Journal Communications (JRN)

Summary

Our fund generally focuses on smaller companies with Ft. Knox balance sheets and large & sustainable free cash flow yields.  We are often seeking a mid-teens FCF yield or higher on an unleveraged basis.  The objective is for the sustainable FCF to eventually drive up the share price to a more reasonable valuation through share buybacks, debt reductions, dividends, or accretive acquisitions.  Obviously, it is important we have a management team that cares about shareholder value.

One stock we like is Journal Communications (JRN), a small broadcasting and publishing company located in Milwaukee, WI.  JRN has 35 radio stations and 15 TV stations and publishes the Milwaukee Journal Sentinel, the daily paper in that city, and various community shopper papers in Wisconsin.  JRN’s broadcasting properties include markets like Knoxville, Boise, Tulsa, Omaha, Tucson, Ft. Myers, and Green Bay.  Most investors still think of JRN as a publishing company with some broadcasting assets (e.g., Yahoo Finance lists JRN’s industry as “Publishing – Newspapers”) and assign the company a low publishing-industry type multiple, but actually the reverse is true:  JRN is much more of a broadcaster than a publisher.  And we think JRN’s TV and radio broadcasting assets are highly under-valued, have strong competitive positions, and are likely to increase in value with inflation over time.  We like the local focus of the broadcast business which gives viewers information that is unique to their local market.

JRN has very strong free cash flow generation.  In less than four years, from year-end 2008 through 9 months 2012, JRN reduced its net debt position from $220m to $50m, or about $170m, primarily from free cash flow.  JRN has about 50m shares outstanding at about $5.60 per share for a market cap of about $280m.  Prior to two recent broadcasting acquisitions we will discuss, JRN had reduced its net debt to $50m at 9/30/12, resulting in a total enterprise value of about $330m. JRN’s debt reduction of $170m in less than four years represented more than 50% of the entire EV.  We believed, prior to the recent acquisitions, JRN would generate close to $70m of EBITDA and $50m of FCF on average in 2013 and 2014 (we average these two years to reflect incremental political and other advertising in even years) resulting in a valuation of about 4.5x EBITDA or a FCF yield of about 15% unleveraged.

In August 2012, JRN repurchased all 3.26m Class C shares (4.45m shares on a Class A equivalent basis) from members and successors of the founding Grant family for $6.25m in cash and $25.6m of unsecured promissory notes.  Management noted the transaction simplified the capital structure and allowed JRN to remove a class of stock that had enhanced voting and other rights.  The share repurchase transaction reduced JRN’s diluted shares to about 50m.

JRN’s management, who we like, continues to increase the company’s focus on broadcasting, and recently completed two acquisitions.  It bought two Tulsa, OK radio stations for about $12m in June 2012 and bought WTVF-TV in Nashville, one of the strongest CBS affiliates in the country, for about $215m in December 2012.  Management believes the purchase price for the Tulsa radio stations will be under 7x EBITDA after synergies and for the Nashville TV station under 8x EBITDA after synergies.

We believe these acquisitions will add $30m of incremental EBITDA to JRN, on top of the $70m we expected JRN to achieve before their acquisition.  Overall, JRN will have about $275m in net debt outstanding and a market cap of about $280m, resulting in a total EV of about $555m compared to $100m of average annual EBITDA in 2013 and 2014.  

We expect JRN’s two recent broadcasting acquisitions to be highly accretive and we expect JRN to rapidly deleverage its balance sheet.  We believe, in 2013 and 2014, JRN could generate average FCF of $70m or $1.40 per share.  Based on these estimates, we believe JRN could trade for $12 per share or 100% more than today’s share price, especially as investors start to recognize that JRN’s broadcast segment will likely be generating nearly 80% of consolidated EBITDA and FCF in 2013 and 2014.

Excluding any strategic acquisitions, share buybacks, or dividends, we would expect a significant deleveraging of JRN’s balance sheet of up to $140m over 2013 and 2014, which would result in a net debt position of about $100m by year-end 2014.

Publishing Segment

One risk to our investment thesis is that JRN’s publishing EBITDA declines more rapidly than we expect.  We believe the local information in JRN’s newspapers, especially the Milwaukee Journal Sentinel, which generates almost all of publishing EBITDA, has value to subscribers and advertisers.  The Journal Sentinel has one of the highest penetration rates in the U.S. for larger cities.  JRN’s publishing segment requires very little capital investment and continues to generate strong, although declining cash flows.  JRN’s management has done a good job of downsizing the cost structure of its newspaper operations in line with revenue declines in order to protect its profitability and cash generation.   We do not know for sure where newspaper advertising revenues will bottom out but we believe JRN’s management will be able to generate significant cash flow over the next few years.

In early 2012, JRN management established a “pay-wall” to access its newspaper content on the internet and implemented a modest price increase to Journal Register subscribers and gave them access to online newspaper content as well.  So far, the circulation for the Journal Register seems to have remained fairly stable.  In addition, customers can receive an online only subscription to the Journal Register for a reduced price.  It remains unclear how the publishing business model will ultimately play out, but we believe there is some value in JRN’s proprietary local content and that subscribers and advertisers will be willing to pay for this content.

While publishing segment EBITDA for 9 months of 2012 was $12m versus $18m in prior year, we note that Q3 publishing EBITDA was closer to flat at $5.5m versus $5.5m in prior year, as Q3 publishing revenue declines moderated to about 4% and publishing operating expenses were reduced by about 4% also.  We are hopeful publishing segment results will decline more slowly going forward but this bears close watching.

Warren Buffett has recently made well-publicized purchases of newspaper properties and commented in his latest annual report that newspaper properties that can offer relevant local news to their readerships have a chance to do reasonably well.  This local focus is exactly the strategy that JRN is pursuing with its newspaper and broadcasting assets.

Overall, we expect the publishing segment to contribute $20m of EBITDA in 2013-4, or about 20% of consolidated EBITDA, but it could come in modestly lower.  We are certainly not counting on a rebound in the publishing segment but we are hopeful for a slower rate of decline going forward.

Strong Cash Flow Generation and Solid Business Model

JRN’s broadcasting and publishing assets produce large amounts of free cash flow with limited capital expenditure and working capital requirements.  From 2009 through nine months of 2012, JRN generated almost $200m in free cash flow or over 50% of JRN’s EV prior to the two recent broadcasting acquisitions in 2012.  Much of this was through an extremely difficult economic environment.  We believe the local-content focus of JRN’s television, radio, and newspaper assets will be an important factor in protecting their business franchises and their free cash flow generation capabilities.

JRN has a high ROIC, non-capital intensive business, where capital expenditures from 2008 to 2012 have averaged $10m per year as compared to cash from operations of nearly $70m per year, resulting in large amounts of free cash flow generation.

Strong Focus on Local Market Information, Diversified Across Many Local Markets, is A Major Asset and Key Competitive Strength

The intense local focus of JRN’s broadcasting and publishing segments is a major asset and key competitive strength.  Buffett talks about this in his recent shareholder letter with respect to newspapers.  The “localness” allows viewers or listeners or subscribers to access relevant and important local information.  It also allows advertisers to quickly reach these groups, as evidenced by heavy spending on local television advertising in highly contested political and issue contests, where both sides were desperate to reach local voters.  We think this speaks to the effectiveness of television’s advertising medium. 

We think JRN’s television, radio, and newspaper assets which primarily benefit from local market advertising dollars have a solid competitive position.  The relevant local information and programming which they provide has some unique characteristics and is not easy to replicate.  Also, JRN’s relationship with local advertisers provides another barrier to entry.

In effect, an investment in JRN is an investment in the growth of its underlying markets, such as Nashville, Boise, Milwaukee, Palm Springs, Las Vegas, Green Bay, etc. and we think this is an attractive investment.  We believe the prospects for the television and radio industries are decent over the next three years.

Solid Balance Sheet and Expected Steady Improvement in Net Debt Position.

Despite re-borrowing to complete the two recent acquisitions and repurchase the Class C shares, JRN continues to have a solid balance sheet.  JRN consistently reduced its net debt position over the past twelve quarters through a very tough economy and we believe it can continue to do so over the next couple of years.  At 3/31/09, JRN had a net debt position of $197m and this was rapidly reduced to $35m by 6/30/12.  JRN was able to generate a significant amount of cash flow even in the very depressed economic conditions of 2009.  We believe JRN’s net debt position could improve by $70m in both FY13 and FY14, absent additional acquisitions, buybacks, or dividends. 

Industry Consolidation Prospects

We believe that JRN’s attractive portfolio of broadcasting related assets, including 35 radio stations and 15 television stations, are being substantially under-valued at current market prices.  We believe both the television and radio industries retain significant competitive advantages in allowing advertisers to reach customers in their local markets.

We believe that JRN’s broadcasting assets could be attractive to a potential strategic purchaser or a private equity investor.  Such an acquisition is probably unlikely given management’s super-voting position in JRN shares but we also believe JRN’s management team is frustrated by its low share price and is likely to take increasingly aggressive shareholder-friendly actions if the share price continues to remain depressed.

2011 Results Provide a Solid Baseline for 2013 Results

For JRN, even years like 2010 or 2012 are stronger due to incremental political, issue, and Olympic advertising and it makes sense to project 2013 results from 2011 results.  In 2011, JRN achieved EBITDA of $63m.  There has not been a lot of organic growth in JRN’s broadcasting segment in recent years and we are not planning on much during 2013.  Instead, we are estimating $65m of EBITDA for 2013 and adding $30m to reflect the recent broadcasting acquisitions.  This yields about $95m in EBITDA estimated for 2013.  We believe 2014 results would likely exceed 2013 results by $10m in EBITDA or more due to incremental political, issue, and Olympic advertising dollars.

Large Share Repurchase Program and Excellent Potential for Share Repurchase or Dividends

JRN currently has a $45m share repurchase program in place which represents over 15% of JRN’s current market cap.  We believe JRN’s management is keenly aware of the current depressed valuation of its share price.  We believe that if JRN’s share price remains depressed, after management initially reduces net debt from the two recent acquisitions, there could be a major acceleration of the share-repurchase program and/or a major dividend program.

Accrued Employee Benefit Obligations

JRN has $88m of accrued employee benefit obligations as of 9/30/12.  These represent retirement plan obligations primarily to former newspaper employees and the program has been suspended.  We expect these obligations to cost JRN about $4-$5m per year over the next 10 years.  These obligations have been inflated in recent years due to a low discount rate which increases the actuarial obligation.  We do not treat these as debt obligations.

Conclusion and Target Price

Based on 10x our average annual FCF estimate of $70m for 2013-14 less a projected $100m net debt position at year-end 2014, we believe JRN could trade for a market cap of close to $600m or $12 per share or more versus $5.60 per share today (+100%).  Based on 7x our average EBITDA estimate of $100m for 2013-14 less $100m of net debt projected at year-end 2014, also results in a market cap of $600m or about $12 per share.  If JRN’s broadcasting and publishing assets perform as we expect, we think our target prices can be achieved.  Further, JRN’s assets are well-established in attractive markets and could be attractive to a strategic acquirer.  We believe JRN could be purchased at a large premium to today’s share price and still be highly accretive to an acquiring company.

** Class B shares are entitled to 10 votes per share.