Tuesday, November 29, 2005
November 29th 2005 - Financial Times
This article was published Financial Times on page 14. Ironically I originally wrote this article about six months ago, but it was pushed back by my other pieces. It was a product of my research on Gannett (GCI), which we decided not to buy--the stock has declined almost 30% since. Google’s (GOOG) incredible top-line growth which is approaching GCI’s very quickly is a sign that there is more pain for newspapers to come. Newspaper stocks are way down from last year's highs, looking cheaper than lowest grade dirt relative to their past premium to the market valuations. Gannett, Knight Ridder and Tribune are trading at a 10-20 per cent discount to the market PE. But "brand" name newspaper stocks - Dow Jones, Washington Post and New York Times - are still trading at a premium PE in spite of their declines. This might look tempting to value investors. But the situation is more dangerous than it appears. Newspaper stocks at the moment represent a "value trap". If the direst predictions are fulfilled and newspapers turn into payphones in a cellphone world, current share prices do not look good. There are several short-term reasons why newspaper stocks are down. First, they are facing tough comparisons with last year's numbers that were bloated by political advertising. Second, although employment advertisements have rebounded, car ads took a plunge because of tough comparisons with last year's numbers and a general decline in spending by car dealers. Finally, circulation has continued a decline that began in the mid 1990s. Much of this will soon reverse. Unfortunately for the rest of us, and fortunately for the newspapers, political advertising will be back next year. And, in the absence of making good cars, US carmakers will have to lure consumers with increased advertising. Thus the softness observed over the last several months should be short-lived. But the news is not that good for circulation, where decline may prove to be a long-lived, secular phenomenon. The internet is changing the way we read. Old habits die hard, and thus the decline in circulation has been in very low single digits. It has not fallen off a cliff. But the decline has taken place when population and gross domestic product have been growing. The internet is a perfect vehicle to deliver news and editorials to consumers. The incremental cost of delivery is virtually free and delivery is instantaneous, benefits not shared by "pulp-made" newspapers. The internet has commoditized news, through services such as Google News, subsequently driving the price of that commodity to zero. Only a handful of newspapers are able to charge for online content and readers are not paying for the "news" content, as there are plenty of free sources of news on the internet. They are generally paying for interpretation and editorials. Local newspapers, once considered a sweet spot in newspaper business as they traditionally had a quasi-monopoly on local print advertising, are still charging advertisers a fat premium over national newspapers. But things are about to change. Google is already luring dollars away from traditional forms of advertising. It is likely to take things a step further by localizing and customizing search technology - a direct threat to the fat profit margins of local newspapers. The recent rush of large newspaper organizations to throw huge sums of money at online properties is an indication of confusion and panic rather than a clear strategy. In Rupert Murdoch's speech to the American Society of Newspaper Editors he indicated that newspapers have not worked out how to embrace the internet and are rapidly losing younger readers. The New York Times' web traffic fell 23 per cent in the last year, according to Mr Murdoch, not a figure you would want to see in a world where online advertising is growing in double digits. It must have been unwelcome data on the eve of the Times' attempt to start charging for some content. Newspapers are not going away. Century-old habits will keep consumers reading them for quite a while. But this doesn't necessarily make newspapers a good investment; the internet creates an unwelcome headwind, and earnings growth is uncertain. Until now, the industry has masked the declining circulation by raising advertising prices. Advertisers are a number crunching bunch and at some point they will realise they are forced to pay more for less every year. Thus increases in advertising rates are not sustainable. Given the new competition from the internet, that trend is likely to reverse. In the short run ad revenues may get a boost from the resumption of car and political advertisements, and acquisition chatter - as has already been seen in Knight Ridder - may lift an interest in newspaper stocks. However, the long-run prospects are a lot less certain, setting a likely value trap for bargain hunting investors. Will newspapers become payphones in a cellphone world? This possibility is already discounted to some degree in the shares of Gannett, Knight Ridder and Tribune. But the "brand" papers' valuations still don't reflect that plausible outcome. Vitaliy Katsenelson is a portfolio manager at Investment Management Associates and teaches at the University of Colorado in Denver. Vitaliy N. Katsenelson, CFA This article is written for educational purposes only. It is not intended as a recommendation (or advice) to buy or sell securities. Author and/or his employer may have a position in the securities discussed in this article. Security positions may change at any time.