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

News Corp Buys Torstar's Harlequin

Last Friday, News Corp announced the purchase of Canadian media company Torstar's book business Harlequin, best known as a romance novel focused publisher, for C$455 million (or roughly 8x 2013 EBITDA of C$56 million).  I think its an interesting deal for both sides, more of an incremental move at News Corp and a transformational one at Torstar.

News Corp
News Corp was spun off of Twenty-First Century Fox last year (it was the spinoff but kept the name of the original parent) and unlike other recent spinoffs, the parent didn't saddle it with debt but instead let it go with $2.5 billion in excess cash.  Originally News Corp created a share repurchase plan and discussed initiating a dividend, but it seems like plans have changed as neither have been utilized and instead News Corp has made a couple small digital purchases in Storyful and a UK Luxury Shopping site.  Now comes a larger one in Harlequin, which is expected to be accretive to earnings and improve News Corp's free cash flow immediately.

Harlequin has a strong brand and a loyal repeat customer base but has experienced trouble making the transition from print to digital under Torstar, maybe under News Corp this trend will improve?  Romance novels initially seem like a great fit to be purchased and read digitally.  Books like 50 Shades of Gray are incredibly popular, yet no one likes to be seen reading a copy on the train, it's easier and more stigma free to read it on your morning commute on a Kindle.  Hopefully News Corp can implement some best practices learned from HarperCollins' move to digital at Harlequin, strip out some fixed costs, and cross sell HarperCollins books through Harlequin's much larger international distribution channel.  It seems like News Corp paid full price, but as a strategic buyer there are some efficiencies to be gained anyway. 

I still think News Corp is an interesting spinoff as I outlined in this earlier post, they have a collection of book publishing and Australian assets that together with their cash position roughly equal the market cap of the entire company.  The majority of their revenue actually comes from the remaining newspaper assets, which have strong valuable brands, but will take time to transition from print to digital.  In the meantime, Murdoch has hinted at even more deals in the works, he's probably not done yet for the year.

Torstar
From Torstar's angle, it was interesting to listen to their investor call on Friday, analysts were congratulating the company on getting a full valuation for Harlequin, sending the stock price up over 20% on the news.  The deal is more transformational for Torstar than it is for News Corp, Torstar will use the proceeds to pay down their debt and will be left with approximately C$260 million in net cash.  Initially it sounds like Torstar will be investing the proceeds into the business or making an acquisition versus returning it to shareholders.  Torstar's remaining businesses include the Toronto Star, 115 weekly community newspapers, and several joint venture holdings in other media assets.  Maybe they could roll-up additional community newspapers in a similar fashion to New Media's strategy?  It also sports a large dividend; on the surface it still looks pretty cheap.

Disclosure: I own shares of NWSA

Buying "New" News Corp

(I actually like the logo)

Over the summer, the "Old News Corp" split up the business into two, the parent company was renamed 21st Century Fox and retained the entertainment and media assets, while the spinoff kept the News Corp name and was castoff with the less desirable publishing and newspaper assets.  Media mogul Rupert Murdoch remains the Chairman and CEO of 21st Century Fox, but also became the Executive Chairman of News Corp and, along with his family, controls 39.4% of the voting right Class B shares.  Even though he appears to have less influence over News Corp compared to 21st Century Fox, his reputation and heart is more on the line with the publishing and newspaper business.  At the May 28th investor day in New York (where the below slides come from) he started off the conference by saying "I have been given an extraordinary opportunity most people never get in their lifetime: the chance to do it all over again."  Rupert Murdoch inherited a paper located in Adelaide, Australia and turned into it the combined 21st Century Fox and News Corp in 60 years, an impressive record.

So there are lots of attractive investment themes at play here for the new News Corp: (1) a smaller unwanted spinoff that was designed to showcase the larger parent's more attractive growth businesses, (2) an owner/operator that is financially committed to the business, (3) an out of favor business with a clean balance sheet and attractive non-core assets that provide a margin of safety.

As I'll layout below, the new News Corp features several non-newspaper assets and a cash heavy balance sheet that when accounted for on a sum of the parts basis roughly equal the entire market capitalization of the company, so you get the newspaper businesses for "free" which generate over 70% of the company's revenues.  While the "for free" argument has significant flaws, when that business is the vast majority of News Corp it makes it a much more compelling thesis.

Cable Network Programming (Fox Sports Australia) & Foxtel
Australia is a rabid sports nation and News Corp owns its largest sports cable channel family in Fox Sports Australia, which is comparable to ESPN's dominance in the U.S. but on a smaller scale as Australia only has 23 million people.  The cable channel business is still an attractive one as content providers get the dual income stream of subscription fees and advertising revenue.

Additionally, News Corp along with Telstra Corp, Australia's largest phone company, each own 50% of Foxtel which was formed in 1995 and is an Australian pay television company operating cable, direct broadcast satellite television and IPTV services.  Foxtel is a dominate player in this space with over 2 million subscribers or roughly 30% of Australia's market.

In September 2012, News Corp purchased Consolidated Media Holdings in Australia for roughly $2B, doubling their stake in both Fox Sports (from 50% to 100%) and Foxtel (from 25% to 50%).

Extrapolating this valuation to News Corp's entire stake and you get roughly a $4B valuation for this segment.  It's interesting that this segment was included in the News Corp spinoff and didn't remain with 21st Century Fox with the rest of the TV and entertainment assets.  The company cites synergies with the publishing and media assets, but I would guess its more to provide an attractive asset or two (along with REA Group below) to carry the newspaper and publishing assets until there is a clearer path to monetizing the shift to digital.

Digital Real Estate Services (REA Group)
News Corp owns a 61.6% stake in the largest residential property website in Australia, REA Group (REA.AX), another non-core asset.  REA Group owns and operates Australia's largest residential property website, realestate.com.au, and Australia's largest commercial property site, realcommerical.com.au, which together have approximately 20.6 million desktop visits each month.  Many believe that Australia remains in the midst of a large real estate bubble, the topic has its own detailed Wikipedia entry even though it hasn't popped yet.  A down turn in Australian real estate values would presumably have a negative impact on REA Group's value as its been a pretty high flyer momentum stock, but its growth is nonetheless impressive.

REA Group is publicly traded on the ASX and has a market capitalization of A$5.38B implying News Corp's stake is worth $3.2B.  News Corp consolidates REA Group on its balance sheet, but doesn't have an intention of acquiring the remaining minority shareholders and is content to collect the dividend.  I'm a little skeptical on the synergies between REA Group and News Corp's other Australian assets and would welcome a sale of their stake given the overheated real estate market.

Book Publishing (HarperCollins)
News Corp operates HarperCollins the second largest English language publisher, which publishes over 200 best sellers every year.  In their stable are many of the popular fiction, children's and religious authors.

The book publishing industry is changing rapidly due to e-readers and tablets as more consumers download book content digitally.  Unlike the music industry where digital downloads essentially eliminated the album format and consumers chose to buy individual songs instead, consumers can't really do that with books, you don't buy only the 3rd chapter of a bestseller, you still buy the entire book.  This means the book publishing industry actually benefits from digital revenues as their margins increase as the production costs, return costs, and working capital needs (inventory) are much lower.  Below is a slide from News Corp's initial investor presentation showing the margin differential between hardcover books and digital copies, the difference between the two was surprising to me.

News Corp's book publishing business generated $142MM of EBITDA in fiscal 2013, putting a reasonable 7x multiplier implies a value of $1.0B for the unit.

Cash/Balance Sheet
21st Century Fox was generous to the new News Corp and left it with a strong balance sheet featuring approximately $2.5B in cash and no debt.  News does have an underfunded pension liability, but with interest rates likely to rise over the near to medium term, the liability should be less of an issue as interest/discount rates rise reducing the accounting value of the pension benefits.

Sum of the Parts w/o the News Divisions
So the main thesis, that purchasing shares today essentially gives you the newspaper assets for free, is laid out below.  The values below might be on the high side based on the control premium that News Corp had to pay for CMH and the potential bubble of real estate prices in Australia inflating the market price of REA Group, but I think it still clearly illustrates the remaining newspaper businesses within News Corp are being considerably undervalued.

So without any consideration for the News and Information Services business and the optionality of the Amplify digital education business, the other assets of News Corp values are greater than the current market capitalization ($9.72B) of the entire company.  So with that in mind, below are the assets the market is heavily discounting and could represent significant value if News Corp is able to drive revenue growth through digital platforms.

News and Information Services
The News and Information Services division of News Corp generated over $6.7B in revenue last fiscal year (~75% of the overall company), for $795MM of EBITDA, so despite the challenges facing the industry at large as people continue to move away from print to (mostly free) digital, this segment has tremendous value.  News Corp, and specifically The Wall Street Journal, as been on the forefront of the switch to digital and actually being able to charge for their content.  The real value driver for this business segment will be whether News Corp is able to take that model and apply its other papers in the UK and Australia.

Dow Jones & New York Post: Back in the pre-Great Recession days the old News Corp purchased Dow Jones for $5B in 2007, its probably worth substantially less now but its also worth noting that The Wall Street Journal has also grown its circulation by 8% CAGR during that time (graphic below), when most other newspapers have been struggling.  The Wall Street Journal is the number one daily newspaper in the U.S. by circulation, and has been proactive from the beginning in creating a valuable pay wall online where others have had difficulty making the transition.  WSJ is a strong brand with a focused demographic where many of its subscribers are not price sensitive (for instance, my work reimburses me for my subscription) giving News Corp ample room to raise prices in the future.  Dow Jones also has an institutional business, the model here is to create a Bloomberg like service where customers pay for real time business news, analysis and statistical data.

Additionally, News Corp owns the New York Post, the oldest daily newspaper in the country that's known for its outrageous headlines (particularly towards NY sports teams) and their Page Six celebrity section.  However, the New York Post is said to be a money losing operation, but also a Murdoch favorite so its likely to stick around.

News International (UK):  News Corp is #1 by print sales in the UK with 35% market share, it operates the #1 tabloid in the UK in The Sun, the #1 quality Sunday newspaper in The Sunday Times, and one of the top quality dailies in The Times.  The UK operations reputation was given a significant black eye after the phone hacking scandal at The News of the World in 2011.

Early in 2013, News International gave a glimpse at its strategy when it acquired the rights to online and mobile highlights of English Premier League matches for three years.  It will show them on the websites and mobile apps of its three remaining newspapers.  The Sun recently started charging for digital subscribers 2GBP per week for its content, it will be interesting to see how well this strategy works in the next few quarters.

News Corp Australia: News Corp owns a smattering of newspaper and magazines in Australia, including daily newspapers in each of the major cities (The Daily Telegraph - Sydney, Herald Sun - Melbourne, The Courier Mail - Brisbane, The Advertiser - Adelaide) and the only national newspaper in The Australian.  As of June 30, 2013, its daily, Sunday, weekly and bi-weekly newspapers accounted for more than 59% of the total circulation of newspapers in Australia.  The Australian newspaper assets probably have the furthest to go in the switch to digital, but at least management has a playbook to work off of and the desire to institute the pay wall model.

How much these business are worth is pretty hard to say given the rapid change going on in the industry, their declining revenues, but you don't have guess someone's weight to know they're fat, I believe the market is being unfair and valuing these businesses close to zero.

Core EV/EBITDA (ex-Foxtel, Fox Sports, REA Group)
Another way to look at the valuation would be to strip out the non-core publishing assets (Foxtel, Fox Sports Australia and REA Group) and look at the EV/EBITDA valuation the market is putting on the core newspapers and book publishing businesses.

Despite what News Corp says publicly, the Australian TV and RE assets seem rather non-core and appear to be included in the new News Corp in order to temporarily support the struggling publishing assets.  As a natural contrarian, I'm attracted to these publishing assets, but also appreciate the margin of safety provided by the non-core assets.

Capital Allocation, Previous News Corp Mistakes, and Amplify
Other miscellaneous stuff that should be mentioned when talking about the new News Corp: At the time of the spinoff, the new News Corp authorized a $500B share repurchase plan to support the stock in the event that holders would elect to sell their shares in the publishing business.  As of the 6/30 fiscal year end, News Corp has not repurchased any common stock.  News Corp will likely pursue some acquisitions although its unclear what form they will come in as they would likely face regulatory scrutiny over any newspaper purchases in their current markets.  There is some risk to having this much cash burning a hole in Murdoch & Co's pockets as evidence by the $5B price tag they paid for Dow Jones in 2007, and the even worse $580MM News Corp paid for MySpace before wrecking it and selling it for $35MM in 2011.

Amplify
News Corp is heavily investing in their educational start up that hopes to reshape the way K-12 is taught in America through digital content delivery.  In fiscal 2013, Amplify featured a $163 million EBIT loss.  This investment is a long term one, also one that operates in an industry with a lot of entrenched (union labor) interests that are averse to change.  While it is strange that the education sector has been exempt from technological change, much of the free cash flow of News Corp is going to Amplify, so an investment in News Corp rests somewhat on their ability to create a profitable and useful benefit (unlike most of the for-profit sector) in this segment.  Expect additional losses for the next 2-3 years, although management has indicated that starting with the 2014 school year, we should see some progress on Amplify's adoption level.

Conclusion
In totality, I'm willing to bet on Rupert Murdoch's attempt to recreate the magic in the new News Corp and rebuild his legacy after the UK phone hacking scandal.  The non-core assets that were included in the spinoff provide a nice margin of safety giving management a little time to monetize their undervalued and underutilized newspaper/digital content brands.  I would put the initial fair value at least 50% higher, and potentially more if the market warms to digital content assets like the ones in News Corps portfolio.

Disclosure: I own shares of NWSA (purchased today at a cost basis of $16.76).  NWSA are the non-voting class A shares, NWS are the voting class B shares, otherwise they are economically the same.