Description
Telegraaf Holdings, N.V. (Bloomberg Ticker: TEAC NA, price = EUR 18.01) is a Netherlands- based newspaper and magazine publisher with a #1 audience market share in the country’s daily newspaper market (at 33%) with its flagship paper, De Telegraaf (40% market share in the national paper segment and almost 48% of total revenues). The Company also publishes several other media including regionalne wspapers (30%) and door-to-door newspapers (11%), consumer magazines (8%) and other activities (owns a radio station, and other internet media properties - 3%). Telegraaf competes in the oligopolistic Dutch newspaper paper market with two other major players: Wegener, which represents about 30% of the market (Telegraaf actually owns 23.9% of Wegener’s equity) and PCM which has about 28% of the market (privately held). De Telegraaf has over a 100 year operating history, and is one of the few global media companies that operates with no balance sheet debt.
--Telegraaf’s valuation is attractive given the company’s leverage to the advertising recovery in the Netherlands.
In FY03, the company posted EBITDA of EUR 77mm, which is nearly 50% of the EBITDA generated in FY00 (EUR 144mm), at the peak of the advertising market. With an economic and advertising recovery taking root in the Netherlands (congruent with the ad recovery in other industrialized nations), Telegraaf will undoubtedly be able to regain a large part of these lost advertising revenues over the next 2-3 years. An advertising recovery, coupled with the removal of EUR 28mm in fixed costs from its cost structure, Telegraaf could easily earn EUR 135+MM in annual EBITDA over the next 3 years (prior to unallocated/ overhead expenses, which run at about 10mm per year). At the current market cap of EUR 945mm less balance sheet cash of EUR 65mm, it is trading at only 6.5x mid-cycle EBITDA. Historically Dutch newspapers, similar to those in the rest of Europe, have traded at multiples of 8.5x-10x (which slightly lower vs. US multiples due to higher labor cost structures). Gannett over the past couple of years acquired two UK-based newspaper companies for cash flow multiples in excess of 10x. Telegraaf also owns real estate which is estimated to have an off balance sheet value (in excess of book) of EUR 400mm; its 23.9% equity stake in a major national newspaper competitor Wegener is currently worth EUR ~80mm (publicly traded, but relatively illiquid); and its ownership in other media properties, including a JV with a Dutch Broadcasting company (SBS Broadcasting), have a book value of EUR 48mm. Assuming it takes 3 years for the ad market to recover to more normalized levels, at which point Telegraaf would generate EUR 135+mm in EBITDA (this includes the EUR 28mm in cost cuts and therefore does not assume the peak level of ad revenue achieved during the‘bubble years’); applying an 8.5x -10x multiple on normalized EBITDA less company overhead would yield a valuation of EUR 1.16BN – 1.36BN. Adding this to the value of the Company’s real estate and investments less balance sheet cash of EUR 65mm results in an enterprise valuation of EUR1.63BN – 1.8BN; This represents an 85%-108% appreciation potential on the stock over the next three years. The company’s balance sheet is essentially debt-free and the Company also currently pays a cash dividend of 0.11 / share (yield of .61% )
--Telegraaf generates significant free cash flow given minimal capex and no interest payments. When looking at Telegraaf, it closely resembles US and UK newspaper companies with respect to all the major attributes: susceptible to economic/ad cycles, cost structures (with Dutch papers having a little more fixed labor costs), high EBITDA margins, low levels of capital spending to maintain the business, and high returns on invested capital (average pre-tax ROIC of 17% on Telegraaf’s established newspapers business). With Telegraaf, again similar to US newspaper companies, the EBITDA and cash flow from operating activities track each other pretty closely after one backs out taxes from operating cash flow; this is typical of newspaper companies given that most of the assets generating the cash flow are long-term fixed assets (net working capital as a % of the balance sheet capital is a small percentage and working capital items don’t fluctuate that dramatically in the operating cash flow statement). Even during Telegraaf’s worst year in 2002, operating cash flow less capex was negative EUR 5mm. In FY03 (still a very depressed year), operating cash flow was EUR 62MM and free cash flow (cash flow less) capex measured EUR 35mm. Run rate capex is pretty minimal or EUR 30-40MM on average (in line w/ depreciation rates), which means that when operating cash flow gets to a normalized level of EUR 130mm, free cash flow would measure EUR 90mm + (a 10% free cash flow yield on the market cap less cash, even before taking into account the value of off-balance sheet assets).
-- Dutch Newspaper revenue drivers are similar to those in most other countries. Newspapers in the Netherlands are cyclical businesses similar to newspapers in the US or any other industrialized country, with economic health, employment levels, and consumer spending being the drivers of advertising expenditures, and hence the drivers of newspaper revenues. When the Dutch economy recovers, ad spending increases will be a part of that recovery. Telegraaf has actually increased its national paper market share in the Netherlands during this past recession (to around 33% from 26% in 1999 and 25% in 1997) largely at the expense of its competitors, thus it will likely disproportionately benefit once the ad market turns. In fact, we are seeing signs of this already; according to management, the ad market has turned in the first 9 weeks of 2004 and management projects a 5% growth in total revenues for 2004 (reaffirmed at the Company’s annual shareholder meeting in April).
Netherlands GDP growth vs. Newspaper Revenues vs. Telegraaf Revenues:
1997 1998 1999 2000 2001 2002 2003
GDP Growth 3.2% 3.8% 3.0% 2.7% 0.4% -0.6% -0.4%
Total Ad grwth 8.5% 11.3% 6.6% 9.3% -3.7% -3.4% -8.2%
Newspr. ad gr. 6.1% 12.4% 4.3% 5.3% -3.9% -7.8% -13.3%
Telegraaf ad gr.5.8% 11.8% 4.6% 12.4% 0.1% -4.6% -2.9%
--Telegraaf’s other revenue sources have been doing very well. As the charts below show, the lost revenue from Telegraaf from the 2000 peak is all from advertising (about half of total revenues); actually revenues in circulation/subscription (in magazines and newspapers) and other businesses (in particular internet related online revenues) have been increasing throughout the recession. Telegraaf lost about EUR 93mm in advertising revenues from the peak; if it regains half of this (EUR 47mm) through an ad recovery (represented by the Mid-Cycle Revenue column in the chart below), coupled with EUR 28MM in fixed costs, the Company will be generating significantly more cash flow.
In EUR mm Peak (2000) Trough (2003) Mid-Cycle
Ad Revenues 438mm 345mm 392mm
Other Revenues* 295mm 338mm 340mm
Total Revenues 733mm 683mm 732mm
* Most of printing division was divested in 2002. Other Revenues exclude this divested division.
--Dramatic cost cuts, coupled with an ad rebound, would yield a much higher EBITDA than today’s depressed metric. Given the large fixed-cost nature of the newspaper business (about 75%-80% of pre-depreciation costs are fixed), coupled with a company policy of lifetime employment for all workers, the Telegraaf experienced the worst year in its entire operating history as the Netherlands ad market fell post Sept 11th and in 2002. Classified and “Help Wanted” employment ads were particularly hit hard. This had the impact of slashing ad revenues by EUR 93mm (or 21%) over the 2001-2003 period, which in turn took EBITDA down to 87mm from a high of 144mm in FY00. As a response to the terrible market conditions, Telegraaf took an unprecedented step for a Dutch company: it abandoned its policy of lifetime employment in 2001 and initiated a cost cutting program (primarily cutting 500+ jobs) to be completed in the 2002-2005 timeframe. By YE 2004, about 90% of these job cuts will have been completed (will be 100% done by 2005). Coupled with other cost saving measures (primarily stemming internet losses & other costs), the Telegraaf has been able to reduce its annual fixed cost base by about EUR 28MM. Once the ad market recovers, much of the lost revenues will be regained and those revenue increases will drop right to the bottom line (again given the large fixed cost portion of the company’s total cost structure).
For the cost structure, I have used 2001 as the base cost structure, since it is the first year where the divested printing operations were stripped out on a pro-forma basis (these are lower margined operations), and the cost cuts implemented in 2001 really didn’t take effect until 2002. The 28mm in annual cost savings to be achieved by 2005 have been taken off the Wages & Salaries line, yielding an adjusted Mid-Cycle Wage/Salaries costs of 181mm. For all other margin assumptions, I used historical averages, which would be used to simulate a mid-cycle financial performance profile. EBITDA is reported before unallocated expenses, which yields a more accurate Private Market valuation (i.e. corporate overhead expenses shouldn’t be given an 8.5x-10x multiple, as in a combination/transaction, most of these costs would be eliminated except for content generation costs and some allocated overhead); For purposes of this valuation, the unallocated/overhead is given a typical 5x multiple.
Cost Structure (in EUR)
2001 2003 Mid-Cycle
Paper/Ink gross margin 86.0% 89.0% 88.5%
Gross Profit EUR 639mm 608mm 648mm
Wages/Salaries Costs 210mm 208mm 182mm
Other Op. Cost Margin 41% 40% 40%
Other Op Cost Cost EUR 301mm 275mm 292mm
Social Security EUR 40mm 48mm 48mm
Total Costs before
Unallocated Exp. 651mm 606mm 606mm
Property-level
EBITDA 97mm 87mm 136mm
Unallocated/Overhead 13mm 10mm 10mm
--Telegraaf’s real estate assets are worth EUR 400mm+ in excess of book. The gross book value of land and buildings on Telegraaf’s balance sheet (before accumulated depreciation), measures EUR 227MM. However, management has disclosed that it insures its buildings and other assets on the basis of replacement/reconstruction costs. As of FYE 2003, the insured sum amounted to EUR 683mm, an increase from 637mm at FYE02. Taking EUR 683mm in insured/replacement value, less gross book value of land/buildings of EUR 230mm, yields an “adjusted” off balance sheet real estate value of over EUR 400mm.
--Other assets are worth EUR 120+ mm. The 24% Wegener stake, as mentioned previously, has a public market value of ~ EUR 80mm. The rest of Telegraaf’s financial assets which are mostly partial ownership stakes (including SBS Broadcasting, and other magazine and local newspaper properties) have a FYE03 book value of EUR 40mm (I think assuming book value as a valuation point these assets is again pretty conservative). Taken together, the real estate and other assets have a value of EUR 530+mm.
--Taking the components of peak to trough revenue declines, coupled with the costs taken out since 2001, below is the mid-cycle valuation of Telegraaf, assuming the company regains only one half of its lost ad revenues from the peak in FY00. I have assumed a multiple of 8.5x EBITDA; in reality, the number one newspaper company in the Netherlands with leading market positions and a superior balance sheet should actually command a premium multiple vs. its competition & historical newspaper trading level averages; to this end, and EBITDA multiple of 10x could be argued..
Mid Cycle Valuation Model (in mm EUR):
2003 ad revenues 345mm
Add ½ of lost ad revenues (recovery scenario) 47mm
Mid Cycle Estimated Ad revenue increases 392mm
Plus Subscription, Single Copy & Other Sales 340mm
Total Mid Cycle Telegraaf Revenues 732mm
Gross margin after paper/ink/materials costs 88.5%
Gross margin (EUR) 648mm
Other Operating costs as % of sales 40%
Other Operating costs (EUR) (292)mm
Income Before Labor costs (EUR) 356mm
2001 Labor costs (EUR) (210)mm
Labor Cost Savings post headcount reductions 25mm
Other cost savings (internet losses & other) 3mm
Pro-Forma Labor costs (182)mm
Social Security (flat from 2003) (48)mm
Company EBITDA (EUR) 126mm
Unallocated/Other costs 10mm
Enterprise Property Valuation:
Property (Newspaper Only) Level EBITDA 136mm
Multiple on Property Level EBITDA: 8.5x – 10x
Property Value: 1.16 bn – 1.36bn
Unallocated/OH multiple 5x of 10mm (50)mm
Real Estate Value 400mm
Wegener Stake 80mm
Other Assets (SBS, internet, other properties) 40mm
Total Enterprise Valuation 1.63bn – 1.83bn
Current Market Cap 945mm
Market Cap less Balance Sheet Cash 880mm
Appreciation Potential on Equity (ex cash): 85%- 108%
Shares O/S 52.5mm
--The Dutch newspaper market has characteristics that significantly favor the Telegraaf. The triopoly in the national newspaper market (between Wegener and PCM) poses significant barriers to entry that are likely to protect the triopoly. Telegraaf’s 23.9% ownership in chief competitor Wegener (the only true publicly traded competitor w/an illiquid share base) gives the Company significant blocking control if some foreign newspaper company (in the US or more likely, the UK) were interested in competing with Wegener. In other industrialized nations, national newspaper markets tend to be more fragmented vs. the Netherlands. The three Dutch newspaper companies have basically maintained market share of around 30% each (+/-) a few percentage points for essentially the last 7 years (with Telegraaf and Wegener gaining share, PCM losing some share). There are few markets in the newspaper business (let alone any business) markets where the top three companies control 85%+ of the market.
--Telegraaf’s size, market position, and financial flexibility have allowed it to invest in new media and emerging businesses, particularly online classifieds and online issues of the Telegraaf, regional newspapers and community magazines. While the “new media/online” investments have historically lost money, almost anyone would agree that moving content and advertising online is a prudent investment for the long-term given that globally, per capita print-copy circulation is trending downward and there is a proclivity for younger audiences to get their news content online. In fact, in terms of total readership through all distribution modes (including print and online), newspapers have actually never been more popular. The issue is that most newspaper companies provide this online content for free and have not yet achieved the pricing model and economies of scale to harness the eventual advertising migration to online sources. Telegraaf, due to its strong business position and financial flexibility (no debt) has been able to invest significantly more in emerging media vs. its competitors (who are more debt laden and have limited investment capacity). Telegraaf has the strongest online position of the Dutch newspaper companies (in fact holds the 8th position in the Top 20 of most visited Dutch Internet sites and is #1 in terms of newspaper sites). Telegraaf also has more cross-platform potential due to its ownership stake (JV) in SBS Broadcasting (which owns TV stations in the Netherlands)
--Telegraaf’s readership demographic is favorable: Telegraaf has the youngest readership profile out of any Dutch newspaper company (according to NOM Print Monitor), with 30% of its newspaper readers being in the 13-34 year-old category (28% each in the 25-49 and 50-64 yr categories) and 18% being in the 65+ age category. The young readership profile is primarily due to some of the new business initiatives begun by Telegraaf, including two leading Dutch “free sheets” Spits and Metro, which focus more on younger demographics and entertainment related articles and ads in various communities. Since the launch of Spits four years ago, its circulation has risen to over 360,000. In terms of daily readers reached, Spits has become the #2 newspaper of the Netherlands, with over 1.5mm readers per day. The high proportion of readers targeted by such papers (young, professional, female, and ethnic readers) have different demographic characteristics (high income entertainment oriented) that are actually the most attractive groups to advertisers.
Weaknesses:
--Declining market share of newspaper-based classified advertising: Classified Advertising represents about 12% of Telegraaf’s total ad volume and this has been declining more rapidly during the ad recession versus the overall ad revenue category. In 2002 and 2003, classified ad volume fell by 17% during each year. While classified and help-wanted advertising is the most cyclical portion of newspaper revenues (similar declines have been posted in the recent US ad recession), there is an emerging trend of the internet being a more efficient medium for posting and sorting through classified ads. While not yet fully evident in the numbers, due to the relative newness of online advertising, Telegraaf is the best positioned newspaper company for distributing its content over multiple media outlets, though its strong online presence, its JV with SBS Broadcasting, and its numerous properties across several local/community papers and consumer magazines. In the US, we have seen that classified advertising online can be run with tremendous success, as witnessed with CareerBuilder (JV owned by Gannett, Knight Ridder, and Tribune) whose year-over-year growth in users approaching 125% (to 15.7mm users). Part of its success is in its ability to offer both a print and an online product to long-established local markets; given Telegraaf’s dominant market presence, its growing community newspaper business, its having the most advanced online platform and popular websites among newspapers, and its greater financial resources vs. its competitors, there is no reason why Telegraaf can’t enjoy success in this field as well. Moreover, aside from online advertising, Telegraaf’s other revenue sources (subscriptions, magazines) have also grown; as mentioned previously the Company’s non-ad related revenues has risen by EUR 43MM (15% growth) from 2000-2003, so the assertion that newspapers are a no-growth business is a mis-characterization.
--Stagnant circulation trends: Like most newspaper companies in the US, the Dutch market has also seen a modest decline in daily circulation trends. De Telegraaf’s subscriptions and single copy sales, which peaked in FY00 at around 800,000, has now dropped to around 730,000. The decrease in circulation was mainly caused by intensified competition from regional daily papers, which sought to deal with the ad recession by shifting their publishing times from the afternoon to the morning. Also, there have been a number of subscription cancellations by readers in relation to the economic situation and there was an absence of major international sporting events in FY02. The Company is dealing with these challenges by 1) introducing a new national de Telegraaf Sunday paper (launched in March 2004 for investment of EUR 20mm), which is expected to result in strong subscription take-rates that could easily reach 100k subs in a few years; 2) introducing a half the money subscription the daily de Telegraaf in certain markets; 3) introduction in 2003 of a national de Telegraaf Saturday only subscription (which has already gained over 25,000 subscribers). The effect of the last two items has been seen positively in the subscription-only piece, which has begun to stabilize (and actually increase from 2001 levels. With regard to single copy sales, which has fallen more precipitously, a rebounding economy coupled with more ‘normalized’ drivers of single copy sales (i.e. large sporting events in FY04 vs. FY03) and more competitive advertising in the Dutch food/grocery retail space should lead to minimally a stabilization of single-copy sales (which is congruent with recent company comments).
--Exposure to paper prices: As with any newspaper company, Paper and Ink prices are the largest variable cost component in Telegraaf’s cost structure (but still a small cost at about 10%-12% of sales pre depreciation vs. its 75% fixed cost base). While the company has not disclosed its newsprint strategy, looking at its operating history over the past 10 years (which include a wide variation in newsprint prices, particularly from the end of FY00 to FY02, when they witnessed a 14% increase), Telegraaf has managed its margins fairly well. Moreover, newspapers as a whole have the ability to pass on higher paper prices through subscription, single-copy, and ad rate increases, however these tend to be implemented with a lag.
--Limited Disclosure: Telegraaf’s financial disclosure is not as good as its US or UK-based counterparts, in terms of the content (notes and MD&A are more limited), and reporting frequency (the Dutch only report financials every six months). However, Telegraaf does produce financial statements and its semi-annual reports in English.
Catalyst
--Eventual advertising recovery, coupled with progress made in cutting costs, will result in nearly a doubling of cash flow, likely within the next 3-4 years.
--Debt-free balance sheet could be used for massive share repurchases (a possibility, however management has run this company with a very conservative balance sheet).
--Cheap price and ability to remove significant overhead would make Telegraaf an attractive candidate for an acquisition by a foreign newspaper company (Dutch national newspaper competitors currently have more leverage and are less attractive as candidates) or potentially private equity investors (who could lever the company particularly by mortgaging or doing a sale/leaseback on wholly-owned property).