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SORC has been a great short idea that has significantly changed its economic model and could easily double from current levels.  I have a feeling I will get a low rating on this one but am looking forward to the discussion thread.

SORC recently announced that they were buying the Enthusiast Media (EM)  magazine titles from Primedia last month.  They were the high bidder in an incredibly competitive process, and by default they overpaid, probably by roughly the amount that the stock has dropped since the announcement (~ $100 million).  Their hurried and unsatisfying conference call added to investor discontent. 

Management, of course, does not believe that they overpaid.  The reason for this is that the synergies that they are able to capture are significant, with almost none of EM’s overhead coming over from Primedia.  Thus, when this asset existed within Primedia it contributed $97 million in EBITDA before corporate overhead, which probably was another $10 million on an allocated basis.  SORC (and their banks) believe that the pro forma EBITDA is closer to $130 million, making the multiple 9x instead of the reported 12x.

There are longer-term efficiencies to be wrung from rationalizing what is still an incredibly inefficient industry with several unnecessary layers of distribution.  However, the investment thesis does not rely on this.  The stock currently has 30% of its float sold short.  The short thesis is/was predicated on a company operating in a deteriorating industry that was inflating its results with aggressive accounting, and this thesis was largely correct.  However, at this point the short case does not seem compelling, despite 30% of the float remaining short. 

The pro forma company is trading at roughly 8x EBITDA for what is now 2/3 high-quality magazine assets.  It is run by a very competent and equity-friendly management team.  And it is growing EBITDA both organically and through cost-cutting, such that it is easy to see how it goes from $200 million to $225 million in the next twelve months.  Due to the leverage that was added to the balance sheet, if SORC maintains its 8x multiple, the equity will double (conversely, if the equity stays at the same price then the free cashflow yield will be over 20%).  If it gets repriced closer to other publishing and media assets (10x EBITDA—still a discount to shrinking newspaper assets), the equity could quadruple.  While there is certainly execution risk and the core (old) business is not great, management does have a shot at demonstrating that the company is a strong platform to acquire other media properties. 

There is an interesting comparison with Primedia (PRM) as it was selling its assets.  The equity reflected little value of optionality and a reasonable chance of financial distress for what was, surely, a heavily-leveraged company.  Yet the debt traded at par, reflecting the credit investors’ comfort with the cashflow stability of the assets.  Similarly, SORC’s banks were willing to fund the entire EM purchase.  Ultimately, PRM’s equity reflected the same view as its debt, and it would not be surprising to see the same outcome with SORC.

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