A.H. Belo (AHC)

A.H. Belo (AHC) is an interesting spin-off situation in an unattractive industry: newspapers.  At year-end, this debt-free company will trade at approximately 0.7x reported 2011E EBITDA while its levered peers (LEE, MNI, GCI) trade between 5.5x to 6.5x forward EBITDA.  While the $150m million market cap and $700k daily trading volume likely explain some of this valuation discrepancy, we believe the company is extremely undervalued.  At 5.0x our conservative estimate of adjusted 2011 EBITDA (detailed below as we capitalize pension obligations and back the expense out to be conservative), AHC would trade at approximately $14.00 per share.  This would represent over 100% upside to the current trading price of $6.75.  This analysis includes $35m of expected proceeds from a sale of excess real estate.      

As AHC's earning power becomes more transparent and the asset sales are completed, it will draw greater attention from the investment community and be re-valued higher.  In the long-run, AHC needs to increase its scale by either acquiring additional newspapers or, more likely, sell the company to one of its larger daily newspaper-focused peers.

Business Description

The Dallas-based company publishes three leading local daily newspapers:  The Dallas Morning News, The Providence Journal and The Press-Enterprise (Riverside, CA).   These newspapers and their related online businesses reach a total audience of 3.7 million people and generated over $500 million of revenue in 2009.  The Dallas Morning News is the 10^th largest daily newspaper in the U.S.  In addition, AHC operates 11 associated web sites which represent 7.5% of total revenues.  Taken together, 66% of AHC's revenues come from advertising while 28% comes from circulation. 

In February 2008, AHC was spun-off at $20 per share from its larger parent Belo Corporation (BLC) which owns and operates television stations.  Given the cyclical and secular declines in the newspaper industry as well as AHC's very small market capitalization, it garnered little investor or analyst attention subsequent to its spin-off. The stock never traded higher than its first day as a separate company.  Indeed with no sponsorship and deteriorating results, its share price declined 96% to $0.60 in March 2009 ($11 million market cap) despite being net-debt free.  Like its peers, AHC has significantly reduced headcount and other operational expenses to bring its cost structure in line with the lower revenue environment the newspaper industry is facing.  However, its operating margins and free cash flow have yet to reflect these changes in their entirety, in part because the calendar first quarter is seasonally week.

From 2006 to 2009, AHC's revenue declined 37% and its EBITDA margin fell from 20% to 7%.  Revenue has stabilized and as the economy recovers it should grow slightly and then resume a low single digit annual decline rate as the newspaper industry continues to cede share to other advertising mediums.  Under its new cost structure and with minimal top-line growth, AHC can generate 15% EBITDA margins or approximately $75 million of annual EBITDA, however we have assumed that the company never grows advertising revenue again and only achieves an approximate 12% EBITDA margin ($58 million of adjusted EBITDA in 2011). It is interesting to note that circulation has actually grown from 2007 to 2009.  The business could be even more profitable in the hands of AHC's peers who are larger, more capable operators.  Gannett (GCI), McClatchy (MNI) and Lee Enterprises (LEE) are generating EBITDA margins today in the range of 18% to 23%.  With minimal capital expenditures and low cash taxes, AHC can generate at least $2.00 per share of annual discretionary free cash flow.

The company has no debt but is obligated to help fund the $196m pension obligation of its parent Belo Corp (to the tune of 60% of it).  AHC is using a tax refund from 2009 to fund its share of the pension contribution in 2010.  After 2010, AHC's funding responsibility will depend on the performance of the pension plan's investments.  Although, it is not expected to be a requirement in perpetuity, if you treat the expected $8 million pension contribution as an annual requirement, this would increase AHC's trading multiple to 2.2x estimated free cash flow. 

In addition to this strong operating cash flow, AHC has $2.00 per share of cash on its balance sheet and expects to monetize real estate assets which could generate $35 million in proceeds, or another $1.50 per share.  This $35m amount is our estimate based upon discussions with real estate brokers though the book value is substantially higher. 

Management has not been specific with its plans to maximize long-term shareholder value but is motivated given that the CEO and other executives own approximately 16% of AHC. Interestingly, the parent's CEO, Robert Decherd, a member of BLC's founding family (established in 1842), chose to leave the higher quality BLC TV business and become CEO of AHC.  In the short-term, the company is protecting value by conserving its cash, maintaining a debt-free balance sheet and exploring sales of non-core real estate assets.

Investment Positives

Unlevered Company with Very High Free Cash Flow Yield: While nearly 30% free cash flow yields are more common in a levered scenario, we believe AHC has been overlooked due to its small size and has been valued similar to its more levered peers despite its vastly superior capital structure. 

Hidden Value through Excess Real Estate to be Monetized: Based on our work, the real estate that AHC is attempting to sell is worth approximately $35 million. 

Margins Are Too Low Relative to Peers Suggesting Potential Improvement Ahead:  As discussed, there is a significant margin improvement opportunity to bring AHC's profitability thresholds closer to those achieved by its larger peers.  Of course, economies of scale may benefit those other companies but it is not unreasonably to anticipate some improvement. 

Minimal Capital Requirements: Since there is not much to invest in here, the capital requirements are not extensive.

Circulation Actually Increased from 2007 to 2009: During a difficult economic climate and in a declining industry, it is notable that circulation revenues proved resilient. 

High Insider Ownership: Management is aligned with shareholders through its 16% ownership in the company. 

Attractive Acquisition Candidate for a Larger Newspaper Company: a small asset like AHC could easily be tucked into a larger newspaper company and redundant costs could be eliminated thereby further improving the potential accretion. 

Investment Concerns

Significant Secular Headwinds: The threats to the newspaper industry are well known and clearly are reflected in the deteriorating topline at AHC.  Of course, part of the decline is also more cyclical in nature and could suggest a moderate rebound during an improving economic climate. 

Underfunded Pension: AHC is on the hook for 60% of its former parent's underfunded pension liability.  This amounts to $116 million and we choose to treat this liability like debt and back-out the associated pension expense. 

Industry Will Never Receive a High Multiple: Because as discussed the newspaper industry is in secular decline and faces substitution threats from the internet, it is extremely unlikely that a company like AHC will ever receive a growth multiple.  

Dual Class Share Structure: The directors and management hold approximately 52 percent of the voting power, though they have economic ownership of 16%.  A. H. Belo's Series A common stock has one vote per share and Series B common stock has ten votes per share.  Accordingly, the market may penalize the valuation of the company for this structure.

DISCLOSURE:  We and our affiliates are long AHC, and may buy additional shares or sell some or all of our shares, at any time.  We have no obligation to inform anybody of any changes in our views of AHC.  This is not a recommendation to buy or sell shares. We make no claims, promises or guarantees about the accuracy, completeness or adequacy of the contents of this document and expressly disclaim liability for errors and omissions in the document.  We have no obligation to update this document.  We may change our position at any time without posting an update.  The views expressed here are merely the opinion of the author.  Readers should do their own research.