Description

Wegener with a 53% market share is by far the largest publisher of regional newspapers in the Netherlands. It has 28% share of the overall newspaper market, and is one of three groups that control 90% of the total market. Newspapers make up 77% of group sales, of which 70% are paid dailies, (circulation 44%, ad revenue 56%) the remainder free door-to-door weeklies. The other division is a pan European direct marketing group active in the Netherlands, UK, Belgium and France. The group recently agreed to sell 70% of its distribution activities to Deutsche Post, which is expected to close in the 4th quarter.
Further information can be found at www.wegener.nl

Positives

1. Valuation: Wegener has an equity value of 225m euros and net debt (including a 90m convertible as debt) of 385m for a EV of 610m and expected ’02 sales of 929m, depressed ’02 EBITDA will be 106m (down from a peak of 163m) At less than 6x depressed EBITDA wegener sells at 2/3 the level of US newspaper companies and half of private market values. However that is with a current 11.5% EBIDTA Margin. Management thinks it could get on a normalized basis to a 20% margin, which would still be well below the 30%+ margins other US and UK regionals achieve. Due to the financial leverage a lot of earnings and FCF accrue to the equity owners, cash EPS (IAS still amortizes goodwill in the P&L) is expected to be 0.51 euro cents down from a peak of 1.4 in 2000, and FCF per share will be 0.95 cents. So the company sells for very low multiples of both depressed and peak earnings and ongoing FCF.

2. Cost reduction: I have some confidence that they will be able to get to these margins due to the fact that they bought VNU’s regional newspapers in 1999 that increased their newspaper exposure by over 50% but due to various anti-trust issues the full integration of these newspapers did not start to take place until this year, in total 40m in costs are expected to be taken out of the cost base by 2004. Printing plants will be consolidated from eight to four, a 5% reduction in the workforce has already taken place in 2002. These saving have not been evident due to the severe downturn in ad volumes. The Dutch ad market was down 17% in the first half, Wagener’s ad volumes were down 10% (regional papers tend to be more resilient in downturns)

3. Market Position: Wegener like most regional newspaper publishers have benefited from consolidation over the last 15 years, wherein most regions have gone from having multiple newspapers to being local monopolies. The number of publishers has gone from 25 to 10 in the Netherlands over the last 15 years. While circulation is slowly eroding, the competition for local advertising is limited and hence both ad rates and subscription rates have been and are likely to rise by more than inflation.


4. Free cash flow generation is predictably strong given the market position and the subscription-based model (negative net working capital). No major capital expenditure projects are planned until 2006, I estimate that the company will be able to generate in excess of 40m euros in FCF per year. Return on Capital Employed (pre-goodwill) is high at 29% and is expected to rise sharply in the coming years due to a return to a more normal advertising market and limited capital investment.

Negatives

1. Balance sheet: Clearly the market is worried about the combination of operational and financial gearing in Wegener. While it is unlikely that Wegener will have any problems meeting its interest payments as operating free cash flow will be about 4x interest expense this year and improving next year as cost reductions kick in and regular repayments of 35m every half year which can be met from a credit facility and free cash flow. They do have a 160m bullet repayment in November ’04 that will need to be refinanced and a 90m convertible (conversion price 18.15 euros) in April ’05. Given the FCF, the cost reductions and further peripheral assets that management have identified to be sold they should be able to problem refinancing these debts. Management expects senior debt/EBIDTA < 2x and EBIDTA/interest > 6x by the end of ’03. Management has not disclosed the convents but say they have a lot of headroom.

2. Management: They are seen as competent newspapermen but have not been great at allocating capital. They paid 12x EBITDA for VNU’s newspapers in November 1999, which in hindsight was peak earnings and a full multiple. They also had a foray into music publishing and retailing in the mid 90’s, which they subsequently sold off at a loss. But now due to the increased debt load they have a renewed focus on the newspaper division and more importantly on profitably. The cost reduction program has to date been successful and they have sold off lower margin distribution and printing assets. They have also benchmarked themselves to higher margin UK regional publishers.

Catalyst

There has been panic surrounding any equity that has real or perceived liquidity issues, a more rational evaluation of cash generation ability and financial stability will lead to revaluation of Wegener. Stabilization in the advertising market, and further progress on debt reduction are also important drivers.
I see a more normal valuation of Wegener at 8x EBITDA, if EBITDA margins went to just 16% in 2005 with no increase in revenues, and they paid back 40m of debt a year, that would equate to a stock price of 20 euros per share. This would be 15x earnings on the same basis, which I see as a reasonable valuation for a strong franchise.