The paroxysmal changes rattling the beleaguered newspaper industry have coincided with unprecedented declines in publishing companies' stock prices. The decimation has affected newspaper publishers regardless of size, geography, or prestige of their mastheads. Driving this decline is a structural shift of epochal dimensions that continues to reshape the way we generate, compile, disseminate, and consume news and information, manifested largely by the rise of the Internet and the proliferation of alternative digital media choices.
The effects of this shift are chipping away at the once-stalwart business model by which newspapers operated for decades. A cyclical downturn in business ad spending--driven by a credit crunch and persistent consumer spending retrenchment--has accelerated the revenue declines at newspapers. The suffering this confluence of factors creates for newspapers is magnified by the suffocating effects of many publishers' debt-laden balance sheets, which leave them with diminished financial flexibility to navigate the treacherous industry environment, and little margin for error to manage a worst-case scenario.
Newspapers continue to respond defensively to declining revenue by implementing substantial--even draconian--cost cuts. Besides trimming page widths and eliminating unprofitable circulation, publishers have slashed employee headcount, declared unpaid work furloughs, and consolidated production operations. With newspaper stocks having fallen so far, and costs being cut so aggressively, can these stocks go much lower? Given the dizzying declines of the past year, we think their downside potential today is considerably less than it was a year ago. However, even if newspapers catch a temporary tailwind from an eventual recovery in ad spending, we think the incipient generational shift in media consumption and ad spending habits are such that those ad pounds will not return with the volume and vigour that newspapers once enjoyed. We think the combination of their high fixed costs, substantial debt burdens, and poor growth prospects will continue to diminish newspaper publishers' profitability, putting a ceiling on a sustainable recovery in their equity values.
In an environment of declining ad sales, newspapers' high fixed costs amount to a financial Achilles' heel. This combination makes it difficult for newspaper publishers to keep expenses in line with diminishing revenue. Besides owning and maintaining expensive printing plants and equipment, they must regularly buy commodities such as newsprint and ink, whose costs tend to fluctuate beyond publishers' control. Distribution expenses have also increased, as rising fuel prices add to the cost of running fleets of delivery trucks, not to mention airplane fuel costs following several UK firms' decision to reduce costs by printing sheets in Spain. Union contracts limit their ability to reduce labour costs, a reflection of newspapers' labour-intensive nature. Taken together, their limited ability to cut costs means that when newspaper revenue declines, profits decline even faster.
The resulting dynamic is a value-destroying feedback loop: Declining ad revenue and readership necessitates cost-cutting. Cost-cutting inevitably affects content. Diminished content, whether real or perceived, alienates readers, who become more likely to cancel their subscriptions and seek out alternative news sources. This accelerates the migration of readers to online sources and the decline in ad revenue, which will necessitate even more cost-cutting. We think the cycle will feed on itself.
Newspaper CEOs expound on their efforts to build their publications' presence online. However, alluding to exponentially rising page views and double-digit growth rates in online ad revenue tend to mask a starker economic reality. Online advertisers refuse to pay up for Web site banner ads as they have for traditional print ads. This is because online readers are perceived as having truncated attention spans and being less engaged with the information. In contrast, paid subscribers' investment of time and money in the print product makes it more likely that ads will resonate with them than with online readers, thereby increasing their value to advertisers.
Online ad revenues simply aren't substantial enough or growing quickly enough to stave off the breathtaking erosion in print ad revenue. During 2008, print ad revenue across the US industry declined by US$7.5 billion, or nearly 18% versus 2007. In contrast, online ad revenue declined by $56 million, or 2%, according to industry statistics. Despite its more modest decline, online ad revenue still amounted to less than 9% of total newspaper ad spending in the United States during 2008.
In the UK, newspaper ad revenue is forecast to drop by 21% in 2009, while digital media ad revenue is seen falling from double-digit growth in previous years to just over 2% this year, according a 2008 Enders Analysis report. Whether you look at the UK or the US, by shifting their operations online, newspapers continue to trade dollars and pounds for pennies.
In the States, the New York Times is reconsidering its once-failed practice of charging readers a monthly fee for access to its own online content, as it struggles to untie the great Gordion Knot of the industry's digital transition. However, doing so involves going head-to-head with the prevailing notion that hiding online content behind a subscription firewall is like erecting an optional tollbooth on a multi-lane motorway. Unless that lane leads to somewhere truly unique and compelling, many would-be users will likely steer clear.
This is exacerbated by the deleterious effects of suffocating debt burdens. Several prominent American newspaper publishers took on billions of dollars in debt in recent years to finance ill-timed acquisition binges that have only magnified the effects of declining revenues. McClatchy, GateHouse, and Lee Enterprises have balance sheets saddled with more than a billion dollars in debt each from dubious acquisitions. As declining revenue erodes profit margins, high fixed costs and debt service obligations siphon away diminishing cash flow, leaving little left for capital investment and innovation.
As revenue continues to decline, some heavily leveraged publishers are straining harder to find the necessary cash to service their debt, forcing them to liquidate assets at fire-sale prices. Many have already reduced or eliminated their dividends. In the US, the New York Times, McClatchy and GateHouse have already eliminated their own dividends, while Gannett's dividend persists in vestigial form, and in the UK, Trinity Mirror and Johnston Press both axed their final dividends earlier this year.
Newspapers' valuations may have cratered from the lofty levels of better times. However, cutting costs in the face of declining revenue is a survival tactic, not a buy signal. In the long run, the newspaper as we know it is unlikely to vanish completely. However, we think the publishing entities that survive the current tumult will be those that successfully morph into smaller, more nimble "multimedia information centres." Besides having lower cost structures and more modest cash flows, we think some of these entities will eventually be managed to satisfy bondholders at the expense of equity holders.
