Saturday, October 14, 2006

JRC Rally Presents Short Opportunity

We couldn't help but notice the recent rally in Journal Register (JRC). The stock was up 13% on October 12th alone, and up 27% in the past two weeks. Previously, the stock had been drifting lower, making new 52-week lows for the past year. Our bear case for JRC is straightforward:

  • secular trends for the newspaper industry are terrible;
  • the economic cycle is slowing, pinching the profitable classified ads category for newspapers;
  • Journal Register has an even less appealing market profile, with exposure to slow growth Michigan and Northern Ohio (40% of circulation);
  • the company has $750MM in debt, levering it at an industry-leading 6.2x, leaving it little financial flexibility;
  • analyst estimates remain too high, and will likely come down before year end;
  • JRC valuation is expensive at 9x EV/EBITDA;
  • fair value for the JRC shares is $5/share.

So what has investors excited about JRC these days? We did a little sniffing around recently and this is what we heard:

  1. "Michigan isn't getting worse"
  2. "Private Capital Management has sold much of its stake, reducing overhang"
  3. "Merrill upgrade"
  4. "Asset sales are going well"

Let's take a look at these reasons individually, we think it is hard to reconcile the move in the stock with these items.

"Michigan isn't getting worse" Michigan is an unmitigated disaster. Journal Register paid $415MM for these slow growth properties back in 2004 and is regretting it now. Auto job losses are tanking the local economy and depressing consumer confidence (neither is good for newspapers). Michigan ad revenues were down 15% in September, but management suggested things weren't getting worse on the conference. Obviously "not getting worse" is better than "getting worse," but the important thing here is what do analysts have in their estimates for next year. Analysts are looking for revenues to remain flat in 2007 suggesting the Michigan properties need to turnaround massively in short order, or the rest of the newspaper portfolio needs to offset Michigan. We are extremely skeptical of these estimates and believe management will lower guidance at the annual media conferences in New York in December.

"Private Capital Management has sold much of its stake, reducing overhang" We guess there is a silver lining to every cloud, but this is a stretch. Private Capital Management's Bruce Sherman was undoubtedly the biggest bull on newspapers in the country, amassing huge stakes in most of the publicly traded newspapers stocks. In a desperate attempt to cut his losses, he forced Knight Ridder to put itself up for sale. The auction was a flop and now PCM is exiting many of its positions. We have difficulty seeing the good news in PCM selling their newspaper stakes at 52-week lows.

"Merrill upgrade" There was not much new in this report. We viewed it more as a valuation call. It is always tough for sell-side analysts to maintain a sell rating, so they are always looking to move to a more positive (or at least neutral) stance

"Asset sales are going well" The company announced the sale of newspapers in Massachusetts and Rhode Island back in August. These are supposedly slower growth markets for JRC, so we are estimating they sell for 9x. EBITDA for these newspapers is probably heading to $8MM, so the company might get $72MM in proceeds. We estimate taxes of $5MM or so and roughly $67MM makes it to the balance sheet, reducing leverage a whopping 0.2 turns to 6.0x.

We think the JRC rally creates an interesting opportunity to build a short position in JRC before management inevitably cuts guidance for 2007.

Disclosure: Hanover Square has a short position in JRC.

Tuesday, October 03, 2006

Now Could Be the Time for Opportunistic Buy of SBSA

Sometimes the best investment opportunities are uncovered upon finding well-run companies, with impressive long term growth rates, trading at attractive prices within a sector that has fallen out of favor with Wall Street. I think this may be the case with Spanish Broadcasting (SBSA), a radio broadcasting company operating out of Miami focusing on Spanish language formatted stations. Wall Street despises radio broadcasters these days, and, admittedly, for some legitimate reasons: slowing cash flow growth, increased competition from the likes of satellite radio and the internet, commercial unit overload, bland formats, and listeners tuning out. Fewer listeners mean fewer ad dollars for radio stations, which in turn pinches cash flow growth. However, there is one segment of the radio industry that continues to post solid growth: Spanish language stations targeting Hispanic listeners.

SBSA represents a growth story in the radio industry, driven by attractive Hispanic demographic trends. While there are some moving parts to this story, we see upside to the SBSA shares of nearly 50% from current levels as investors sort through the company’s recent TV investment (discussed below).

Demographics Position Spanish Language Stations for Growth.
The US Hispanic population has been growing at three times the overall population, leading to a larger pool of potential listeners. In addition, the disposable income of Hispanic is growing at triple the rate of the US average, encouraging advertisers to reach out to Hispanics. Better than average population growth combined with improving disposable income puts SBSA in a sweet spot, much like Univision is in television.

Strong Ratings Remain a Good Lead Indicator for Future Growth.
Ratings trends for radio stations in the US has been down about 1% per year for the past decade. But stations targeting Hispanics have dramatically outpaced other stations, leading to higher ratings growth. The most recent ratings book showed more of the same with Spanish language stations achieving growth of 14% vs. a decline of 1.3% for the industry.

Lehman analyst, DiClemente hits the nail on the head in one of his reports:
”Based on revenue-weighted performance ratings over the past four ratings periods, Hispanic broadcasters continue to be the biggest winners. Spanish Broadcasting (#1 overall) improved ratings 18% Y/Y in New York, and Univision (#2) saw double-digit growth Y/Y in four of its top five markets.” (emphasis added)

Advertisers are always a little slow to pay up for higher ratings, so expect these strong ratings to drive revenue growth in the next 6-12 months.

Industry Leading Revenue and Cash Flow Growth.
Impressive ratings growth has been helping to drive ad revenue growth at SBSA and much of this has been dropped to the cash flow line. Over the past six quarters SBSA has averaged high single digit EBITDA growth on a same-station basis, compared to the industry that has been flat. The outperformance should only continue as higher ratings are monetized and start-up stations start to develop.

Looking forward, consensus estimates show an increase in EBITDA from $41.8MM in 2006 to $59.1MM in 2008, an increase of 41%. Included in these estimates are some operating losses from the TV station start up (run-rating about $4-5MM per quarter in 2006, winding down in 2007).

Recent TV Station Investment Masks Strong Underlying Radio Fundamentals.
Historically a radio company, management bought a TV station (WDLP-TV, now changed call sign to WSBS-TV) in South Florida last year for $37.6MM. The station was re-launched March 1st of this year and will require some investment to get to cash flow positive. SBSA has very strong presence in radio in the Miami market and I think this should help speed up the transition. A number of investors didn’t like the TV acquisition and felt SBSA was straying from its core competencies in radio (a view we don’t disagree with). The stock is down some 50% since the deal was announced on July 13, 2005, versus the radio industry down roughly 20%. Using some very rough numbers, the excess decline in value between SBSA and the rest of the radio industry might be a good estimate for how much the market has penalized SBSA for the TV station acquisition, or $160MM of market cap. Keep in mind this station was bought for $38MMmm and we suspect could be sold for roughly the same amount today. So we have a market disconnect of nearly $200MM, representing 75% of SBSA’s current market cap. A better way to calculate what SBSA is really worth is to estimate radio-only EBITDA (stripping out estimated operating losses at TV) and apply an appropriate multiple (we think 11X-12X is reasonable based on peer multiples and relative growth), then to assign some value to the TV station (we think cost is a decent estimate). Following this methodology, we arrive at price targets 35-57% higher than the current share price. See table 1 for more details.

Few Analysts Cover this Small Cap.
The SBSA story is not a simple one for the average investor to get his/her arms around. Unfortunately, the decline in the radio business has led to a dwindling of radio analysts on Wall Street as well. SBSA used have a dozen analysts covering it back in 2000, today that number has slide to a half dozen (most really doing only maintenance coverage on the name). This presents an opportunity for investors that do their homework.

Stock Near Its 52-Week Low, While the Rest of the Group has Bounced.
Interestingly, the rest of the group has been showing some signs of rebounding, up a couple of percent over the past three months, while SBSA has yet to make its move and is down some 13%. The stock appears to have formed a bottom recently (I will leave it to a CMT to describe this in detail), and looks poised to move higher.

Valuation is Compelling for SBSA.
We have attempted to strip out TV losses from consolidated EBITDA estimates to get a better picture for what SBSA might be worth. Our target calculation suggests 37% to 70% upside from current prices.

Private Market Value Even Higher
Management has suggested it would explore going private (see Miami Herald article 5/9).
I am not believer that the company is actively shopping the company, but I do think that it helps set a floor for the stock, limiting downside from current levels. While the value of the stations is substantial, we think the tax leakage could be an issue. Viacom currently owns a 10% stake in SBSA.

Investors Could Hedge By Shorting Some of the Other Radio Names.
Investor may consider shorting another radio company to limit their market risk and industry risk. One suggestion would be Cox Radio (CXR), currently trading at 12X 2007 EBITDA and generating only minor EBITDA growth.

HSCM is long SBSA.

Tuesday, September 26, 2006

CECO CEO Larson Steps Down, Shares Poised to Step Up

Look for a rally in the CECO shares today following the news of Career Education Corporation CEO Jack Larsen stepping down as CEO. Larson will remain on as Chairman. After listening to the conference call last night we are feeling more comfortable with our long position in the CECO shares.

The action suggests the company is serious about change, which we view as a positive.
Keep in mind the company has been plagued by regulatory and legal problems, as well as slowing enrollment growth. Investors have pounded the shares as the problems emerged with the CECO shares shedding 43% of their value in the past 52 weeks. Change was likely necessary and we got that last night.

Management change should provide much needed catalyst for CECO
We think this might provide the catalyst the CECO shares have been lacking. The CECO shares have been inexpensive for some time, but lacked any catalyst to get investors interested.

  • The news should encourage frustrated investors to remain patient;
  • And could help on the regulatory front, signalling to regulatory bodies that some heads have rolled following past problems;
  • A management change could make it easier to implement substantial cost cuts;
  • Lastly, the move could suggest the company is in play (see comments below).

Valuation compelling
Shares are inexpensive at only 4.1X 2007 EBITDA. Consensus EPS is $1.65 for 2007 so the shares trade at only a 12.8 P/E. Consensus suggests a LT EPS growth rate of 13%. ROIC remains robust at 20% and the balance sheet is strong, with $4/share of cash on the balance sheet.

Expect talk of take-out to start up again.
Recall Education Management was taken out by Providence Equity and Goldman Sachs Capital Management for $3.6B back in March of 2006.
Last night's announcement that Educate (EEEE) has received an offer for a management-led buy out will only add fuel to the fire.

Saturday, September 23, 2006

Burying the Lead

Scrolled across the top of the cover of Barron's this weekend is the headline "Tribune Mess May Help Newspaper Stocks." I suppose there was similar headline when Knight-Ridder was forced on the block late last year. In the meantime, publishing stocks are down 6.59% YTD while the broader media sector is up 8%. Newspapers stocks are not going to get bailed out by more chatter of LBOs or assets sales. Investors will continue to focus on deteriorating fundamentals, while trying to reconcile these results with current valuations, and the stocks will move lower. Accordingly, I continue to have a negative view on the newspaper publishers.

A Tribune LBO is not likely in my view.
Private equity players walked away from Knight Ridder and have shown little interest in the current list of newspapers on the market. Tribune is already levered at over 4x trailing EBITDA, leaving little leverage left to take out equity holders. Meanwhile, private equity firms continue to struggle to estimate what exit multiples might look five years from now. I think multiple contraction is obvious, making attractive returns elusive if not impossible for private equity players.

Selling Assets Appear a Better Idea on the Surface.
Selling TV stations or newspapers at 13x while trading at 8.5 times seems like a slam dunk, but investors should be skeptical of "historical" private market values and wary of potential tax leakage from asset sales.
First, the market seems to be flooded with traditional media assets for sale. New York Times is selling its broadcast group. Dow Jones recently put it's Ottaway newspaper group on the block, and Journal Register is trying to delever by selling newspaper assets as well. Second, the traditional buyer of these assets (publicly traded newspaper and broadcasting companies) all seem to be net sellers these days, resulting in a supply/demand imbalance that will likely hurt asset pricing. Third, the threat of an economic slowdown with lead to cautious bidding by potential buyers. Lastly, most of the assets for sale have a very low tax basis, leading to very high tax payments on whatever gains are achieved, limiting their impact on the stock.

While there may be money to be made trading around TRB, I think a simpler investment strategy is to avoid these more controversial names in the group and look for names where investors are focused on operations.

Investors are Focused on Fundamentals, and they're Not Pretty.
The problem with newspaper company stocks is simple: cash flow growth is non-existent, and multiples remain too optimistic. The resulting combination of cash flow multiple compression and reductions in consensus cash flow estimates will continue to drag these stocks lower.

Despite the secular threats and the pathetic operating fundamentals, the group still trades basically in the middle of their long term EBITDA multiple range of 7-11X. I would argue this range should be closer to 4-6x based on existing growth rates.

Classified advertising is just starting to show signs of rolling over and when this category does, estimates will be coming down quickly. Classified advertising likely boasts 65% EBITDA margins, so any weakness here will be extremely painful.

I would focus my attention on companies that are less likely to have major asset sales, be a likely take-out candidate (because too big, or too stubborn), or are located in especially soft markets.
Accordingly, we remain short:
1) Gannett (GCI - trading at a seemingly reasonable 7.7x '07 EBITDA)- too big to be taken out and focus of investors seems solely on fundamentals. EBITDA has barely budged in the past five years.
2) New York Times (NYT - trading at a 8.4x '07 EBITDA) - experiencing difficult times in larger markets, Sulzberger family controls the vote and will never relinquish control, and questionable senior management team.
3) Journal Register (JRC - trading at a 8.0x '07 EBITDA) - the worst geographic exposure of any major newspaper group, with large percentage of circulation coming out of Michigan and Ohio. A highly levered balance sheet limits options.

The bright spots in the newspaper world are companies that have other business segments that are showing real growth. Scripps (SSP - trading at 9.1x 07 EBITDA) with its cable networks (HGTV, Food Network, etc) and online exposure (,, etc) seems very well positioned, generating 10% EBITDA growth. Washington Post Company(WPO - trading at an attractive 7.7x '07 EBITDA) also has a more attractive growth profile with its education business and cable operations. We have been long these names, pairing them with the GCI, NYT and JRC shorts.