Description

Lee Enterprises is a newspaper publishing company in 50 mid to small markets in 22 states including Madison, WI, Billings, MT, DAvenport, IA and Lincoln, NE.  In many markets, the company lacks any print competition, which obviously does not shelter it from secular trends, but does benefit the company in the transition from print to digital.  The company reaches 1 mm households daily, 1.3 mm on Sunday and 25 mm unique digital visitors monthly.  The company has been all but left for dead, and is now trading with a 2016 (untaxed) FCF Yield of 99%, a taxed 2016 P/E of 2.8x and and EV/EBITDA of 4.2x.   The company has a $134 million NOL which should shield it from cash taxes until at least 2019.  However, between now and then, the company will bring leverage south of 2.5x, as it continues to use every $ of FCF to pay down debt.  Incidentally, the company also has by far the best EBITDA margins in the industry and is showing improving FCF trends.  They have successfully managed to slow FCF declines to low single digits over the past several years, and can actually begin to grow it given large debt repayments, continued cost cutting which is offsetting continued Revenue declines.  Growing revenue streams including digital and subscription are now ½ of total revenue, which is working to slow the overall top line impact of print advertising revenue declines.

The company has done a decent job of diversifying its revenue base, and now gets 63% of revenue from advertising, 30% from subscriptions and 7% from digital services, commercial printing and other services.  Of that 63% advertising revenue - about 80% of that is from local advertisers rather than national and about 20% of it is digital.  Both circulation and digital services and advertising are growing, working to offset the 9-10% annual declines in print advertising revenue.  Digital for LEE is a combination of combined print and digital advertising campaigns, and 2 independent operations. Big Pitch helps medium sized advertisers to formulate combined print and digital advertising campaigns. And the larger TownNews provides digital infrastructure and digital publishing services for nearly 1,600 daily and weekly newspapers, along with universities, television stations and niche publications.

Additionally, the company has done a solid job of cutting costs to offset revenue declines, and has come close to keeping FCF constant despite a falling top line for the past 3 years.  In Q1 2016 ended 12/27/2015 (9/30 FYE), cash costs fell by 3.1% and the company has guided to a further 3.5%-4% decline for the full FYE 2017.  EBITDA is a decent proxy for Unlevered FCF, given a $134 million NOL, capital spending at 2% of revenue and minimal mandatory pension contributions.  Interest expense continues to fall, as the company is buying back both its 9.5% 1st lien notes in the open market at a discount, as well as paying down its 1st lien Term Loan.  Average interest cost is currently over 9%, largely due to a 2nd Lien Term Loan issued at 12%, but which can only be repaid minimally at present with excess cash flow from its Pulitzer assets (acquired back in 2005), if the prepayment is accepted by noteholders.  If the company sells real estate tied to these assets (which it is in the process of doing), it mandatorily pays down these notes.  Alternatively, this paydown provision expires in March 2017 - and the company can move to repay or refinance those notes more aggressively.   The company’s goal before returning capital to shareholders is to get leverage below 3.25x, which it should be able to do by the end of FY 2017 (ended 9/30/2017).  The company has used all cash to pay down debt annually, and can continue delever at about 0.5x / year.  Debt covenants preclude the company from declaring dividends until leverage is less than 3.25x.  There are warrants tied to the 2nd lien notes for 6 million shares, or about 10% of the shares, however given the strike price is $4.19, it’s obviously anti-dilutive at this price. The company does not have any significant debt maturities until December 2018 through 2022, due to a 2014 refinancing.

The business has not seen a significant deceleration in the decline of print advertising, which has been averaging around 9-10% annually.  The positive offsets now represent 50% of revenue and include digital advertising, subscriptions, digital services, commercial printing and distribution deals, which the company believes it can continue to grow.  Q1 2015/6 did see an overall revenue decline of 5%, with total advertising revenue falling 8.8%, which implies print declines of 12%, a deterioration from last year.  The company cited continued weakness in classifieds, which dropped 13.4% as automotive, real estate and retail continued its secular decline specifically.   Management did offer some optimistic commentary that trends in December and January had improved from the beginning of the quarter and were trending back towards historical declines.  Recent revenue declines in the 3-4% range, with  print declines of 9-10%, while digital advertising revenues have been increasing around 7%.  Subscription / circulation revenues have been growing - as the company sells its combined digital/print ‘all access’ product to subscribers.  Normalized cash costs (excluding severance and debt repayment expenses) declined 7.8% last year, exceeding the company’s guidance of 5.5-6% declined 3.1% last year, and the company has guided to reducing cash costs an additional 3.5-4% in FY 2016.

The company has pointed out for the past year that they are being impacted by the energy downturn in classifieds in several of their markets where the local economy has large exposure to energy - namely Casper, Wyoming, Bismarck, ND Rapid City, IA and to a smaller degree Billings, Montana.  The company is beginning to cycle through those difficult comparisons, but worth noting that there is some financial impact embedded in the numbers.  

The company’s pension has a surplus of $13.4 mm - with the total liability as of 9/27/2015 of $52.5 million.  The company paid $3.4 m in 2015 and will pay $5.8 m in 2016.

Additional upside

• The company has initiated a review of its real estate portfolio - which has an un depreciated value of $ 200 mm.  While the company has selectively been selling real estate where it does not have operations - now it is reviewing its full real estate portfolio to see if sale/leasebacks or other transactions might make sense, given the company has significantly downsized and not utilizing much of the owned space.  

• While not large - the company does have a $5 million share buyback authorization, which it was historically reluctant to use, but given the stock is trading at such a depressed level, is now revisiting this.  

• Publishing is a consolidating industry with several recent transactions.  A recent article in the WSJ walks through recent consolidation and the more active acquirers including New Media Investment Group, Gannett and Berkshire Hathaway Media Group.  The WSJ cites 70 daily newspapers changing hands in 27 transactions totaling $827 million in 2015.  New Media, which was formed out of the ashes of bankrupt Gatehouse Media, has acquired more than 100 newspapers for $637.5 million over the past two years.  Gannett bought Journal Media and its 15 papers with 615k circulation for $215 million in 2015.  The scale benefits in this secular declining industry are evident, making LEE a highly attractive acquisition target.  

Valuation

The company trades at a massive discount to the overall industry on almost every metric.  If the company had some reversion to the mean, the stock could easily triple.  As the company continues to transfer value to equity holders through debt paydown, rising FCF, the value should become apparent.  The stock is not followed by the sell side, and has a minimal market cap at this point, making it difficult to invest in by larger funds.  There is not a concentrated shareholding - with 3 funds owning slightly more than 5% each.  

While there is a wide range of FCF yields that the sector trades at, the average is 17%, with the average EV/EBITDA at 6.0x.  While the leverage in the industry, excluding MNI is lower than LEE, the margin profile of the industry is drastically worse than LEE.  LEE’s margins, are more than double the average EBITDA margin of the industry.  Among other things, this stems from more rigorous historical cost cutting, and a smaller unionized labor force given the smaller market footprint.  If the stock was to even trade at a 25% FCF yield - which would still be relatively high, - the stock would be up almost 300%.  Similarly, if it were to trade at an average EV/EBITDA multiple the stock would be almost 400% higher.

Catalysts

• Continued debt paydown, open market purchases at a discount to face

• Real estate sales with proceeds going towards debt paydown

• Reaching target leverage sooner - initiation of a dividend

• Sector M&A

Risks

• Continued acceleration in rate of print declines not being offset by digital/subscription increases.

• Delisting b/c of market cap limitations?

Catalyst

• Continued debt paydown, open market purchases at a discount to face value

• Real estate sales with proceeds going towards debt paydown

• Reaching target leverage sooner - initiation of a dividend

• Sector M&A