Monday, January 27, 2014

GCI: Gannett remains a value-play

If you look at the chart on Gannett Co., Inc. (GCI), you might think we are a bit late on this name as it has moved up more than 36% during the past 12 months; and this includes the 10% decline in the stock during the last two weeks.  However, we think it is a value-play with enough upside and not much downside, making it an attractive name.  The Company is profitable and recently closed an accretive acquisition which we think will improve its overall operating margins and cash flow going forward.  On a 'base' case scenario assumption, the 50/50 combination of our DCF and sum-of-parts valuations methods spits out a $38.61 per share valuation of GCI, which represents a 41.1% upside from where it closed on 1/27.  The stock could decline a bit more given the recent pull-back in the overall market, which we still regard as overvalued.  However, we think over time and basically ignoring its Q4 results (which will be released on 2/4), the market will realize what we consider to be GCI's fair value.

Gannett is a media company operating mainly in the US and UK.  It owns the well-known and widely read USA TODAY newspaper, along with 82 daily publications serving local markets.  This part of its business is the publishing segment.  GCI's digital segment consists mainly of also the well-known and widely used  And the Company has a broadcasting segment consisting of 23 TV stations in the US as of the end of 2013.  GCI's TV stations will jump to 41 this year as it completed the acquisition of another media company, Belo, in late 2013.    

Broadcast Segment

GCI's broadcasting segment is what mainly attracted us to this name.  It became much bigger after the Belo acquisition, which will nearly double GCI's TV stations this year and puts its market penetration, in terms of US TV households (HHs), at close to 35%, approaching the regulated limit which is 39%.  The deal was an all-cash deal at approx. $1.5bil, 85% of which was financed with debt.     

Business in this segment is very seasonal, and seasonality comes from large events that bring in a lot of TV spots and therefore revenues.  Election years, especially Presidential election years, and Olympic years, both even years, are the best years for broadcasting.  For this reason, Y/Y growth doesn't provide a clear picture of how the broadcast segment is performing.  

Excluding Belo TV stations, we think TV ad revenues will grow at an average rate of 3.4% during the odd years up to 2019. That figure will likely be 5.6% during the even years, helped by Olympics and elections.  Within the even years, political spending during Presidential elections drive growth rate higher than in the mid-term election years.  As compared with 2012, we expect GCI to generate 26% more TV ad revenues in 2016, which is the next Presidential election.  In our opinion, this is mainly due to the fact that no candidate will be running for re-election and that Hillary Clinton will likely participate, which means a lot of money will be spent, on both sides.  We expect 6.3% TV ad revenue growth during mid-term election years.  Again, these figures exclude the acquisition of Belo.  With 18 additional Belo stations, GCI TV ad revenues will be significantly higher.  

We note that the Company will also benefit much more from the Super Bowl ads in 2015 and 2016 as the game will be broadcast on NBC and CBS, respectively.  Post Belo acquisition, GCI is the number one NBC and CBS affiliate in the country.   

The second part of GCI's broadcasting segment, retransmission revenues, also make it attractive.  These revenues are what GCI gets paid by cable, satellite, and other distributors which have to carry the TV station channels due to FCC regulations.  Retransmission revenues, although they represent only around 1/5 of total broadcast revenues, are practically 100% margin and go straight to the bottom line.  GCI and many of its peers have been successful at renewing their contracts (with average duration of 3 years) with cable and satellite companies at higher prices.  We expect such 'inflation' to continue at an average of 10% per year, in a base case.  In fact, we think our assumption might be a bit conservative as other studies, such as one conducted by SNL Kagan, expect a 16.6% CAGR in overall retransmission revenues from 2013 until end of 2018.  While we hope they are correct, the 3-year average duration of those contracts, which force both parties to agree to a fixed annual price increase, may prevent TV stations to demand a higher price every year until contract renewals come up.  

Based on the assumptions mentioned above, we expect retransmission revenues to represent nearly 28% of broadcast revenues by end of 2019.

Total broadcast top-line growth, which includes growth in the 100% margin retransmission revenues, will drive margin expansion in this segment.  In our base case scenario, we expect broadcast operating margin to increase to 52% in 2019, from an estimated 48% in 2013.  We have EBITDA margin growing to 55.2% from 51.2% during the same period.  

This year's winter Olympics and what will likely be heated mid-term elections (which include gubernatorial elections in CA, FL, MI, NY, and TX), we believe, are near-term catalysts that will drive growth in GCI's broadcast segment.

Digital Segment

GCI's digital segment is again mainly composed of which is growing but is in a very competitive space.  We note that revenues from the digital segment do not include digital revenues generated in publishing or broadcasting.  Careerbuilder acquired EMSI, Economic Modeling Specialists Intl., in 2012.  This acquisition has given it more access to economic data as Careerbuilder is trying to enhance its services in terms of HR management software and analytics (mainly for seeking, finding, and hiring the right talent) that it provides to current and potential clients.  Based on various annual NFP and job opening estimates, along with our 40% - 45% assumption of Careerbuilder's market share, we believe GCI's digital segment revenues grew 5% in 2013.  We think those revenues will grow approx. 5.6% this year and at a 6-year CAGR of around 3% by 2019.

We believe this segment will continue to be profitable and its operating margin will expand slightly from what we think was 18.5% in 2013, to 19% this year and 19.5% by 2019.

Publishing Segment

Revenues generated in publishing include ad and circulation revenues.  Ad revenues consist of print ads and online ads (ads on newspapers' websites).  Growth of online ads continues to be more than offset by decline in print ads.  And due to the online ad pricing pressure brought on by Google (GOOG), Facebook (FB), Twitter (TWTR), etc., we do not think GCI's publishing digital ad growth will be enough to turn around its total publishing ad revenues.  

In the US, print ad revenues declined at approx. 8% per year from 2003 until end of 2012.  And while the newspapers' online ad revenues grew at an average rate of nearly 11% per year, their total ad revenues declined by 7% per year.  This is due to the fact that print ads still represent over 80% of total ad revenues for newspapers.  We think this 80/20 print/online will go down to around 57/43 by end of 2019.  In addition, we estimate newspaper online ad growth to average at around 12% until 2019, but we also think print ads will decline at more than 7% per year.  

GCI also provides digital marketing services to local small and medium businesses within the markets that its publications serve.  Growth in these services will also help slowdown the decline in print ads.  But while GCI is likely to experience online ad and marketing services growth, continuing decline in print ads will persist.  We estimate total publishing ad revenues to decline at a -1.5% 6-year CAGR until 2019.

GCI's publishing circulation revenues, basically what readers and subscribers pay for its publications, increased 5% in 2012, but we think they were flat in 2013 and expect them to remain flat this year and once again begin to decline in 2015.  GCI implemented a new online subscription model in 2012 within some of its markets, which with 'auto-pay', helped push circulation revenues up a bit.  The Company then applied this model to the rest of its markets in 2013.  We do not expect the Company to attract more readers for its premium content.  For this reason we think circulation revenues likely began to flatten out in 2013 and will not change much this year.  The Company has increased the content within its publications by including more national related content from its USA TODAY.  We are not sure whether this strategy will be applied to all of its newspapers.  In addition, and more importantly, whether this move can help grow volume of circulation, remains to be seen.   

With all of this said, GCI's publishing segment will remain profitable, although we look for lower operating margin given lack of top-line growth.  We have assumed publishing operating margin of approx. 8.5% for 2013, which we think will decline to 8% this year and 7.25% by 2019.  We have EBITDA margin moving from 11% in 2013 to 10% this year and 8.3% by 2019.

Financial Condition

The Company's balance sheet was strong prior to the acquisition and will remain strong post acquisition, in our opinion.  GCI generates enough cash to not only easily pay interest on its debt but also amortize the principal at a 10% annual rate, which is what we have assumed going forward.  We expect GCI's EBIT interest coverage ratio to increase from 5.2 in 2013 (our estimate) to 8.7 in 2019.  EBITDA interest coverage will likely go up to 9.7 from 6.4.  If the Company does amortize its principal at a 10% rate, it could end up with a net cash balance on its balance sheet by 2017, assuming it will not raise additional capital by issuing more debt.  And we see the debt ratio decline to 19.3% in 2019 from what we think was 36.0% in 2013.

GCI certainly faces some risks such as a much faster decline in its newspaper business, not being able to renew the retransmission contracts at higher prices, and a much slower growth, or decline, in the economy resulting in less job openings.  We believe we have accounted for those and other risks in the base case scenario of our model.  There are, of course risks associated with the overall equity market.  For example, we continue to believe the market is currently overvalued and driven higher mainly by the Fed's QE programs.  However, as described above, GCI, as a company, remains attractive and undervalued, in our opinion.  If we see a correction in the overall market, it is very likely that GCI will also decline; but we think over time the Company's performance will convince the market to value it at its fair value, which we believe is higher than where the stock is currently trading.


In terms of valuation, our DCF model results in a per share valuation range of $35.26 - $53.89, with the base case being at $44.27.  Due to the large swings in TV ad revenues and margin (which impact CF very positively), when comparing even and odd years, we took the average EBITDA of the last two years in our model as the terminal year EBITDA to which we applied a 7.5x terminal value EBITDA multiple.   For this reason we also included the same number of odd years as even years, which forced us to apply a 6-year DCF model to value GCI.  We also valued GCI using a sum-of-parts model, which resulted in a $26.68 - $39.48 range, based on 5x publishing EBITDA, and 8x digital and broadcast EBITDA; with the base case being at $32.95.  The EBITDA estimates used in this valuation are the average of our EBITDA projections for FY '14 and FY '15, due to the same reasons we mentioned when discussing the DCF model.  

A 50/50 combination of DCF and sum-of-parts base case valuations results in a $38.61 valuation of GCI, representing a 41.1% upside from where it closed on Monday (1/27).  Some of our projections are provided below (click on image).

No comments:

Post a Comment