In his 24/7 Wall Street post on Friday November 16, 2007 Douglas McIntyre published the latest of many unsettling predictions about the future of newspapers:
There is little left for the newspaper industry other than to cut people. Paper and delivery costs have already been taken down. The costs of printing and production cannot be brought lower. That leaves headcount.
While he didn’t say so, this conclusion speaks directly to The New York Times (NYSE: NYT) because of what its most vocal critic sees as the companies prolific spending on, among other things, headcount. That critic, Mr. Hassan Elmasry of Morgan Stanley (NYST: MS), blames the company’s ownership structure on management's freedom to engage in this "overspending." In his October 17, 2007 post "Morgan Stanley Walks Away From New York Times Fight" on BloggingStocks, Tom Barlow wrote:
The Global Franchise fund, which looks for undervalued but world-renowned brands, spent the first part of 2007 in a full-court press, attempting to change NYT's direction. Among Elmasry's concerns were (in his view) overstaffing, the cost of a new headquarters, a flawed internet strategy, and too-generous option grants.
The reason for the New York Times "curious ownership structure" is the belief that newspapers in a democracy are a public trust. In the May 13, 2007 edition of The Becker-Posner Blog Professor Posner wrote:
The idea is that if people unrelated to the founder … controlled the newspaper, they would manage it with the aim of maximizing profits and thus would give the consumer what he wanted rather than what he needed in order to be an informed citizen.
This belief, of course, implicitly assumes it's not possible to operate as a public trust and -- at the same time -- maximize profits. The purpose of this post is to show that in the case of the Times this assumption does not stand up to the data. The company remains a public trust while maximizing profits.
MAXIMUM EARNINGS MARKET SHARE
In a post on June 3, 2007, "Dow Jones: Anomaly or Hidden Value," I placed the Times in a strategic group with Dow Jones (NYSE: DJ), the Gannett Company Inc. (NYSE: GCI), and the Tribune Company (TRB). A strategic group is a set of companies that share a customer base and have comparably deep pockets. In newspapers the “shared customers” are advertisers. This report is based on the same 10 years of financial accounting data I used in that earlier post.
Maximum earnings market share occurs when the marginal cost of the next share point is equal to its marginal earnings -- net of “enterprise marketing expenses.” For the details on accounting for these expenses see my book Competing for Customers and Capital. In the newspaper industry enterprise marketing expenses are listed in the income statement as "Selling, General & Administrative expenses." Most of these expenses fall into the category of “headcount.”
The following chart compares the NYT's maximum earnings market share with its actual market share from 1997 through 2006. In 1997 the company's maximum earnings share of the group's $12.9 billion revenues was 30.5%. Its actual market share was just 22.2%. Conclusion? In that year NYT management was seriously under-spending on enterprise marketing.
But by the close of business in 2006 management had successfully driven their revenues and expenses to the point where the company’s maximum earnings market share (17.2%) and actual share (17.7%) were separated by only 50 basis points. How did they pull this off?
The following chart reveals the truth about the management of earnings and expenses at the NYT. The company's marginal earnings per basis point (that's 1/100th of a share point) were $0.72 million in 1997, when its marginal cost per basis point was just $0.57 million.
By the close of business in 2006 NYT’s management had brought their marginal earnings and expenses into near perfect alignment at $1 million per basis point.
THE NEWSPAPER OF RECORD
There's a simple analog to the incremental cost per basis point that's a lot easier to calculate and understand. It's the average cost per dollar (CPD) of revenue.
This table shows a side-by-side comparison of the CPD for each of the four companies in this strategic group. In 1997 it cost the NYT 35¢ to generate $1 in sales revenue. That was twice what it cost GCI. Over the next nine years the NYT cost per dollar increased to 45¢, while GCI remained unchanged at 16¢ per dollar. By 2006 NYT management spent almost three times as much to generate a dollar of revenues as CGI and far more than either DJ or TRB.
While the critics call this overspending, the Times management probably would call it brand building. What did the company spend the "extra" money on? Some clues are given in Anthony Bianco's cover story of Business Week on January 17, 2005 titled "The Future of The New York Times:"
[Arthur Sulzberger] reinvented the "Gray Lady" by devising a radical solution to the threat of eroding circulation that had imperiled the Times and other big-city dailies for years. Sulzberger changed the paper itself by spending big money to add new sections and a profusion of color illustration.
At the same time, he made the Times the first -- and still the only -- metro newspaper in America to broaden its distribution beyond its home city to encompass the entire country. Today, nearly 50% of all subscribers to the weekday Times live somewhere other than Gotham.
In the mid-1990s, NYT Co. became one of the first Old Media companies to move into cyberspace ... Today, NYTimes.com consistently ranks among the 10 most popular Internet news sites ...
Did this spending actually build the brand? A study published in August 2007 by the Joan Shorenstein Center on the Press, Politics and Public Policy on "Creative Destruction: Exploratory Study of News on the Internet" found that:
Brand-name newspaper sites are gaining audience. Their traffic in April 2007 exceeded their April 2006 traffic by more than 10 percent, which corresponds to an average gain of nearly a million unique monthly visitors (page 7).
Building the brand's reach and supporting the company’s worldwide reputation as the newspaper of record is far more important then making sure last quarter earnings per share meet analyst's expectations. It is all the more important since management was able at the same time to maximize earnings. This is an achievement unmatched by the other newspapers in this group. In 2006 the Times relative earnings productivity [REP] was -0.1% -- meaning the company's actual earnings were only 1/10th of 1% less than maximum potential earning. In the same year the relative earnings productivity of GCI, TRB and DJ were -7.4%, -8.2% and -27.0% respectively.
ALL THE MONEY IT’S FIT TO EARN
In 1997 the company’s management fell $63 million short of maximum EBITDA. But by the close of business in 2006 actual and maximum earnings were exactly equal at $264 million.
The downward trend in the Times earnings is severe and reflects the hard times also suffered by Dow Jones. Given that fact, if you will forgive me a paraphrase of the Times masthead, the company is making all the money its fit to earn while continuing to build the brand in a harsh environment.
Anthony Bianco's cover story is perhaps the most comprehensive, unbiased account to date of the Times performance under the leadership of Arthur Sulzberger, Jr. That article sums up the two major issues affecting its future today -- economics and politics:
In essence, Sulzberger is doing what his forebears have always done: sink money into the Times in the belief that quality journalism pays in the long run. "The challenge is to remember that our history is to invest during tough times," he says. "And when those times turn -- and they do, inevitably -- we will be well-positioned for recovery."
Investors continue to discount the company’s stock in part because of Mr. Hassan Elmasry's "full-court press." His battle with the Times over ownership structure and spending clearly took its toll on the stock. Now that this two year assault is settled, there remains the deeper issue highlighted in the Business Week cover story: the ideological divide within the country.
What a growing, or at least increasingly strident, segment of the population seems to want is not journalism untainted by the personal views of journalists but coverage that affirms their partisan beliefs...
Does all this add up to a case of investor myopia? What do you think?
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