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Newspapers: Buys Among the Battered

By Pearl Wang From Standard & Poor's MarketScope

If newsboys still stood on corners trying to hawk papers, this could be one of their pitches: "Extra, Extra, Read All About It! Pundits Ring Death Knell for Newspaper Biz!" The demise of the newspaper industry has become a favorite topic on both Wall Street and Main Street. Doomsayers point to perceived fundamental weaknesses as circulation figures weaken and advertisers shift spending away from newspapers and toward other media.

Not so fast, says analyst James Peters, who follows publishing stocks for Standard & Poor's Equity Research. Peters has a positive fundamental outlook on newspaper stocks. "With lower valuations after recent declines, the group has become more attractive, in our view," he says. "And with competition for advertising from alternative media rising, we think publishers will seek to grow earnings by gaining scale."

STUCK STOCKS. Indeed, the industry appears ripe for a consolidation boom. One large -- and vocal -- shareholder at Knight Ridder (KRI) has been clamoring for a sale of the company. Peters believes other newspaper companies are also likely to join the acquisition binge, as buyers or sellers.

However, takeover speculation hasn't done much to lift newspaper stocks this year. Year-to-date through Dec. 2, the S&P Publishing & Printing index was down 14.3%, vs. an increase of 4.4% for the Standard & Poor's 500-stock index.

Investors appear to be paying more attention to weakening fundamentals, and less attention to takeover potential. Newspaper bears cite reduced readership stats incessantly. The latest circulation figures for U.S. newspapers from the Audit Bureau of Circulations show a continued decline in the number of readers at most major publications. The newspaper industry's twice-yearly report showed weekday circulation at the more than 700 newspapers with audited data was down 2.6% year over year in the six-month period ending Sept. 30. The six-month period ending Mar. 30 showed a 1.9% decline.

BUFFETT'S GLOOM. Circulation figures are important because they're used to set advertising rates. Moreover, S&P sees lower newspaper circulation revenues in 2005, despite industry efforts to broaden circulation and raise prices.

Even Warren Buffett has predicted grim tidings for the newspaper industry. "The economics of newspapers are very, very close to certain to deteriorate over the next 10 to 20 years," the Oracle of Omaha warned at the 2004 annual shareholders' meeting for Berkshire Hathaway (BRK.A), adding, "I see nothing that will turn around the erosion from both the circulation and advertising standpoints."

Buffett has an inside view of the newspaper biz, since his company owns the Buffalo News, and is the largest institutional shareholder of Washington Post (WPO). Berkshire also owns a stake in Gannett (GCI). It should be noted that both WP and Gannett are longstanding positions. There is no evidence that Buffett has been a recent buyer or seller of either stock.

LOOK LOCALLY. Still, what do S&P and other bullish investors see in this seemingly battered industry?

Investors bullish on newspaper stocks point out that local newspapers can likely add more value than larger companies, given they remain the best way that local advertisers reach local customers. Also, such newspapers offer specialized regional information, such as the area's high school games, elections, or town gossip, which is harder for larger national papers to cover.

Newspaper-stock proponents also argue that newspapers have competitive economic "moats" -- they don't face direct competition from other dailies in their particular markets. Newspapers also benefit from the "network effect," which means that the paper with the largest circulation tends to attract the most advertising as marketers are interested in getting their message to as many consumers as possible. As papers get larger and gain increased advertising, they tend to squeeze out competitors. Plus, newspapers have high startup costs, which discourage competition.

PUSHING A SALE. What's more, potential positive catalysts for the industry include the sale of companies, share buybacks, restructuring, and mergers.

Investors are actively trying to create value by pressuring managements at newspaper companies to devise new ways to increase the value of their shares. On Nov. 1, Private Capital Management, which owns 19% of Knight Ridder, urged the company's board to "aggressively pursue the competitive sale of the company."

Harris Investments, which has an 8.2% stake in Knight Ridder, joined in, writing in a letter to the board, that Harris "believes that its clients, together with other owners of the company, deserve the opportunity to obtain fair value for their shares through an open auction of Knight-Ridder, and we urge the board to begin this process immediately."

PRIVATE-EQUITY APPEAL? Knight Ridder, the publisher of the San Jose Mercury News, The Miami Herald, and other newspapers, has responded to the increased shareholder pressure by announcing it would work with financial adviser Goldman Sachs (GS) to explore a possible sale and other options.

S&P's Peters believes the pressure on Knight Ridder has heightened the possibility not only for its takeover, but also for other industry mergers. For one, a major New York investor has written to the Dow Jones (DJ) board urging a sale of the company that owns The Wall Street Journal (see BW, 5/09/05, "How Now, Dow Jones").

If prices of newspaper companies continue falling, it's likely that private-equity investors or activist investors will step in as catalysts for change at the newspapers. On Dec. 1, three private-equity firms (The Blackstone Group, Providence Equity Partners, and Kohlberg Kravis Roberts) announced that they're considering the purchase of Knight-Ridder. If a sale of Knight Ridder happens in the near term, Peters believes it could lead to shakeups at other newspaper companies, as managements may realize the need to do more for shareholders.

MULTIPLE STREAMS. Meanwhile, according to S&P analyst Peters, newspaper companies will continue to find other ways to boost revenues, such as looking online. "We also expect to see a continuation of the recent trend by newspaper companies of acquiring Web sites," Peters notes. "In a slow-growth industry, Web sites offer an opportunity to capture a rapidly growing revenue stream, in our view. We forecast a 25% Internet-revenue growth rate for 2006, though we note online revenues represent only about 4% of overall publishing-company sales."

S&P also sees newspapers leveraging their increased consumer reach through the Internet "by upselling customers on advertising in multiple mediums," Peters says.

Standard & Poor's Equity Research recommends Gannett and Tribune (TRB) as the newspaper stocks that are best poised for outperformance in the next 12 months; each is ranked 4 STARS (buy). Dow Jones, Washington Post and Knight Ridder are each ranked 3 STARS (hold).

Wang is a reporter for Standard & Poor's Global Editorial Operations

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