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 Careerbuilder.com. 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
Careerbuilder.com 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.
Valuation
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).
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