Journal Media Group (JMG) – Small Spin-Off

Summary

• Spin-off of newspaper publishing assets from Journal and Scripps. We are guessing not too many people owned either JRN or SNI for their newspaper businesses. Stock sold off from the spin from over $10 to around $7.75 and currently sits around $9

• Investment case comes down to whether or not (i) management’s EBITDA estimates are close to being correct (we are less concerned due to significant costs historically allocated that suppressed EBITDA so not fully reliant on “synergies” to make the EBITDA number) and (ii) management can handle the revenue decline to come. EBITDA and SG&A estimates are within comp levels and seem reasonably achievable

• Management estimates roughly $50M in 2014 PF EBITDA. Assuming a 65% conversion to FCF, JMG trades at 4.2x 2014 PF EBITDA and 6x 2014 PF FCF

• ZERO debt and $10M of cash at spin on $200M MC. Pension liabilities are fully funded and not overly material although disclosure could be a lot better

• The Company owns the majority of its locations including its headquarters in Milwaukee. The total amount of land/land improvements on the books at cost is $55M. It’s a nice potential kicker

   

Background

JMG is a spin within a spin. It is the net result of the newspaper publishing businesses of Journal (JRN), which is primarily the Milwaukee Sentinel, and Scripps (SNI), roughly a dozen local smaller cities/towns. Journal and Scripps combined their broadcasting assets into Scripps, and their newspaper business into a Spinco (JMG). Unlike most spins, they put zero debt on the Spinco and actually launched it with $10M of cash.

The CEO had quite a colorful quote to launch the spin:

“As dawn broke across our markets this morning, Journal Media Group continued a vital and proud tradition of providing communities with compelling public service journalism. That tradition started with the commitment of media pioneers Edward W. Scripps and Lucius W. Nieman and has continued for more than 130 years under the stewardship of The E.W. Scripps Company and Journal Communications,” said Tim Stautberg, president and CEO of Journal Media Group.

-4/1/15 8-K announcing close of the spin.

And the CFO drove home part of what makes this so compelling: 

Jason Graham, senior vice president, CFO and treasurer of Journal Media Group, acknowledged the company’s starting capital structure — lauded early on as a major benefit of the new company.  “In addition to our company’s many strategic assets, we are launching with a solid balance sheet and no debt,” he said.  “We’re excited to have the financial flexibility to make strategic decisions that will help our enterprise navigate the ongoing transformation of the local media landscape.” (emphasis ours)

-4/1/15 8-K announcing close of the spin.

The owners of JRN received 41% of the combined business while Scripps shareholders received 59%. The stock has sold off as one would expect given that there are unlikely to be too many shareholders of either JRN or SNI that owned those stocks for their publishing businesses.

The Business

Like the rest of the newspaper publishing companies out there, this is not a great business. The real question is not how will they grow the business but instead how will they manage the decline to generate sufficient cash flows for shareholders to justify owning the stock. Some of the publishers have been more successful at this than others. Some have argued the smaller city papers are in a better place vs. the large publishers such as NYT and TPUB. That argument is born out somewhat by the fact that Warren Buffett has been buying up the smaller newspapers and hasn’t touched the large papers. This is likely due to price more than anything else as he has stated he wants to pay around 7x earnings.

We’ll look at the historical businesses of the Journal (Milwaukee Sentinel) and Scripps (everything else) next.

Journal Newspaper Business

The Journal financials are pretty easy to understand given that it is just the Milwaukee Sentinel that has been contributed. Operating results for the last five years and 9m14 have been filed in the prospectus. From this we can see Journal has more or less stabilized its margins post-2011 and has managed the decline in the last few years quite well. Revenues for LTMSep14 are off only 2% or so. EBITDA has also remained flat and margin has crept up slightly from 2012.

It’s worth a more granular look at how they have managed this decline.

We can derive a few observations from these results:

1. Stabilizing Revenues: Like every other newspaper company out there advertising revenues have been coming down, albeit in LTMSep14 the decline has been largely halted. Interestingly enough, the subscription revenues have been nearly flat over the last few years. Subscribers have come down slightly which indicates the company has been able to push through some small price increases.

    

2. Stabilized Margins: The Company has been able to strip out both COGS and G&A costs to maintain their EBITDA margin at around 11%. SG&A as a % of revenue is quite low here compared to competitors in the industry. In fact, it is by far the lowest of any comp we have seen. Management indicated the corporate allocations to Journal were about right in terms of where they would be as a public company. This should be taken with a grain of salt.  

Scripps Newspaper Business

Here are Scripps financials:

As Scripps’ revenue has come down, EBITDA has followed. It’s worth diving into the financials a bit deeper.

Here it becomes pretty obvious what the problem is. On the revenue side Scripps is similar to Journal. Scripps has been able to keep subscription revenue flat however advertising has been falling at a mid-single digit annual decline rate. On the cost side, COGS has actually come down slightly as a % of revenue but SG&A has not only stayed roughly flat, but also increased as a % of revenue due to the revenue declines. Looking at the SG&A from the Scripps 10-K filed, we can see why:

Some of the employee comp and other expenses have to do with how the Company allocates into various buckets (some IT people went into corp overhead in 2014) but the main reason for the lack of G&A decrease to off-set declining revenues comes from the corporate allocation. This is where the rubber hits the road in terms of what JMG as a combined entity is worth.

Bridging the Gap From Reported EBITDA to Pro-Forma EBITDA

Here are the reported combined financials for JMG:

For LTMSep14 combined EBITDA was $12M of which Journal contributed $18 and Scripps contributed negative $6M (there are rounding differences here, it’s close enough). Based on every other publishing company’s filings and discussions with Management we know that Q414 was worse than Q413 so it’s fair to assume LTMSep14 likely overstates full year 2014 somewhat.

In order to get a rough approximation for where Management is coming up with their $48M of pro-forma EBITDA we can look to the proxy and the estimates used by Management in determining the values of the business. Of course these are squishy but it’s a roadmap.

In the proxy each company took a stab at estimates for their own business and for their merging partner. The average EBITDA above simply takes the average of each valuation (so for Journal we averaged what Journal thinks their business will do and what Scripps thinks Journal’s business will do). These were done in July or so and things got worse in the 2^nd half so this certainly isn’t perfect.

But here we can see the $52M in EBITDA for 2014 is pretty close to the $48M put forth by Management in their roadshow slide deck. In fact, if you add back the $5M in transition expenses, the $48M plus the $5M transition expenses comes awfully close to the $51.6M above. So if we need to get to $48M from $12M here we can at least see where management expects to get it in terms of Journal and Scripps.

One thing to note is that in the prospectus/proxy the Company indicated they see $35M in synergies across both the publishing AND the broadcasting business. Given the size of these two business one would think broadcasting would get more of the synergies, however management did not break this out and did not want to discuss this on our call given what was disclosed. So, somehow we need to pick up $36M in EBITDA for JMG where the entire deal only provides $35M in synergies.

Here is what we are pretty confident about:

1. COGS synergies should not be material given their footprint. Management confirmed this

2. Journal was already run pretty lean and the corp allocations were on par for a stand-alone company according to management. That does raise some questions about how you get to $5M in increased EBITDA for Journal (2014 estimate from above of $22.7M and LTMSep14 of $18M). It’s not the biggest piece of the puzzle however so we did not grill them on this

3. Apparently Scripps put all kinds of expenses into the corporate allocation that did not come with the combined company

Number three is the most important by far because the only way to pick up $36M in EBITDA with a combined $35M (of which a fair amount is probably broadcasting) of synergies is by having a historical allocation that does not reflect your ongoing business….in other words costs that are not yours even though they were allocated to you.

This is the story management is telling as well. Apparently Scripps pushed down a large amount of costs related to digital strategies that are either staying with Scripps Broadcasting or being discontinued. We were not able to get a great feel exactly what these initiatives were or how much exactly they cost, but it would appear they were material…at least to JMG.

If we assume the synergies between broadcasting and publishing are 1/3 JMG and 2/3 broadcasting that would indicate $12M to JMG in synergies. Adding back $6M in pension plan expense that should be roughly $500K now gets you another $5.5M.  That’s $17.5M of the $36M we need to bridge the gap. That would indicate the digital strategies were around $20M of cost a year that should disappear.

A fair retort to this is that this is conjecture without hard numbers. We can’t disagree with that but it also does not sound crazy to us that Scripps would want to put as much expense as possible into the publishing business that none of the analysts followed or really cared about and make their broadcasting business look as good as possible. Given that broadcasting largely drove the stock, the incentives were certainly there for Scripps management to do that.

The fact that a fair share of the EBITDA “GAAP” from reported to pro-forma is not synergies but allocated costs that will not continue makes us much more confident than if they were relying purely on “synergies”.

A final check here would be just to look at the implied SG&A as a % of revenue and overall EBITDA margin against some of its “comps”. We are fully aware there aren’t great comps out there anymore but we will have to take what we can get.

Based on the above assumptions, G&A would come in at 34.2% of revenue and the EBITDA margin would be 8.9%. We have found two comps that have broken down SG&A, NEWM and TPUB. Two data points isn’t great but it’s better than nothing.

In the Q414 earnings presentation (page 19) NEWM shows $652M of revenue and $212M in SG&A. That comes out to SG&A as a % of revenue at 32.5% which is comparable to the assumed SG&A of JMG. All in NEWM’s 2014 Adjusted EBITDA margin was 13.7%.

In TPUB’s 2014 Southwest Ideas Investor Conference presentation TPUB reported (LTMSep14) $1.7B of revenue and $619M of SG&A. This calcs to 35.6% of revenue TPUB’s 2014 pro-forma EBITDA margin was 9.4%

On the other hand, AHC’s 2014 EBITDA margin is only 6.2%.

These three data points do not tell a perfect story but they do confirm that the expected SG&A and EBITDA margin are not 100% out of left field. The question of course is who is running this thing and can they / are they incentivized to pull this off.

Management

CEO

The Company will be run by Tim Stautberg. Mr. Stautberg was the CFO of Scripps (the entire company) from 2009-2011 and in Aug11 left that role to run Scripps’ newspaper business. Now there are, of course, a couple of ways to read this:

1. He oversaw the newspaper segment’s significant decline in EBITDA and failed to fix it

2. He knows how to fix it and now that he is running the show as CEO of the entire company as compared to an SVP of the overall Scripps company, he will have the ability to fix it

One thing that provides at least some measure of comfort: Mr. Stautberg has effectively signed off on the EBITDA estimates, both in their use for the valuation of the businesses in the merger and also in the Mar15 company presentation. It’s hard to imagine Mr. Stautberg would have put those numbers out there at the start if he did not have a feeling they could at least get close to them. In fact, you would expect a new CEO to sandbag those numbers. That being said, a lot of us saw how those TPUB estimates worked out only a few months later despite management’s best “estimates”.

In terms of compensation, Mr. Stautberg will be required to own 3x his base comp in stock (other execs 2x). There will be an LTIP which is expected to start in 2016. There will also be “Founders” grants (must be nice) for execs to ensure they have “significant equity stakes in JMG”. It would be better if they had to purchase said equity stakes in JMG but such is corporate governance in America. His base comp will be $700K and he is getting a grant of 120% of his base salary, so roughly $840K.

On top of the $840K Founders Grant, Mr. Stautberg owns roughly 56K shares which are currently valued at $475K. All in all, he should own currently around $1.375M of stock or roughly 0.67% of the stock. The LTIP will be able to issue up to 2M shares (8% of the Company), so that should get him up to his 3x salary goal of $2.1M worth of shares (roughly 1% of the Company).

For those VICers who also do financial planning, Mr. Stautberg also received $15K worth of financial planning compensation to figure out what to do with his new found wealth.

Chairman

Steven Smith, the Chairman and CEO of the old Journal, will be non-executive Chairman. Mr. Smith should own 235K shares according to the prospectus (most recent Form 4 says 160K shares…either way it is over $1M).

Other large holders

The largest holders at the spin were GAMCO (6.8%), Dimensional (6.3%) and Blackrock (5.2%).

Valuation

So of course the question is what would you pay for a declining business that requires some faith in management around the “pro-forma” SG&A numbers Some scenarios would be helpful.

For some perspective, AHC trades around 5x, TPUB around 6x and NEWM around 8x. This makes sense given the businesses EBITDA margins with AHC around 6%, TPUB around 9% and NEWM around 13%. So, depending on where you think the margins for JMG will shake out, there is some variance. Here is how we see it:

This gives us a 1:1 reward to risk on base to low and 3:1 high to low. The lack of leverage is critical here and the land may be worth something to the right buyer although it’s purely an option and not part of the overall thesis. To be honest, we also don’t see any reason why this company needs to exist as its own independent entity.

Just to round this out, management also guided to $27.5M D&A and $5M CAPEX. If we assume an 8% margin, so $40M of EBITDA, we can expect a couple of million in taxes and $5M in CAPEX. This gets us to $32M in FCF. That puts us less than 7x FCF on the current EV. Buying at less than 7x FCF, coupled with its strong balance sheet, gives us enough margin of safety to buy into a declining business.

Disclaimer: This research report expresses our research opinions, which we have based upon certain facts, all of which are based upon publicly available information. Any investment involves substantial risks, including complete loss of capital. Any forecasts or estimates are for illustrative purpose only and should not be taken as limitations of the maximum possible loss or gain. Any information contained in this report may include forward-looking statements, expectations, and projections. You should assume these types of statements, expectations, and projections may turn out to be incorrect. This is not investment advice nor should it be construed as such. You should do your own research and due diligence before making any investment decision with respect to securities covered herein. The author and his clients have a position in this stock and may add, reduce or sell out of the position completely without informing readers.