|Shares Out. (in M):||109||P/E||26.5||38.6|
|Market Cap (in $M):||2,396||P/FCF||13.2||14.2|
|Net Debt (in $M):||857||EBIT||238||130|
|Borrow Cost:||General Collateral|
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TIME INC. (NYSE: TIME)
TARGET PRICE: $8-$14
RETURN (NET): 32%-55%
TIMING: 6-24 MONTHS
Time Inc. (“Time”) is the largest print magazine company in the U.S. with 24% market share. It has over 90 titles globally / 23 titles in the U.S. including PEOPLE, Sports Illustrated, InStyle, TIME Magazine and Real Simple. It was spun out of Time Warner in June 2014 and is the only public pure play magazine company. Time generated FY 2014 revenues of $3.3Bn, EBITDA of $525MM, and free cash flow of $385MM. The Company generates the majority of its revenues through magazine sales (33% of sales) and related advertising (54%). Time mainly operates in mature markets, and generates 82% of its sales in the U.S. and 13% in the U.K. Additionally Time has subscale third party book and magazine publishing services that account for the balance of its sales (13%).
Magazine industry revenues in the U.S. are in decline and the rate of decline has been accelerating in recent years. Circulation is declining by 2-3% per year driven by annual declines in single copy sales of 13% and subscription sales of 2%. Additionally advertising revenues, which account for over 50% of industry sales and a higher portion of profits, are declining at 7-8% per year. This decline in advertising revenues is being driven by 1) a decline in circulation, and 2) a decline in ad pages per magazine. As circulation declines, the available advertising inventory for sale referred to as total ad pages declines in proportion. The decline in ad pages per issue, which is largely driven by an increasing preference by advertisers for more cost efficient forms of advertising such as online, accelerates the decline in total ad pages. This confluence of negative headwinds has resulted in total ad pages declining 7-8% annually. To date, magazine publishers have chosen to hold pricing on ad inventory in the face of falling demand resulting in the aforementioned decline in ad pages. As demand for magazines continues to fall driven by shifting ad spend from print to digital media, magazine companies will likely have to capitulate on pricing to be more in line with digital advertising CPMs (cost per thousand impressions), which would further exacerbate declines in advertising revenue. Magazine publishers currently charge large price premiums in excess of two times digital alternatives.
Furthermore, in the event of revenue declines the magazine industry will face challenges to profitability given its high fixed cost structure and low profit margins. Time currently runs at an operating margin of 13%, with fixed costs representing over 65% of sales. Alternatively said, for every $10MM decline in sales, operating profit will decline by at least $6MM on average. Declines in sales from advertising will result in greater operating profit declines given the minimal variable costs associated with advertising revenue. This combination of declining revenues and high operating leverage in a business with low margins can result in drastic declines in free cash flow from only modest declines in revenue. Furthermore, Time management has been proactive at identifying opportunities for cost cutting and has been communicative with the market on the timing and scope of these cost cuts. While substantial, the identified cost cuts are not sufficient to offset the negative revenue trends in the business. Given Time’s declining revenues and limited cost savings opportunities, the Company has considerable exposure to a sizeable decline in earnings.
Furthermore, Time has limited strategic alternatives to unlock value. The Company has largely sold their valuable non-core assets (i.e. real estate) and value enhancing M&A is unlikely. The only logical acquirer of Time in the magazine industry is Meredith, which has a magazine business that accounts for 50% of its profits. However an acquisition of Time by Meredith is unlikely given that 1) Meredith has shown little interest in acquiring Time in its entirety (Meredith 2014 Q1 earnings call), 2) the transaction would only be accretive at a small premium to Time’s current trading value and 3) the transaction would be tax inefficient until the summer of 2016 given Time’s recent spin out (Time 2014 Q4 earnings call) at which point in time Meredith’s ability to offer Time shareholders a healthy takeover premium would be further reduced because deal synergies would have been greatly reduced by Time management’s execution of overlapping cost saving opportunities. Meredith has shown some interest in acquiring select Time magazine brands, but such a transaction would likely be dilutive for Time given that Meredith would target Time’s best performing brands and that brand sales would be tax inefficient given the likely low basis of assets being sold. The other magazine publishers of scale that would have meaningful synergies, Conde Nast and Hearst, are family owned and not interested in engaging in large strategic M&A (Time 2014 Q4 earnings call). There is always a possibility that a non-economically driven buyer of Time emerges such as was the case with Jeff Bezos and the Washington Post, John Henry’s purchase of the Boston Globe and Warren Buffett’s purchase of Media General’s. However, I view this scenario as unlikely for Time in its entirety given that it would be a large purchase by any standards at ~$4Bn. The sale of select brands is possible, but still unlikely given the high price that would have to be offered to offset tax leakage from low tax bases and loss of scale benefits and resulting reduction in earnings under new ownership. However, it is possible that a non-economically motivated buyer with an affinity for one or more of Time’s magazine’s brand would offer the Company an accretive transaction.
In light of the secular challenges facing the magazine industry, Time’s management has begun to increase investments directed at transitioning the business from print to digital. Time’s transition to digital is in its infancy as evidenced by the Company’s marginal 2% digital magazine circulation adoption and 17% contribution to advertising revenues from online. The transition to digital will likely be value destructive due to Time’s reduced ability 1) to charge for content online given the large amounts of often free and easily accessible alternatives, and 2) to command magazine level ad rates online where ad inventory is abundant and ad rates are lower. Only the most premium editorial brands such as the Wall Street Journal and The Economist have been able to charge consumers the same rate for their content digitally as they do in print. Digital pricing will likely have to decrease in the future in order to stem print subscriber losses, which would result in declining circulation revenues for magazine producers. Additionally, providing print content online opens magazines to new competition. Digital distribution of content opens new growth potential, but also sets these magazines up directly against established mainstream websites and even many blogs that have gained traction. Many of Time’s brands occupy leading category ranks among print magazines, but have failed to maintain their advantageous competitive positioning in the transition to digital. To the extent that readership shifts from print to online, Time will continue to face meaningful pressure from new sources of competition.
Finally, the magazine industry is poorly understood by the Street. Time Inc was a small part of media conglomerate Time Warner (8% of profits) until the spin-off in June 2014, and as a result had poor financial disclosure. Naturally, investors and sell side coverage analysts had limited interest in the business given its limited relevance to Time Warner. Currently, Time is covered by analysts with limited experience analyzing print businesses in decline. The Street is not modeling the business properly creating a sizeable delta between projections and the earnings potential of the business. A key example of this short coming is how the Street is modeling cost cuts for Time. As I discuss in detail later in this write-up, the Street is implying massive additional headcount reductions at Time in 2015 and 2016 earnings projections that are unrealistic and will likely result in the Company missing projections by a meaningful margin. Additionally, the Street is projecting a return to revenue growth in 3-4 years which is optimistic given the significant challenges involved in transitioning a historically print business to digital medium while growing earnings.
I recommend shorting Time with a target price for the business of $8-$14 or a net return of 32%-55% (after dividends, easy to borrow, and a timeframe of 6-24 months. I value Time on a free cash flow yield basis assuming a range of 8-15%, which is in line with businesses with similar free cash flow decline profiles and where Time currently trades, applied to my base, downside and upside operating case scenarios. I believe that there are multiple catalysts to send the stock lower including a continuation / acceleration of negative operating results, increased clarity on future profitability through earnings results and better disclosure, negative stock re-ratings by sell side analysts, poor capital allocation decisions by management towards low ROIC investments in digital and the passage of time without a value creating M&A transaction of size or management commentary downplaying the probability of such an event occurring. The risks to my thesis include the timing and magnitude of magazine industry declines, M&A and to a significantly lesser degree higher than expected cost savings and an earnings accretive transition of the business from print to digital.
1) Magazine Circulation is in Decline and Accelerating
Both subscription and single copy circulation have declined in recent years at accelerating paces (see table below). Single copy sales are declining rapidly driven by an increasing allocation of shelf space at newsstands to more profitable (higher turnover / margin) products such as confectionary goods. This is particularly concerning for magazine companies given that single copies sold through newsstands are generally three to four times the price of copies sold through subscriptions and account for the majority of operating profits generated by circulation revenues given the low margin characteristics of circulation copy sales. While subscription copy sales have declined moderately to date, they have shown signs of accelerating in recent years which could continue given the secular headwinds that face print media.
Many of Time’s core and largest magazine brands including People, TIME Magazine, Sports Illustrated, Money and Entertainment Weekly have exhibited similar negative circulation trends as the broader magazine industry. Time’s portfolio in aggregate is declining in the low single digits, while the profitable single copy sales are declining at high single digit rates (see tables below). Last quarter, Time’s circulation revenues declined 8% organically, driven by 6% and 12% organic declines in subscription and single copy revenues respectively.
2) Magazine Advertising is in Decline Driven by Circulation Reductions and Marketing Spend Shifts to Digital
Demand for print advertising of all forms including magazines, newspapers, direct mail and directories have been in decline since the early 2000s. Print advertising spend market share has declined from 59% of total ad industry spend to 35% in 2014 and is projected to decline to 21% by 2021 (see table below). Given that total advertising industry spend has historically grown at GDP growth rates, it is unlikely that total dollars spent on advertising will grow meaningfully in the future. As a result, it is likely that print advertising spend will continue to decline from this combination of declining market share and modest advertising spend growth.
Not surprisingly, magazine advertising revenues have been declining in the high single digits in recent years. This has been driven by the previously discussed decline in magazine circulation and a decline in ad pages per magazine issue (see table below). Ad pages per issue have been declining in the high single digits driven by a decline in demand for magazine advertising in favor of more cost efficient alternative forms of advertising. As a result of the decline in ad pages per issue and low to mid single digit declines in circulation, total ad pages have been declining at a brisk 13%.
In recent years, advertisers have become increasingly focused on allocating marketing budgets towards higher return on investment forms of advertising. As previously discussed, this has resulted in a clear shift of marketing dollars away from traditional mediums such as print advertising towards newer forms of advertising such as digital. One of the most widely accepted forms of measuring the reach of an advertisement is known as a CPM or the cost of an advertisement per one thousand impressions made. This measurement can also be used as a means to compare the cost effectiveness of advertisement types across the various medium. Magazine advertisements are one of the most expensive forms of advertising on a CPM basis and can cost in excess of ten times an online advertisement (see table below). This price premium that magazines charge is likely unsustainable given adoption of digital advertising mediums and a heightened focus on data driven allocation of ad dollars towards cost efficient mediums by Chief Marketing Officers. Furthermore, magazine advertisements are sold on a guaranteed minimum level of magazine circulation known as an ad rate base. If the committed base rate is not met, the price paid by advertisers is adjusted downwards meaningfully. This could result in additional downward pressure on effective CPM rates going forward.
3) Transition to Digital will be Value Destructive
It is challenging to convince consumers to pay for print content online. Only the most premium editorial brands such as the Wall Street Journal and The Economist have been able to charge consumers equivalent rates for their content digitally as they do in print (see table below). Digital content pricing is generally lower priced than print content as is the case with the New York Times, or is only offered in a bundled package with a print subscription as is the case with Time Magazine, People Magazine and Vanity Fair. Magazine brands have attempted to protect magazine pricing by either not providing a digital only subscription option, or pricing the digital only option higher than the print option. This has resulted in very modest digital magazine circulation. Digital magazine circulation represents only 2% of total magazine circulation despite many magazines having offered digital subscription options for over five years. Digital pricing will likely have to decrease in the future in order to stem print subscriber losses, which would result in declining circulation revenue for magazine producers.
Additionally, providing print content online exposes magazines to new competition for readership dollars and impressions that can be sold to advertisers. Digital content places magazines directly in competition with both established mainstream websites with large content budgets and innovative blogs that have gained market share with marginal capital spend. The internet is a relatively low cost form of distribution for content allowing poorly funding blogs to flourish, and is capable of distributing print, video and audio content effectively putting magazine companies at a disadvantage relative to companies that are providing consumers with a broader array of content. As shown in the table below, many of Time’s brands occupy leading category ranks among print magazines, but have predictably failed to transition into the digital world. For example, Sports Illustrated which is the leading sports magazine brand is only ranked 16th in website hits amongst sports brands, and is behind established sites like ESPN.com but also relatively new and modestly funded blogs such as Deadspin.com and SBnation.com. This phenomenon is also true for some of Time’s other leading magazine brands such as TIME Magazine, Money, People and Entertainment Weekly (see table below). To the extent that readership shifts from print to online, Time will continue to face meaningful pressure from new sources of competition.
Finally, as previously discussed, digital advertising pricing is substantially lower than print advertising pricing (see “Advertising Rates by CPM Medium” table). To the extent that eyeballs shift from print magazines to online magazine content, the overall advertising revenue pool that magazine companies earn will likely decrease due to lower average CPM rates driven by the mix shift from print to online ad inventory.
4) Magazine Business Model is Poorly Understood by the Market
Up until the spin-off in June 2014 Time Inc was a small and relatively unimportant part of the large cap media conglomerate Time Warner, which released limited information on the subsidiary. Accordingly, investors and sell side coverage analysts had limited interest in the business. Currently, Time is covered by analysts with limited experience covering print businesses in decline (see table below). Only four of the eight analysts covering Time cover other print businesses, and of those four analysts three primarily focus on covering television related content companies. Furthermore, Time is the only pure play public magazine media asset. As a result of the lack of information on the magazine business model available to investors, I believe that the market is not modeling the business properly creating a sizeable delta between projections and the earnings potential of the business, which I will discuss in detail (see “Divergence from the Street” section).
5) Limited Strategic Alternatives to Unlock Value
Time management has already completed or is executing on the low hanging fruit options to unlock value at the company including a sizeable headcount reduction and real estate consolidation. The Company provided the market with detailed cost savings figures at the time of the spin out and these figures are already accounted for in analyst projections. The remaining sizeable source of potential strategic value that investors point to is a sale of the Time business to Meredith which has its own sizeable magazine business (along with broadcast television assets). However, I view this transaction as unlikely for a number of reasons. Both Meredith and Time management have publicly stated that they’re not interested in a combination. Time’s CEO stated that he believes that the transaction could not occur in a tax efficient manner until the summer of 2016, at which point many of the synergies that would make the transaction compelling would have already been implemented by Time management (Q4 2014 earnings call). Furthermore, even if both companies were to agree on a transaction given the relative trading multiples, limitations on desired pro forma debt, and the relative sizes of the businesses, an acquisition of Time by Meredith would only be accretive up to a modest premium from where Time is trading today and Meredith would end up with less than 50% of pro forma ownership (see table below). As noted earlier, Meredith’s ability to pay would only decrease as time passes and the size of the cost synergy opportunity deceases. As a result, I do not view an acquisition of Time by Meredith as a credible threat to the bear thesis.
6) Limited Ability to Cut Costs Meaningfully
Time management has prioritized cutting costs in the business and provided clarity on specific areas where the Company can achieve cost cuts. Nevertheless, analysts are overestimating fixed cost reductions substantially. Time has provided the public with figures that allow investors to bridge from the Company’s 2014 realized cost base to 2015 projections (see table below). The identified adjustments to the 2014 include the following items. The Company has targeted $110MM of annual savings of which $40MM were achieved in 2014, leaving an incremental $70MM of run-rate savings in 2015 onwards. The Company is moving headquarters from the Time Life building in midtown Manhattan to a lower rent location in downtown Manhattan, and will realize $80MM of net savings starting in 2016. The Company has identified $70MM of new public company costs of which it realized $41MM in 2014 for the 7 months that Time was a public company, leaving an incremental $29MM of run-rate public company costs in 2015 onwards. Lastly, the Company identified $38MM of incremental ongoing annual expenses related to its digital business that it expects to incur in 2015 onwards. This results in projected incremental costs of $34MM in 2015 and annual cost savings of $55MM in 2016 and 2017. These figures compare to annual cost savings of $100-150MM that the Street is projecting. Given the headcount reduction that would be necessary to reach these cost savings figures, it is extremely unlikely that the Company will accomplish these figures. I discuss this in detail in the following Divergence from the Street section of the write-up.
DIVERGENCE FROM THE STREET
My financial projections differ from the Street in two important areas 1) core revenues, and 2) fixed costs.
On revenues, I believe that analysts are underestimating the future decline in both advertising and circulation (see table below). The Street is projecting a return to revenue growth in 3-4 years which is optimistic given the significant challenges involved in transitioning a historically print business to digital medium while growing earnings. In advertising, I have print revenues declining at 9-10% vs. the Street which is projecting a 12% decline in 2015 and then much lower rates of decline in 2016-17. I’ve based my projections on the most recent 2014 organic decline rates and do not see a basis for reducing the decline rate in 2016-17 given that data that I previously discussed indicates that we’re likely in the early stages of a secular decline. On digital advertising, I have revenues growing at 8-15% over the next three years vs. the Street which is projecting 16-27% growth. I’ve based my projections on a belief that the Company will be able to grow its digital advertising revenues as it focuses its efforts on monetizing its websites, but as previously discussed, I believe that the value of their websites is becoming increasingly marginalized relative to the alternative sources of often free content online and the growing availability of online ad inventory which should increasingly put pressure on ad rates.
On circulation, I have subscription revenues declining at 6-8% vs. the Street which is projecting declines of 2-5%. I have newsstand revenues declining at 6-8% vs. the Street which is projecting declines of 3-7%. With regards to both sources of circulation revenues, I’ve based my projections on the most recent 2014 organic decline rates and do not see a basis for reducing the decline rate in 2016-17 given that data that I previously discussed indicates that we’re likely in the early stages of a secular decline.
On costs, I believe that analysts are overestimating Time’s ability to reduce fixed costs substantially (see table below). I have operating costs declining by 3%, 3% and 2% in 2015, 2016 and 2017 respectively, vs. the Street which is projecting declines of 6%, 3% and 1% respectively. This difference is largely driven by the Streets projections for meaningfully larger declines in fixed costs (SG&A, Production Overhead and Editorial Costs).