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Lee Enterprises (NASDAQ:LEE) is one of the biggest newspaper publishers in the U.S., with 77 daily and hundreds of weekly publications.
LEE has suffered almost two decades of value destruction caused by the secular decline in newspaper revenue from printing, competition from other news sources, and bad capital allocation decisions in the 2000s.
Still, the company trades at a significant discount of FCF, has reduced debt significantly, and may have chances to fight back in some of its markets.
Although my long-term view of the company’s newspapers is not as bleak as that of the market, I recognize that the company has been unable to break the decreasing organic revenue and profitability trend.
Therefore, I am interested in LEE’s business in the long term, but I will avoid the stock for the time being until my longer-term market thesis is confirmed.
Note: Unless otherwise stated, all information has been obtained from LEE’s filings with the SEC.
Business description
A secular decline story: LEE owns and manages newspapers, and they have suffered enormously. Total newspaper revenue has fallen to one-third since its top in 2005, at $60 billion. The reason for the fall is not only the digital migration; we will analyze them in a separate section. LEE is no different in this respect.
Coupled with cycle top acquisitions: The company acquired Howard Publications in 2002 for $700 million and Pulitzer Inc. in 2005 for $1.5 billion. These pre-fall valuations left the company sagged with debt it has been slowly repaying.
Today’s financing is composed of a 25-year maturity loan made by Berkshire Hathaway (BRK.A) to the company as part of LEE’s purchase of BH Media and the Buffalo News from BRK. The loan characteristics are interesting and we will cover them in the valuation section.
Small outlets: Most of LEE’s daily and weekly publications are located in small cities throughout the U.S. These markets have specific characteristics that may make them more resilient to threats against traditional newspapers than their bigger cousins.
No significant owner: The company has no significant owner, with two funds owning 10% of the stock each and executives and the Board with another 10%. Usually, I prefer companies with strong owners, especially owner-managers.
Compensation is high for the company’s market cap and net profitability (more than $6 million for the Board and the three highest-paid officers in FY22), but not so much compared to the level of revenue and operating income.
Defined benefit pensions: LEE has pension plans with expected discounted benefits of approximately $200 million. The company was slow to close these plans, waiting until 2021 for 4 out of 7. However, as of FY22, the company’s plans are covered by assets and records net pension assets, not liabilities. In this situation, the company could sell the plans to an external manager (it did so for $86 million in liabilities in FY22, recording a $5 million gain).
Industry and valuation
Cash and accrual earnings, multiples: Newspapers, particularly the modern digitalized versions of newspapers, are relatively low-asset-intensive businesses. For example, the company generated $56 million in operating income using $300 million in tangible assets in FY21. The return is even better when we remove working capital liabilities of $120 million.
Low asset intensity businesses sell for a premium of book value, which is recorded as goodwill and intangibles in the acquirer’s balance sheet. The purchase price (leaving under and overvaluation aside) might not represent the cost of building the business (and therefore a true representation of cost for ROIC), but rather the cost of purchasing the business, using an earnings yield or DCF approach.
LEE carries loads of goodwill and intangibles on its balance sheet, a relic from the 2000s acquisitions and the recent BH Media acquisition in 2020. Part of those intangibles is amortized yearly, at a rate of approximately $20 million per year in recent years. I do not believe those costs are a cost of doing business but rather a cost of acquiring them (or conversely, a reflection of the extra value created with few assets by the sellers), and should therefore be removed from profitability measures.
When we look at LEE’s FCF, it is much higher than net income. This is explained mostly by the amortization of intangibles (and depreciation as well). In the first chart below, I show FCF minus changes in working capital expenditure because a decrease in receivables has temporarily reduced the company’s FCF after working capital.
If we consider multiples of accrual net income, the company trades at a P/E ratio of 20x to annualized earnings from 1Q23 data ($1 million net income attributable to common shareholders). I use 1Q23 data annualized because FY22 and FY21 accrual data is significantly affected by net asset impairment and gain/losses from asset sales ($10 million net loss in FY22), restructuring charges ($22 million in FY22), and benefits from restructuring the pension plans ($23 million gain in FY22). The 1Q23 does not suffer from these non-recurrent charges as much.
If we consider FCF, and the average figure of the 2020-2021 period (including expenses on WC), the company trades at a multiple of 3x to FCF, much lower.
Will the business improve? If we look back at LEE’s history, the multiple to FCF is above the past decade’s average of only 1.8x. Yet, if we had purchased based on that ‘low multiple’ in 2010, today, we would be 60% down on our investment. So the question remains, can LEE’s business improve? Otherwise, the low multiple simply discounts a worse future.
Print is dead, but that is not the only threat: Newspapers lost a lot of readers because they concentrated on their printed businesses rather than on the increasingly digital market until it was too late.
I believe that is a dry discussion that was obviously won by digital. The question still remains though: Can digital newspapers survive? There are many other threats to other fundamental aspects of the business.
Workers and capitalists: The advent of digital publishing has also allowed industry workers (journalists and content creators) to free themselves from media owners. The cost to scale a publishing business is now much lower (no printing or physical distribution required, many sites offer free hosting of blogs, etc.), and therefore a journalist can choose to work for a newspaper, join an independent publication, or create his/her own publication (like Substack). This has significantly shifted bargaining power in favor of workers.
Of course, the publication does have some bargaining leverage through its reach. The company might own ‘digital distribution’, meaning the digital following already amassed. That distribution is not so easy to mimic quickly.
Social media: News can now be delivered in formats that do not only include words and are not centralized in a single outlet. People can receive news on their Instagram feeds, read their Twitter walls, watch YouTube or listen to a podcast on Spotify.
True, newspapers also thrived against the radio and television, but radio and TV are impermanent, while social media is not. Social media is just as on-demand as newspapers are but more ubiquitous, cheaper, and decentralized.
Social media also helps reduce the startup requirements mentioned above because the platform already provides reach and infrastructure.
Lower attention spans: Related to social media, people may not want to read long detailed stories anymore, preferring the continued form of tweets or the addictive dopamine hit of an Instagram reel.
I do not believe this is a true threat because the last decade also saw the rise of long-form podcasts with several hour-long conversations. YouTube content is not short-form, and many digital-native media outlets are long-form.
This indicates some people at least still want long-form content, maybe even more than before.
Entrenched in the towns: Lower startup requirements and social media are the two main threats to traditional centralized newspapers. I think the main defense lies in the scale necessary to run a service for towns and small cities. To be fair, independent journalists can also compete with local newspapers, but maybe not as effectively as a national outlet.
The data to support this idea comes from LEE’s monthly average page views (under the ‘Daily Newspapers and Markets’ heading).
We have several examples.
The Bismarck Tribune averaged 5.6 million monthly visits in FY22. The Bismarck-Mandan MSA has a population of 130 thousand. The Columbus Telegram from Columbus, Nebraska (population 22 thousand) averaged 1 million monthly visits.
Compare that to the Buffalo News, with 15 million page monthly visits for an MSA population of 1.2 million, or the New York Times, with 600 million visits for 300 million people in the U.S. and many more abroad.
What this indicates, in my opinion, is that local outlets are much more popular in their areas than national or big city outlets are. At the cost level, small newspapers are probably several orders cheaper than their national counterparts. This arises from simple complexity rules: social interactions and complexity (and therefore news) increase exponentially. Therefore, the cost of having humans cover those news also grows exponentially. Some of LEE’s local outlets do not even have daily webpage publications because not so much is happening over there.
For example, according to their FY22 10-K, the New York Times (NYT) had $1.2 billion in CoGS in 2022 and generated 100 times more monthly visits than the Bismarck Tribune. I doubt the Bismarck Tribune requires $12 million to be run.
Further, the small scale of town and small city newspapers provides some benefits of scale to a company like LEE against independent journalists trying to build their audience on Twitter, YouTube, or Substack.
Improving the finances: As mentioned, all of LEE’s debt is owned by BRK and stood at $465 million as of December 2022. The debt yields a fixed 9%, or $41 million yearly, at current levels.
This debt eats most of LEE’s profits but is not necessary to sustain the company’s operating assets. It is a relic from the unprofitable acquisitions made in the 2000s. If LEE repaid those debts, it would not need to refinance its assets in some other way.
Further, the debt has no financial ratio covenants or specified repayment dates but has strict repayment conditions. All excess cash above $20 million in reserves (LEE currently has $18 million) has to be used to repay the debts.
Because, as we saw, LEE generates millions in FCF above net income, the company can repay debts relatively quickly, which improves net income and debt repayment capacity.
For example, if the company uses the $20 million expensed (but not cash) intangible amortization charge to repay debts, it saves around $2 million in interest expenses the next year. This greatly helps future profitability growth.
Operating efficiencies are not improving: My disquisitions about the long-term prospects of local newspapers against their national counterparts, social media, and independent, decentralized journalism are worthless if they do not translate into increased profitability, and in this respect, LEE is not improving.
Both revenues and margins continue to fall. The reversal of this trend is the main condition required for an investment in LEE to make any sense. Otherwise, cash profitability will decrease, affecting debt repayment and permanently impairing accrual (net income) profitability.
Conclusions
LEE’s valuation is not expensive on a cash multiples basis, but it has remained like that for over a decade, and shareholders have lost money investing in the company.
The market offers a low multiple because it believes that LEE’s business will continue decreasing, and therefore the yield premium is justified. Until now, the market has been right.
In my opinion, LEE’s business can survive and compete in the digital world. However, I also recognize that the factors behind my thesis have been present for over a decade, yet LEE’s revenues and profitability margins continue trending down.
Until that trend reverts, I prefer to remain on the fence. LEE’s stock is not an opportunity yet.
Editor’s Note: This article covers one or more microcap stocks. Please be aware of the risks associated with these stocks.
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Image and article originally from seekingalpha.com. Read the original article here.