates to 16% of revenues before dividends.

3 Balance sheet flexibility: Interest coverage is 18x; they have the flexibility to leverage through share buybacks or new media investments.

4 Share Buybacks: The Company has retired 25% of their shares outstanding in the last three years. In theory the company could buy back all the shares at the current market price by borrowing at 10% and still have EBITDA interest coverage of more than 2x.

5 Internet investments: They own 23% of Brass Ring (amongst other things) in conjunction with The Washington Post and The Tribune Company. It is expected to go public this year with an approximate total value of $800m (their share $185m). It is currently a drag on EBITDA of around 18m.

Negatives

1 Newsprint prices: Every $50 dollars per ton increase will decrease earnings by 7%. Recent consolidation in the Newsprint industry has increased the risk of rising prices. (Currently newsprint is $520 per ton)

2 Macro environment: Advertising volumes are cyclical. Advertising makes up 80% of revenues. These remain strong but we are late in the economic cycle.

3 Internet: This is the overriding concern about the long tern viability of newspapers. I believe that circulation will not be the major concern but classified advertising is better suited to the web. The paper must become the local portal for their regions.

4 Family Ownership: The Company is controlled by a foundation. This does not seem to have impaired their economic performance (the company has above average margins), but it cannot be taken over.

Valuation:

The company sells for 5.1x this years EBITDA and 4.4x times next year, if you adjust for the values in Brass Ring it sells for 4.03x and 3.4x for ’01. This is an extreme value for such a high quality franchise. Private market values are around 12x EBITDA for small regional papers even with the current Internet cloud, ECP is selling for 1/3 of its private market value.
On a P/E basis it trades at 10.5x adjusting for Brass Ring. These valuations are lower than any time in the past 10 years, including times of recession.
This stock should be selling in line with the pure newspaper group at about 8x EBITDA, which equates to $53 per share.

Catalyst