Gannett: Rumored Deal with New Media

Gannett (GCI) is the publisher of the USA Today and about one hundred other midsized and smaller daily publications, newspapers are clearly in secular decline and have been for some time.  Newspaper publishing is an industry that went through a period several years back when there was a trend of spinning off the newspaper business from TV broadcasting or other media businesses (current GCI was a spinoff of the original Gannett that was renamed TEGNA).  I participated in several of those breakups and was lucky to make a little bit of money despite the backdrop of the industry, so why not give it another try with two companies I've written about previously potentially merging.

Last week, the Wall Street Journal reported that New Media Investment Corp (NEWM) was in talks to purchase Gannett in a cash-and-stock deal.  New Media is similar to Gannett, just without the USA Today, they own a bunch of small town newspapers and a couple midsized ones.  New Media is externally managed by Fortress Investment Group (now owned by Softbank), NEWM is one of the few operating businesses (non-REIT/BDCs) I know of that is externally managed, it was a spinoff of Newcastle (now Drive Shack) originating as the result of Fortress buying the debt of local newspaper publisher GateHouse Media (the entity WSJ references as the buyer) within Newcastle and later taking control of the post-reorg GateHouse.  Fortress has since used New Media as a vehicle to roll-up the distressed local newspaper industry at low single digit EBITDA multiples and then pay an out sized dividend to attract retail investors (standard externally managed playbook type stuff).

This deal has a hint of HPT buying SMTA's master trust to it, Fortress gets paid a management fee of 1.5% off of New Media's equity, Gannett is a low-quality asset but represents a way for Fortress to roughly double their management fee with one of the last large willing sellers (the other publishers are mostly controlled/family owned) at a price that both could claim victory with given the synergies at stake.  As an asset gatherer, New Media will be aggressive in pursuing Gannett and will likely get a deal done.

As a little recent background on Gannett, earlier this year they fended off a hostile takeover and later a proxy fight from PE owned MNG Enterprises (dba "Digital First Media"), the owner of the Denver Post and the San Jose Mercury News among other publications.  MNG Enterprises offered $12 per share for GCI (currently trades at ~$9.60) but the hostile bid and lack of committed financing led Gannett management to dig in their heels and resist the effort.  While this was happening, Gannett's CEO stepped down in May and the company has been without a named successor since.

How could this be a win for all three parties (Fortress, New Media, Gannett)?  The Wall Street Journal references $200MM of potential synergies being discussed in the deal, which sounds like a lot compared to Gannett's $290MM EBITDA guidance for 2019, and it is, but there is a lot of overlap between the two's footprint and $200MM is roughly 25% of Gannett's run rate G&A expenses, I think there is some reasonableness to the synergy number that a PE manager could extract from the operations.  New Media's stated acquisition criteria is to buy publishing assets at 3.5x-4.5x EBITDA, GCI trades for 5.6x standalone EBITDA of $290MM (mid-point of 2019 management guidance).

New Media can buy Gannett for "4x EBITDA" using a post-synergy number of $490MM and all three parties can claim victory: 

1. Fortress gets to roughly double their management fee; 
2. New Media gets a large acquisition within their stated price target to bleed for continued dividend yield, and given NEWM trades at a premium to the industry (due to the high dividend yield) it would be accretive to shareholders; 
3. Gannett gets a higher price with credible financing than what they turned down earlier this year justifying their actions

Speaking of financing, New Media's debt is primarily a term loan that is owned by CLOs.  The leveraged loan industry is under a microscope at the moment, primary issuance is down considerably year-over-year as investors prepare for lower interest rates (loans are floating rate products) and loan mutual funds have seen 30+ months of outflows.  However the demand for CLOs has kept a strong bid under loans and have essentially created forced buying of risky debt.  New Media is already a familiar name and present in dozens of CLOs, they could presumably finance a bid for Gannett through this channel.  Fortress is a strong PE sponsor and an active CLO manager in their own right.

So how might a cash-and-stock deal look like?  New Media has conventional debt of $450MM against a $180MM LTM EBITDA, or 2.5x levered, if they added the $490MM (let's save EBITDA addback math for another time) and kept leverage roughly the same they could raise enough financing to pay $6-7/share in cash and then issue the rest in NEWM stock.  I'm also including Gannett's pension shortfall in EV, NEWM likes to exclude their capital leases and pension liability from their leverage numbers so maybe they could justify paying on the higher side of my back-of-the-envelope estimates.  Anyway, I think this deal crosses the finish line as Gannett is floundering and doesn't have a controlling shareholder, New Media wants to gather additional assets for its external manager, it's a win-win for a dying industry.

Disclosure: I own shares GCI (and a few calls as well)

Year End 2014 Portfolio Review

The back half of 2014 was a wild ride for my personal account, I was up almost 30% at the half way mark of the year and at one point in the fall I had lost all my paper gains for the year.  I sold most of my mistakes in energy (Civeo, Paragon Offshore and to lesser extent Ultra Petroleum) and with a little luck the market perked back up salvaging much of what I gained in the first half.  But onto the results, there were no deposits or withdrawals into the blog portfolio during the period:

Another good year, and I'm pleased to keep my lifetime-to-date IRR above 20% which is my goal over the course of the market cycle(s).  I really enjoy the investing process over the proceeds, but if I'm not out performing, might as well consolidate my holdings into index funds and focus more time/energy on my day job.  Moving to 2015, my aim is to reduce the number and impact of my mistakes, which will likely mean fewer trades and potentially more diversification, but I'll continue to highlight interesting ideas for the blog, even if they don't make it into my personal account.

Below is breakdown of the attribution of each holding during the year to my performance, which is interesting at least to me, the grayed out holdings were closed out during 2014:

And then below are my current holdings as of end of day 12/31/14:

Additional Miscellaneous Thoughts:
New Media vs News Corp
Missed the opportunity in New Media (NEWM), Fortress has executed nicely on their plan to rollup small local newspapers and basically doubled this year.  I might have to change my strict rule against third party management agreements to just a higher hurdle to overcome.  I picked the wrong horse in the newspaper spinoff crowd (at least in the short term) with News Corp (NWSA), it's my lowest conviction holding currently, while incredibly cheap on a sum of the parts basis, shareholder returns don't seem to be their top priority.  If you listen to CEO Robert Thompson on any of their quarterly calls, its more about story telling, empire building and self promotion than actual business results.  I like their assets, but may find a better use for this cash soon.

Civeo Corp
Obviously was a disastrous investment for me, I got a little too excited with REIT conversions and then add the spinoff dynamics with a couple respected hedge funds backing it... turned out to be peak everything in one.  Luckily I trimmed some of my position in July at $26.50, but still took a big hit with the downgrade in guidance and rejection of the REIT conversion, and sold everything in October at $12.00, was lucky to avoid the next leg down this week.  There's some good discussion in the comments section of my two posts on Civeo, could be an interesting addition to a basket trade of washed out energy names in 2015.  Not that I'll likely be participating, need to recalibrate my ability to take the market temperature in commodity industries, have some work do before I'd feel like its in my circle of competence again.

NOL Shells
I like the NOL theme right now, most of these companies seem below the radar (or restricted) of larger hedge funds/other investors, and a less crowded theme than spinoffs.  I've highlighted a few this year in Green Brick Partners (GRBK), MMA Capital Management (MMAC), Par Petroleum (PARR), Tropicana Entertainment (TPCA), and Cadus Corporation (KDUS).  Others that I'm looking at and might blog about in upcoming posts include Signature Group Holdings (SGGH), WMI Holdings (WMIH), and Special Diversified Opportunities (SDOI); Signature has made it's operating company purchase and WMIH and SDOI are still looking at potential acquisitions.

Thank you to everyone for reading and happy new year.

Disclosure: Table above is my blog/hobby portfolio, its a taxable account, and a relatively small slice of my overall asset allocation which follows a more diversified low-cost index approach.  The use of margin debt/options/concentration doesn't represent my true risk tolerance.

Newspaper Spinoffs

I did another lunch investment pitch roundtable today, this time the topic was "Impact of Technology on Communication and Stocks".  I was already looking into the recent news/print spinoffs, so I decided to squeeze them into the topic and pitch the whole basket.

Below is my deck with some commentary, outside of News Corp and New Media Investment Group, I've only looked into these spins at a surface level, so some numbers might be completely wrong.  But the sector seems attractive as its bottoming and figuring out the correct corporate structure, digital strategy and industry dynamics to survive.

The first quote from David Carr of the New York Times came from his column "Print Is Down, and Now Out" published on 8/10/14 after the announcement of Gannett's newspaper spin.  His column and this quote sum up the consensus view of the newspaper industry, it's ugly, unwanted, and destined for red ink in the digital age.  However, news and content is still valuable, it just needs to be more tailored to its audience.  A (digital) subscription to The Wall Street Journal is virtually a requirement for anyone in finance or a senior management position in corporate America.  On the other end of the spectrum, community newspapers are the only news source for many small cities and can provide valuable targeted advertising.

As for the spinoff dynamics, most newspapers have been essentially hiding within otherwise growing media conglomerates, by exposing the print business, management will be forced/incentivized to adapt their product to the current marketplace.

There's nothing really new in this slide compared to my post on News Corp nearly a year ago, but REA Group's market value continues to rise, Harlequin was added, and hopefully Amplify is closer to wider acceptance.  One minor complaint, the quarterly conference calls sound like management is telling a story rather than a business update, makes the lack of a clear capital allocation plan even more of a concern.  But it's clearly cheap.

This is another update slide for blog readers, I'm still on the fence about New Media, like the strategy but I remain concerned about the third party management agreement and how that might be bought out or internalized.  Fortress is a savvy shop, and they've executed on the plans they've laid out.  Their quarterly presentations are transparent, a little promotional, but it clearly presents the investment thesis and should net investors high teen returns as they buy local papers cheap and they're rerated in the public markets.

Now we get to recent spins, Tribune Publishing is the riskiest of the bunch, its leveraged and doesn't have the benefit of its real estate assets.  Its papers are primarily large metropolitan newspapers, a segment that's similar to a JCPenney's in the retail space, stuck in the middle without a loyal customer base.  However, its very cheap and has a lot of upside if turned around, parent Tribune Media emerged from bankruptcy about 2 years ago and former creditors (unnatural holders) might be taking advantage of the liquidity of an NYSE listing and selling.

The newspaper spins really picked up in the last two weeks, Gannett announced they were going to spin off the publishing business earlier in the week.  I don't know the exact timing of the filings, but Carl Icahn curiously filed a 13D after the spin was announced, suggesting the spin.  There might be some upside left, but this transaction is well publicized and pretty straightforward.

E.W. Scripps & Journal Communications
The more interesting transaction is the "double spin/double merger" of E.W. Scripps and Journal Communications, where both will combined their TV/radio broadcast divisions and then spinoff their newspaper segments into a new company to be named Journal Media Group.  Both companies would be free of cross-media ownership rules and could therefore pursue acquisitions in markets they were restricted from as combined broadcast and print companies. 

Today the two companies have a combined $1.5B market cap, if you take management's guidance of $200MM EBITDA and use a 9x multiple (low end of comparable broadcast companies due to radio exposure) the "new Scripps" is worth roughly the current market cap and you get the Journal Media Group newspaper business "for free".  It's a complicated transaction that won't close until sometime in 2015, and there are more merger details including a $60MM special dividend to Scripps shareholders, but with more consolidation in both industries likely, it initially appears to be an attractive deal for both future companies.

Each of the recent spins are a little different, but as a group they should outperform the broad market over a 2-3 year time.  I could also see regulations relaxing in this space, newspapers/radio/local TV entities aren't as influential as they once were, encouraging more consolidation.

Disclosure: I own shares of NWSA

New Media Investment Group Spinoff

New Media Investment Group (NYSE: NEWM) is a recent local newspaper/media spinoff of Newcastle Investment Corp (NYSE: NCT).  It was formed as a result of Fortress/Newcastle's ownership in GateHouse Media debt prior to a prepackaged bankruptcy and their purchase of Dow Jones Local Media Group from News Corp in September 2013.  For me it hits several themes that I like, (1) it's an unwanted spinoff from an investor base that's likely to sell it off,  (2) it operates in an out of a favor industry, and (3) it is run by a capital allocation expert (although at a cost).

Local Newspapers

Berkshire Hathaway's Warren Buffett recently purchased 28 local newspapers for $344 million dollars.  It's a very small purchase for a $270B+ Berkshire Hathaway, and Warren has a soft spot for newspapers, but he still wouldn't make the purchase if it didn't make economic sense.  The industry has value.  Local newspapers have a connection to small communities who rely on their hometown newspapers for updates on local schools, sports teams, community politics, and local advertising that's hard to replicate for free.

Most people also assume that newspapers are in permanent decline, but I think it's a wrong assumption that the move to digital will permanently lower the revenue and profitability of the newspaper industry.  Owners of businesses demand a certain return on investment, and businesses are fairly organic, it may take time, but eventual newspapers will restructure, consolidate, and earn a respectable ROI.

Deal History
Prior to GateHouse Media's bankruptcy, the company had a total of $1.2 billion face amount of debt, majority of which was owned by Fortress/Newcastle.  GateHouse Media went into the credit crisis overleveraged and ran into trouble, Newcastle (externally managed by Fortress) grouped together with other debt holders and restructured the company this past November.  Newcastle basically dual tracked the purchase of Dow Jones Local Media Group from News Corp (another spinoff and one of my holdings) in September, together with GateHouse Media, to form a new local news media company.  Since Newcastle is a REIT, it makes little sense to hold a non real estate operating company like New Media within the restrictive REIT structure, so they decide to spin out the media assets into a new entity.

Post Spinoff
After the spinoff, New Media will have 435 community newspapers, related mobile sites, and 6 yellow page directories.  That appears to be just the start, as Fortress has identified nearly $1 billion in potential acquisitions they believe can be purchased at between 2x-5x EBITDA, and then presumably integrated with GateHouse/Local Media, costs cut, resulting in increasing operating leverage.  There is a track record here, as Newcastle/Fortress was able to buy Local Media from News Corp at roughly 3.4x EBITDA (after backing out the real estate value).  By doing this, Fortress projects they can earn 20-25% unleveraged returns, and 30-35% return on equity with leverage.  New Media will also get attention from investors as it plans to pay out a significant portion of their cash flow in the form of a dividend.

Investors post spinoff might get the chance at a better return as the price is likely to decline in the near term due to uneconomic sellers for the following reasons:

• New Media is unrelated to Newcastle's core business (senior housing REIT, and some legacy CDO debt), there's probably not a lot of shareholder overlap other than those who are loyal to Fortress Investment Group.
• Newspapers and yellow page directories are an out of favor business that are unpopular and unsexy to discuss at cocktail parties.
• Unfortunately, I thought there might be more index fund selling due to New Media not being a REIT, but as Newcastle is transitioning from a mortgage REIT to an equity REIT structure, it's not included in the MSCI US REIT Index.  But there still might be some REIT focused holders that will be forced to sell New Media in the coming weeks.

Valuation
While revenues have been stabilizing, they're still falling, New Media hopes to reverse the trend with their digital advertising business Propel.  I would encourage people to check out their slides on Propel in their recent presentations, but I don't put much value in it.

As for a current EV/EBITDA multiple, below are the actual/projected numbers for the two newspaper companies forming New Media, as reported in their initial investor presentation in the fall.

If you combine the two 2013 numbers, you come up with $105 million in EBITDA.  New Media has 30,000,000 shares outstanding, based on today's closing price of $12.20 you get a market capitalization of $366 million.  New Media took on $185 million in debt after the GateHouse restructuring and the purchase of Local Media Group, making an enterprise value of $551 million, and an EV/EBITDA multiple of a little over 5.2x, definitely cheap, but on the high end of what Fortress thinks they can pay for acquisitions in the industry.  I'd like to pay to a little below 5x and that's before the issue of the external management expenses.

External Management
New Media will be externally managed by Fortress Investment Group, a large private equity/alternative investment manager with little direct expertise with media companies.  Fortress is handsomely paid for this arrangement; it receives 1.5% of equity annually and 25% of adjusted profits (adding back depreciation and amortization, among other adjustments) above a 10% hurdle, so you're essentially investing in a cheap media company with a private equity fee wrapper.  The advantage of having a private equity fund manage an operating business is the capital allocation, Fortress says they have identified up to $1 billion in potential acquisition targets in the near term, which would almost quadruple the size of the company (and presumably add operating leverage along the way).

But external managers have their downsides, (1) the management fee is based on assets which essentially incentivizes them to increase the asset base irrespective of the price they pay for the assets, and (2) the incentive fee may cause the manager to take unnecessary risks as their payoff is skewed to the upside and they don't participate equally in the downside.

The benefit usually touted for externally managed REITs is the manager has greater scale and charges the REIT less than what they'd pay internal management.  But unlike other externally managed REITs which have limited staff that work directly for the company, New Media has its own operational management team, including a separate CEO, so I'm a little cautious on how this type of model will work in a non-REIT entity.   Will the additional costs outweigh the cheapness?

Another question I have is around the potential incentive alignments with an acquisition, to me New Media would best be run as a short term vehicle that would later be acquired by a true private equity investor or a larger media company.  But its unclear to me how that would benefit Fortress and if they'd really go for it?  Yes, they have a decent size equity position, but the fees they earn from keeping New Media as a separate entity far outweigh any premium they would get for their equity in a buyout scenario.  

Conclusion
New Media has a lot of attributes that I like in a potential investment, but I'm holding off for now to see if it will get cheaper and I'm still trying to get my arms around what discount it should have with an external manager.  I'd appreciate any thoughts or comments on New Media, especially around the external manager arrangement, feel free to leave a comment below or email me at clarkstreetvalue@gmail.com.

I have another 2-3 ideas that I'll post over the next few weeks, and will probably buy my favorite 1-2 of those.

(I'm not 100% positive on some of the numbers above as the financials are still settling, please do your own research)

Disclosure: No Position.. yet