Extracting costs – and cash
For newspapers, access to capital at anything approaching a reasonable rate is now impossible. Usually, given the circular logic that prevails in the world of investing, the presence of the smart money alone convinces others to jump in without looking too closely at what they’re buying. The opposite holds true, too. Once one bank turns down a deal, the others reflexively follow suit. Most institutional investors began to smell a rat four of five years ago and decided to keep their wallets in their pockets when newspapers came begging. That left only the hedge funds. Enter Alden Global Capital, run by Randy Smith, the man who practically invented vulture investing.
Once again a hard-nosed financial practitioner was buffaloed by a record of remarkable cash generation. Like Sam Zell with Tribune or Warren Buffett with the Washington Post, Smith failed to understand that the Internet had blown up the monopoly on which newspaper profit was based. He thought there was still plenty of cash to be extracted through a long, slow decline from 40% margins to zero. But instead, newspapers fell off a cliff.
Alden stepped in to finance distressed newspaper chains until it found itself with significant holdings in the Media News Group and Journal Register Company, later combined into Digital First Media, and also McClatchy, Belo, Gannett, Freedom Communications, Philadelphia Newspaper Holdings, even Tribune Company. Then it started operating like a private equity company. Around here we like to call that “corporate hospice.” All the familiar tools were applied, including of course that old staple, “strategic bankruptcies” to solve the problem of “legacy obligations” such as underfunded defined pension plans.
But to make his money, Alden had to get the companies sold. That meant they had to be perfumed by conjuring up the potential for earnings recovery and share growth. So markets were cut and consolidated and clustered for “operating efficiencies.” And then Alden proclaimed they were betting on digital. They seemed to be serious. But for “digital” to work, investors would have to see digital subscriber growth and increased margin. They didn’t. They still haven’t, despite John Paton’s promises at Digital First. So returns continued to head south. Under the age-old Theory of the Greater Fool, there is probably another patsy or two out there even at this late stage who think more value can be extracted from these properties through “better” management, more “astute” marketing, a “long term perspective” and my personal favorite, a “higher commitment to quality journalism.” In our time we’ve seen plenty come and go, especially the believers in “quality journalism.” They write for themselves, not the market, it’s a fatal flaw.
Alden found a few buyers who brought into their pitch about efficiencies and digital recovery. They took most of the newspapers off Alden’s hands. Digital First is all that’s left now, and it’s on the block. Smith is halfway out the door.
Most deleveragers talk a good game, they have to, they get to see themselves in the mirror every morning, but the only differentiating plan they ever seem to have is a less encumbered approach to asset-stripping than everybody else. Because Alden became the last source of capital, the capital it provided was very expensive. Any and all free cash flow is going to be applied first and foremost to servicing that debt. The desperate strategy of stacking leverage on top of leverage on top of leverage cannot end well. But private equity did what private equity does. It rode a legacy business down, taking costs out as quickly as possible to recoup the money as quickly as possible. In this case the private equity smart money bet on a horse too late in the race. It had already pulled up lame.
So here’s how the story will end. We call it the “Sayonara Strategy.” You began to see it in 2015 and the pace will quicken through 2017 and on.
Newspapers are going to stop printing a newspaper every day. They’re not even going to fall back to producing a newspaper three of four times a week, as Advance Newspapers, a very pragmatic company with an unusual degree of moxie, has already done. As the final step in cost-cutting, they’re going to print only a weekend newspaper. They will distribute it with a part-time delivery force only on Sundays.
They will finesse this final stage by promising to provide breaking local news during the week on their online newspaper. The Sunday print edit will promote readers to the digital companion product.
Most newspapers now lose money six days out of seven, anyway. Sunday is their savior. The Sunday-only publishing cycle spreads production demand over the week, leveraging sunk capital. Sunday circulation has declined more slowly, and Sunday advertising now represents in some cases as much as 50% or more of total advertising, thanks mainly to pre-printed inserts delivered into specific zip codes. In other words, there’s still a little Sunday business. There is no classifieds advertising in the print newspaper, that’s long gone, but there’s still some local retail display advertising.
Some will say that the digital product should be accessible through a paywall at a low, bundled subscription. Whatever. I wouldn’t go there, all the evidence suggests that the product lacks sufficient intrinsic competitive value to support a fee-based model.
Since it’s way too late for digital innovation, full cycle reduction like this is nothing but an exit strategy. It’s not a long-term plan. It’s not a Hail Mary. But this last gasp is ultimately all that’s left. Dispensing with the expense of everyday operations might actually prolong life. Even a poor soul with an incurable illness can sometimes gain a little more time with an amputation. It’s better than pretending that nothing is happening.
Figuring on the back of an envelope, the annual print revenue in a major market from this play is perhaps $20-$25 million today, with a lower margin even than the companion online service. There, maybe, revenues can be worked up to $5-10 million. It’s a stretch, perhaps delusional, it’s not even close to the 50% print/digital revenue split newspaper companies would once have killed for, but in a metropolitan market you can maybe get to a $35 million business throwing off $5 million a year. But that’s it.
You won’t get there in a straight line. A newspaper company will now always find itself behind the eight-ball technologically and functionally, so today’s revenue guess will no longer prevail after the next 12 months.There’s no significant long term balance sheet improvement. Nor is there any prospect of long-term audience growth. Many newspapers will hesitate to rely completely on a digital substitute during the week so at first they’ll offer a scaled-down print product once or twice a week, like Advance. But economics will drive them all the way there sooner rather than later. It’s called the law of diminishing returns.
The timing for making such a transition is obviously critical, with even keener expense management there may still be time to mine still more financial value out of the daily print product, but you heard it here first: Once one big newspaper takes the plunge and makes the call for full cycle reduction, it will be a stampede.
As business circumstances change in response to evolving market forces, great pressure is placed on the existing financial formula. But there is usually very little room for adjustment. No business formula can be applied outside the competitive context for which it evolved. It must be jettisoned and replaced. But newspapers simply substituted “users” for “readers” in their formula and carried on happily replicating their newspaper on the Internet, trying to make the comforting principles of local news and monopoly pricing and broad reach work in the new world of targeted, databased, digital distribution. They simply substituted digits for trucks. The driving force of advertising efficiency may have changed the world of marketing forever, but it couldn’t change the way newspapers go to market.
See, that’s the problem with any business formula. It becomes habit-forming. Newspapers had been milked dry. They had no capacity or appetite for the kind of radical change that would have resulted in setting new products free to create new value and new growth.
So sadly, all that’s left now is an exit strategy.