Wednesday, September 27, 2006

The Newspaper Industry: Cheap or destined for failure?

The onset of the internet has revolutionalized many of our lives for the better, but newspapers are clearly one exception. The internet has reversed the core advantage that newspapers once enjoyed. Newspapers used to dominate their market and people relied on them to inform them of major and local events. Their only other news source was television, which usually was not as extensive and informative. This established a huge audience for newspapers, which was truly their prized asset. Newspapers used this audience to give advertisements and classified ads a way to reach a targeted and local market. Once a newspaper dominated a market, it was near impossible to establish a competing brand. For a long period, these companies used this competitive advantage to earn extremely high returns. Most the cash went straight to shareholder value, because newspapers had minimal capital expenditures that they needed to make.

The internet has changed that. Warren Buffett recently commented on newspaper companies at the 2006 annual shareholders meetings. (courtesy of hypergene Mediablog for the comments)

Do you think that the media business has become permanently less profitable due to new technology?

WB: People will always want to be entertained and informed. But people just have two eyeballs, and there are only 24 hours in a day. Fifty or 60 years ago, media for most people consisted of the local movie theater, radio, and the local newspaper. Now people have a variety of ways of being informed faster (if not necessarily better), and have more entertainment options, too. But no one has figured out a way to increase the time available to watch entertainment.

Whenever more competitors enter a business, the economics of that business tends to deteriorate. Newspapers are still highly profitable, but returns are falling. The size of the audience for network TV is declining. For years, cable TV was thought to operate in its own world, but that’s changing. Few businesses get better with more competitors.

The outlook for newspapers is not great. In the TV business, a license from the government was essentially the right to a royalty stream. There were basically three highways to people’s eyeballs, and companies like P&G, Ford, Gillette, and GM would pay a significant amount of money to be get on those highways and advertise their products to a mass audience. But as the ways to get in front of people’s eyeballs increases, the value of those highways goes down.

World Book used to sell 300,000 sets per year in the mid-1980s, each for $600. Then the Internet cam along; it didn’t require printing or shipping, and people became less willing to pay for World Book sets. It doesn’t mean that it’s not worth $600. But competition has eroded returns.

CM: It’s a rare business that doesn’t have a way worse future than it has a past.

WB: The thing to do was to buy the NFL when it was first organized. There are now more ways than ever to transit events; value can be extracted from them in different ways.

If you were looking at newspaper publishers as possible investments, what would you use as a margin of safety?

WB: What multiple should you for a company that earns $100 million per year whose earnings are falling by 5% per year rather than rising by 5% per year? Newspapers face the prospect of seeing their earnings erode indefinitely. It’s unlikely that at most papers, circulation or ad pages will be larger in five years than they are now. That’s even true in cities that are growing.

But most owners don’t yet see this protracted decline for what it is. The multiples on newspaper stocks are unattractively high. They are not cheap enough to compensate for the companies’ earnings power. Sometimes there’s a perception lag between the actual erosion of a business and how that erosion is seen by investors. Certain newspaper executives are going out and investing on other newspapers. I don’t see it. It’s hard to make money buying a business that’s in permanent decline. If anything, the decline is accelerating. Newspaper readers are heading into the cemetery, while newspaper non-readers are just getting out of college. The old virtuous circle, where big readership draws a lot of ads, which in turn draw more readers, has broken down.

Charlie and I think newspapers are indispensable. I read four a day. He reads five. We couldn’t live without them. But a lot of people can now. This used to be the ultimate bulletproof franchise. It’s not anymore.

CM: I used to think that GM was a bulletproof franchise. Now I’d put GM and newspapers in the “Too Hard” pile. If something is too hard to do, we look for something that isn’t too hard. What could be more obvious?

WB: It may be that no one has followed the newspaper business as closely as we have for as long as we have—50 years or more. It’s been interesting to watch newspaper owners and investors resist seeing what’s going on right in front of them. It used to be you couldn’t make a mistake managing a newspaper. It took no management skill—like TV stations. Your nephew could run one.

That pretty much sums it up. The internet added a huge new competitor by providing a cheaper and quicker way to distribute the news. This clearly has hurt their circulation numbers as more people have migrated to the use of internet. But the problem gets even worse. The internet also provided more effective ways of advertisement. Companies can use pay-per-click models to ensure that every advertising dollar corresponds with an interested user. Classifieds can target national or local markets for practically free through the use of Craigslist or other online classified sites. Newspapers don't seem to have a way to counteract either of these trends. Most companies were too slow to realize the changes happening before them with the interact and didnt prepare for these shifts.

All these problems could be overlooked if newspaper stocks were trading at the right price. But unfortunately, most of the companies are heavily leveraged and their stocks continue to trade at hefty multiples. If you use a discount rate of 10%, you would need a PE of at least 10 to justify flat earnings. But most companies still trade at multiples in the mid teens. These prices do not justify the inevitable deterioration of their core business. At a recent media conference, Warren Buffett raised his hand and asked an executive "If the internet had been invented first, do you think we'd have newspapers today?"
The executive thought for a little and finally responded with a no. "Then that's all you need to know about the future of newspapers."

Of the potential stock investments in the newspaper industry, only one company has stood out as a possible value. This company will be written up shortly. But in general, readers will be best advised to keep newspaper companies out of their investment portfolios for the time being.


BC said...


Good blog. Buffett paints the negative future economics of the entire newspaper industry with a wide brush stroke. The reality is that the dailies business is definately in decline, but the small town weeklies business is thriving. There are very few places to get local news if you live in Timbuktu, other than the local weekly newspaper.

Nnejad said...

I agree to a certain extent. There will always be a need for local news. The local resident will need to get this news from the local newspaper company. But the resident's decision to get this news from that company online or through publication will have a significant impact. In both situations, the newspaper company will get a subscription fee. But subscription fees usually make up 10-25% of a newspaper company's revenues. What is more important is the advertising. The publication version used to be able to command the local classifieds and advertising. I'm not certain if their internet version will also be able to do the same and generate the same kind of revenues as before.