Description

You can find a PDF version here - the tables likely won't post correctly below:  https://dl.dropboxusercontent.com/u/13999385/MNI%20write-up.pdf

The McClatchy Company is a newspaper publisher, with the largest properties being the  Fort Worth Star-Telegram, The Sacramento Bee, The Kansas City Star, the Miami Herald, The Charlotte Observer and The (Raleigh) News & Observer.  The company trades at a 22% 2014 FCF yield, has significant off balance sheet hidden assets and is seeing improving overall trends in its business, creating a stable to growing FCF base on a go forward basis.  

With upside of 50%, several catalysts exist which could drive the company closer to fair value.  The company owns 15% of CareerBuilder, and 25.6% of Classified Ventures - which operates Cars.com and Apartments.com.  Apartments.com was just sold on Monday to CoStar group for $585 million, or 20x 2013 EBITDA.  Apartments.com has about 30% EBITDA margins, vs. Cars.com closer to 20%, however the market position of Cars.com is better.  Applying a similar 20x multiple to the remainder of Classified Ventures, implies additional value of $441 million, or $5.11 / share (vs. a share price of $5.74).  The value of the 15% stake in CareerBuilder using a 9x trailing EBITDA multiple is about $211 million, or $2.45 / share.  Both of these assets throw off significant dividends to their shareholders, with a total of $42 million in 2013, up xx% from 2012.  With the divestiture of Apartments.com, the company should see a slightly lower runrate of minority distribution cash flow in 2014.  

Underlying all of this, is the stabilization of what has been a falling FCF / share metric for years.  FCF should grow from $1.37 per share (after Pension) in 2013 to $1.27 in 2015, and $1.40 in 2015 - through a combination of both improvements above and below the EBITDA line.  

1. Digital, Marketing Services and Circulation now make up 60% of revenue, slowing revenue declines.  Core print advertising is modeled to continue to decline at 8% in 2014 – but is a smaller % of the total
2. Effective cost cutting, combined with newsprint pricing declines & volume declines are reducing the cost base
3. Declining cap ex budgets - should move the company towards maintenance capex level of $20 million / yr
4. Pension contributions should decline going forward.  They are contributing $25 million in 2014 and $23 million in 2015.  For each 1% change in interest rates, the pension deficit falls by $225 million.  From 12/31/2012 to 12/31/2013 it fell from $587 to $303.  It could be all but gone in the next 12 months from an accounting point of view.
5. Debt pay down —> With free cash flow of ~$1.30 / share, MNI will pay down $29 million of debt in 2014 that comes due, followed by additional buybacks of bond issuances in the open market.  The company will likely use the $91 million after tax proceeds of the recent apartments.com sale to pay down debt.  Highest yielding bonds are 9% senior notes due 2022.
6. Additional rationalization of off balance sheet digital assets – company is open to monetizing at the right price

Business Outlook

The company now generates upwards of 60% of revenue, from non traditional sources (ie: not print advertising).  These growing segments include circulation revenues, digital only advertising and marketing services.

On the advertising front, the company has been seen growth in low double digits for pure digital advertising, unbundled from print products.  Pure digital ad is growing as a % of revenue, and now represents 17% of traditional revenue, up 12% y/y.  The company is seeing growth in retail and nat'l display as well as with 'audience extension networks’, where they use their local sales force to sell local premium inventory for Yahoo. The company is also seeing modest growth from digital marketing solutions - where they are acting as feet on the street selling digital advertising solutions to SMBs - similar to a ReachLocal, Web.com. This business is growing in the low single digit range (2.2% in 2013).  All of this is short of offsetting traditional print declines, which were down 11% in 2013, but should moderate in 2014 off easier comps.   Q4 was down ~8-9% on the print only side.  The company has guided for digital only advertising to be up low double digits in 2014, with marketing services up low single digits.  The wild card is how print advertising performs.  We are modeling declines of 8% for the full year 2014. 

Circulation now represents 30% of total revenue.  Circulation revenue increased 3.3% in Q4 and 5.4% in 2013, and should continue to grow in 2014, as changes to the bundled digital offering anniversary.  In late 2012, the company implemented its ‘Plus” bundled digital subscriptions, which effectively were a price increase, where print subscribers were given digital access unless they opted out.  This flex program added over $31 million in incremental revenues in 2013, 50% higher than their expectation.  The pure digital product, with about 66k subscribers, is a metered pay wall with 15 free articles / month.  When implemented, the company saw a brief dip in traffic, followed by continued growth in average daily uniques.  They are looking at selected price increases or other ways to further increase digital circulation revenues.   

MNI continues to be effective at cost cutting, expecting further declines in newsprint and personnel costs in 2014.  The company has targeted areas that do not affect the reporting product, mainly through optimizing technology, regionalizing and centralizing business, production consolidation, outsourcing selected printing markets, while insourcing and scaling other markets to gain efficiencies.   Currently, the company prints 14 newspapers at outside facilities or other MNI facilities, and where it hasn't made sense to outsource production, they have scaled and in-sourced through printing other companies newspapers in 9 markets.  A recent example was an agreement with the Dallas Morning News (owned by AH Belo) to begin printing the Fort Worth Star-Telegram, and in January announced they were buying the Dow Jones production facility in Charlotte North Carolina, and will be printing both the Charlotte Observer (MNI) and Dow Jones (NWS) publications at the facility.  

The combination of moderating revenue declines, combined with continued cost cutting is working to stabilize EBITDA.  Combine this, with debt paydown resulting in lower interest expense, lower capex and growing cash distributions from equity investments (adjusted for apartments.com sale), and the company can see stable Free Cash Flow grow going forward.  2014 declines from 2013, largely from the impact of lower cash distributions from Classified Ventures.

The company continues to pay down debt, and is now levered @ 5.3x excluding equity distributions, and 4.6x including distributions.  Covenant leverage is currently at 4.8x, vs. total indenture leverage limits of 6.0x.   They have over $80 million of cash on the balance sheet, will receive $91 million after tax from the sale of apartments.com.  Some of that will be used to retire $29 million of debt due in November, 2014, while another portion will be allocated to buying back bonds in the open market.  None of the debt issuances are currently callable, but they will be buying bonds in the open market when attractive. The $900 mm notes due 2022 have a carve out for repayment of the 2014 and 2017 notes – which will likely be the target of deleveraging near term.  The average yield is currently 7.9%.  Most maturities have now been extended almost 10 yrs, with $251 mm due in 2017.  

The company has a pension fund, that is currently underfunded by $303 million.  This is down from $588 the previous year and a 1% increase in LT rates reduces the liability by $225 mm.  For the IRS, it is currently unfunded by less than $128 mm (this is a y/e 2012 # adjusted for contributions, but will come down with rising rates for 2013), which will not respond as quickly to falling interest rates as it looks back further on its discount rate than GAAP.   The company has already paid $25 million of contributions for 2014 and estimates $23 million in 2013. 

Valuation

The company is extremely cheap when looking at it on Free Cash Flow yield of 22%.  We have also looked at a sum of the parts valuation, and target a FCF yield of 15%.  

Catalysts

The company can benefit from some soft catalysts throughout 2014, most of which are just related to improving fundamentals of the business.

• Top line declines should moderate as print becomes an increasingly smaller % of revenues (<40%).  Print declines were exacerbated in some of MNI’s markets in prior years because of deeper macro economic challenges – that are beginning to reverse – specifically Miami and Sacramento
• FCF stabilization throughout the year
• Continued debt paydown reducing interest expense
• Monetization of other non-core minority interests
• Potentially some sell side exposure – but unlikely given secularly declining group

Risks

• Low visibility into the print advertising environment currently – if declines are larger, could reduce some of the upside in the stock
• Highly levered balance sheet-  small changes in forecasts have outsized impacts on the equity valuation
• Print business is in secular decline – if the company cannot offset costs to keep up with a declining top line, EBITDA will continue to fall, and the company may encroach upon debt covenants.
• Sum of the parts overvalues minority investments.  (I do not actually put any EV value on a handful of other investments that have distributions of ~$5 mm / year.)  

Catalyst