The future of traditional media is in jeopardy. Traditional media is fighting for survival in the Facebook, Twitter, instant news era. Throughout the developed counties, traditional media such as television stations, newspapers, radio have all seen declining revenue to varying degrees over the last decade. Worst hit is the print publishing with circulation continuing to fall and advertising dollars being channelled more and more every year to Google, Facebook etc, some say the business model is broken.
For more on the dire straits of the publishing business, watch this ABC documentary. http://www.abc.net.au/mediawatch/transcripts/s4481060.htm
Naturally, the level of investor expectation reflected in the share price of traditional media companies is very low, which is where I like to start searching for some hidden gems.
Enter New Zealand Media and Entertainment (NZME).
NZME is the leading media company in New Zealand with publishing, radio and e-commerce businesses. Up till June 2016, NZME was part of the APN group and was subsequently spun off as part of corporate restructuring exercise.
NZME’s publishing division has a network of six regional daily newspapers, 23 community newspapers and includes The New Zealand Herald (NZ Herald) which is the #1 read national newspaper, reaching 1.3 million (publishing and online) New Zealanders each week. The New Zealand market is much smaller and more concentrated than the Australian market. Unlike Australia, New Zealand market consists of one national paper with a few regional papers. The national paper NZ Herald has an annual circulation (Dec 2016) of 123,793 compared with #2 newspaper in the country, The Dominion Post which has a circulation of 52,115 – mainly Wellington (Dec 2016) (source: newspaper.abc.org.nz).
As well as having the #1 newspaper, the radio division operates Newstalk ZB, the #1 radio station in New Zealand. The radio division operates 9 stations across New Zealand and has a 37% audience share of the commercial radio market which reaches more than 1.4 million Kiwis. Newstalk ZB operates a talkback radio format and has a 10.1% commercial radio market share according to the latest 2016 GFK survey.
Although the talkback format is more popular with the baby boomer generation, audience stickiness is usually higher than music stations due to loyalty to the radio host. Popular radio host such as Mike Hosking have a loyal fan base and that drives Newstalk ZB’s market share.
Its ecommerce business is represented by Grabone, which promotes daily deals in New Zealand. GrabOne gets its revenue from commissions which are driven by a combination of site visits, conversion rates (proportion of visits which results in a sale), average value of orders and he commission rates. NZME is also utilising GrabOne as a platform to leverage existing brands through digital display advertising and transaction commissions.
Divisional earnings trend
From a reporting perspective, NZME segmental reporting after the spin-off has less clarity on the earnings of each division. However, to get a glimpse of their individual earnings, I referred to APN’s past reports.
The trend for the publishing business is undeniably heading south and consistent with the global trends. The e-commerce business is also under pressure.
From a valuation perspective, in assessing whether NZME was a good buy, I inverted the problem to find a solution. There weren’t many comparable pure play publishing companies listed on the ASX and with the publishing business being in structural decline it was difficult to work out what it was worth with a reasonable degree of certainty. On the other hand, the radio business was much easier to value given the consistency of its earnings and available references. I wasn’t too worried about the e-commerce business as it was insignificant compared to the publishing and radio divisions.
In 2014, APN acquired the remaining 50% of the radio division (which included both Australian and New Zealand divisions) for A$246.5m which represented an EBITDA transaction multiple of 6.9x. This implies a transacted value of the NZ radio business of around NZ$150 million using historical exchange rate.
The above transaction multiple is consistent with the current trading multiple of Macquarie Media, a radio broadcaster with comparable size and profit margins. The half year results imply that the forward EBITDA multiple may be lower.
Adopting an EBITDA multiple of 6.7x results in a NZ$144.7 million ($21.6m x 6.7) valuation of the radio business. In assessing the above value, I’ve used the FY15 segmental EBITDA less pro-rata share of the unallocated cost.
Using this radio valuation, I worked out what implied value the market is placing on NZME publishing and e-commerce business.
Based on the current share price, the market is implying a valuation of 2.6x to the e-commerce and publishing business. I believe this is very low given it has by far the #1 newspaper in New Zealand and some of the following growth initiatives being rolled out by management:
- Merged divisions to create “one newsroom” for efficient multi-platform content creation.
- Leverage on the integrated, multi-platform sales proposition.
- Cost savings initiatives which delivered savings exceeding NZ$20 million in FY16.
- Diversifying revenue by growing digital audience
Although revenue declined by 6% in FY16, it appears that some of these initiatives have managed to maintain earnings (EBITDA and NPAT) at levels similar to prior year which is the first time NZME has been able to do so within the last 4 years. There may be additional scope for cost cutting (management may have kept this low hanging fruit for FY17). Fairfax NZ reported margins are still higher than NZME even though they operate more newspaper publications.
A potential avenue for revenue which hasn’t been tapped is a paywall. In Australia, Newscorp and Fairfax all have some form of paywall for their news sites. The Otago Daily Times, a regional newspaper in New Zealand introduced a metered paywall in 2016.
Fairfax NZ merger
A key catalyst for re-rating of this stock would be if the Fairfax NZ merger gets the go ahead from the New Zealand Commerce Commission (NCC). A merger with Fairfax NZ would create significant synergies as it would bring together the NZ’s two largest newspaper networks and two largest news website. The merger would create a dominant news company with an audience reach of 3.7 million (>80% of NZ’s population), dare I say a monopoly.
The consideration for the merger will include a cash payment of NZ$55 million and an issuance of 136.2 million NZME shares to Fairfax NZ, representing 41% interest in the combined company.
To value the consideration, I assume that the combined entity will be valued on the same EBITDA multiple as NZME which maybe not be completely accurate given NZME has a different mix of businesses.
Yeah, I know many of you would argue that it’s too simplistic to assume the combined firm would be valued on the current NZME multiple given the higher value assigned to the radio division which is a fair point. In response I would point out that the above analysis does not include any synergies, which in my opinion would be substantial and would more than offset the potentially erroneous multiple assumption. Having said that, an EBITDA multiple of 3.9x is not overly unreasonable and in-line with some reports showing publishing businesses being valued at an EBITDA multiple of 3-4x.
In November 2016, the regulator NCC issued a draft report rejecting the deal on the basis of quality and media plurality which they believe would deteriorate after a merger. In response, NZME shares fell from NZ$0.70 to a low of NZ$0.49 cents. Based on the market reaction, it appears to me that the market believes this deal to be value accretive rather than dilutive.
So based on the above analysis, the merger could potentially lift the share price to NZ$1.13 from NZ$0.85 (A$0.79) currently. However, I don’t know whether the NCC will give the green light (although they have recently extended the review process – which I understand is a good sign) so we’ll just have to wait and see.
It is assumed that the industry that publishing will continue to see advertising dollars fall away so I won’t add anything further.
In my opinion, management has sound initiatives to stem the decline (multi-platform sales) and growth of new revenue sources (digital). The key is generating quality journalism that their audience will pay for and leveraging their existing channels for distribution. The risk is in the execution of this strategy.
There is also a currency risk but given the close correlation between the Kiwi and Aussie dollar, I’m not too worried about it.
Even though the share price has moved up quite rapidly since reporting it’s FY16 results, I think the company is still a buy for the following reasons. Given the recent run up in price, the shares may pull back as punters take profit.
- The market is selling the #1 newspaper and #1 radio station in New Zealand and is trading at an EBITDA multiple of 3.9x or price earnings multiple of 6.0x.
- A possible merger with Fairfax on the cards with would bring significant synergies make it by far the dominant news content provider in NZ.
- After the spin-off, there is more alignment (and control) between management’s remuneration to the Company’s results which may provide better incentives.
- Digital revenue is growing and the company has an option to put up a paywall on the NZ Herald website.
- NZME paid a NZ$0.095 dividend for the FY16. At the share price of NZ$0.85 this represents a dividend of 11.2%.
Joel Greenblatt’s “You can be a stock market genius” talks about the merits of investing in spin-offs and studies have suggested that spin-offs do outperform the market. The great thing about spin-offs is that at inception, there is a lack of competitive bidding for the shares (unlike an IPO) and since it is an inefficient way of distributing shares, some shareholders like index funds or ETF (who are not mandated to hold these shares) are forced to sell their shares which create downward pressure in the first few months.