Assessing GateHouse, er, New Media Investment Group

GateHouse Media now operates within New Media Investment Group. It is a spinoff of Newcastle Investment Corp. -– a real estate investment trust affiliated with Fortress Investment Group LLC.

You can now buy stock in New Media Investment Group. If you owned GateHouse stock, you have the right to buy New Media stock at a discount.

So what do we know about New Media?

New Media still believes in newspapers, which is a good thing for the United Media Guild members working in Peoria, Pekin, Springfield and Rockford. CEO Michael Reed challenged the notion that his industry is a “melting ice cube” during a conference call for investors.

Analysts seem impressed by the current absence of debt, an anomaly in the newspaper industry. Analysts support the strategy of buying newspaper companies at their dramatically lower, post-recession prices.

After all, if Warren Buffett believes this is a good idea, it must be a good idea.

The opening New Media stock price seems to be in the ballpark of true value, although a price drop seems inevitable when Newcastle investors dump stock to get out of the media business.

Compass Point gave the stock a “buy” rating.

“At a high level, NEWM’s business strategy is simple: implement technological improvements and make strategic acquisitions,” analyst Jason Stewart wrote. “The company has several levers to pull for growth, and unlike some of its peers, a clean fair value balance sheet and minimal leverage.

“Our 2014 and 2015 estimates reflect declining circulation volumes and lower advertising revenue per publication, which is in-line with industry estimates. Currently, shares of NEWM trade at a ratio of enterprise value to 2015 EBITDA of 5.7x, compared to peers who trade at 7.5x, despite better growth prospects and a lower debt-to-equity ratio. In addition to higher growth prospects, NEWM is expected to be the only dividend-paying publicly traded newspaper company.”

Meanwhile the Clark Street Value blog was more guardedly optimistic last month.

“There is a track record here, as Newcastle/Fortress was able to buy Local Media from News Corp at roughly 3.4x EBITDA (after backing out the real estate value).  By doing this, Fortress projects they can earn 20-25 percent unleveraged returns, and 30-35 percent return on equity with leverage.  New Media will also get attention from investors as it plans to pay out a significant portion of their cash flow in the form of a dividend.”

But it also observed:

“New Media will be externally managed by Fortress Investment Group, a large private equity/alternative investment manager with little direct expertise with media companies.  Fortress is handsomely paid for this arrangement; it receives 1.5 percent of equity annually and 25 percent of adjusted profits (adding back depreciation and amortization, among other adjustments) above a 10 percent hurdle, so you’re essentially investing in a cheap media company with a private equity fee wrapper.  The advantage of having a private equity fund manage an operating business is the capital allocation, Fortress says they have identified up to $1 billion in potential acquisition targets in the near term, which would almost quadruple the size of the company (and presumably add operating leverage along the way).

“But external managers have their downsides, (1) the management fee is based on assets which essentially incentivizes them to increase the asset base irrespective of the price they pay for the assets, and (2) the incentive fee may cause the manager to take unnecessary risks as their payoff is skewed to the upside and they don’t participate equally in the downside.”

And . . .

“Another question I have is around the potential incentive alignments with an acquisition, to me New Media would best be run as a short term vehicle that would later be acquired by a true private equity investor or a larger media company.  But its unclear to me how that would benefit Fortress and if they’d really go for it?  Yes, they have a decent size equity position, but the fees they earn from keeping New Media as a separate entity far outweigh any premium they would get for their equity in a buyout scenario.”

Here are UMG’s concerns about the company:

  • Relentless cost-cutting has diminished the quality of New Media newspapers. While the company improved its cash flow by slashing newsroom staffing, it also invited readership decline.
  • Aggressive circulation pricing also contributed to readership erosion. We fear circulation revenue won’t stay nearly as stable as Reed predicted in his conference call.
  • Readership decline accelerates the migration of advertising to other media.
  • The debilitating employee churn extends to the very top of newspaper operations. At the State Journal-Register – one of the key properties in the company – publishers have come and gone at a dizzying pace.
  • Digital advertising will keep growing, but not fast enough to offset print revenue declines. More robust websites could speed that growth, but New Media has stripped many of its news operations to the skeleton.
  • Propel Marketing might or might not become a significant revenue source. As Reed noted, New Media is in the “top of the first inning” with this venture. Clark Street Value didn’t put much stock in it. Salespeople in the smaller markets are finding it especially hard to sell.

We hope New Media gathers steam coming out of its reorganization. But we fear it will lack staying power if it doesn’t reinvest in its operations at meaningful levels.

The company does a nice job with recruiting and training new employees, but it should place more value in experience, expertise, community knowledge and source relationships. To remain a trusted provider of valued local news, it must retain journalists, photographers, editors and digital specialists with the expertise and market experience to produce consistently compelling content.

If New Media loses those audiences, what will it have?