Do the Economics Make Sense?

Sorry to disagree with analysts at two of the biggest companies on the planet, but the economics make a lot of sense if you look at the long term impact of Mr. Murdoch's buyout of Dow Jones through the lens of the enterprise marketing framework.

BACKGROUND
In my post on "Dow Jones: Anomaly or Hidden Value? I placed the company in a strategic group with the New York Times (NYSE: NYT), Gannett Company Inc. (GCI), and the Tribune Company (TRB). The result of applying my Competitive Stock Valuation theory suggested that both the market and Mr. Murdoch undervalued Dow Jones. The present value of its stock four years out was $75 a share, or the company was worth a little over $6 billion. I discounted the forecast (nominal) value of its stock in 2010 (about $118) by 12.5% to adjust for my guess about the riskiness of Mr. Murdoch's acquisition.

THE HEAVYWEIGHTS: IT DIDN'T MAKE SENSE
At 9:00 this morning the following report appeared on the New York Times DealBook:

General Electric’s NBC unit and Microsoft explored making a joint bid for Dow Jones … But after the preliminary discussions and a more detailed analysis by NBC and Microsoft executives, they decided against going further. “Mainly, the economics just didn’t make sense,” a person close to NBC and Microsoft told The Times.

WHAT WOULD MURDOCH DO?
On June 6, 2007 Steve Stecklow and Martin Peers published a wide ranging interview of Mr. Murdoch's role as a proprietor and his plans for the Journal. This was one of the most revealing exchanges in that interview:

WSJ: So you would focus on generating more ad revenue?
Mr. Murdoch: … The Journal has had no money spent on marketing that I'm aware of for years. I imagine whatever we do would take the profit down in the short term… I mean of the Journal… It's got to have money put back into it, particularly on the digital side.

STRATEGIC ASSUMPTIONS
What if his bid for the company were successful? To find out I made these assumptions as inputs in my Competitive Stock Valuation model to forecast DJ's price in 2010:

(1) Mr. Murdoch's skill at running a paper combined with his marketing savvy would cause the CAGR in group revenues to jump from its historical 3.8% to 4.8%.
(2) he would stop in its tracks the steady 2.3% compound average annual decline in DJ's percent gross margin;
(3) his competitors would back-off the compound annual rate of growth in enterprise marketing (SG&A) expenses from 4.2% over the past decade to 1.8% in the ensuing four years;
(4) under Mr. Murdoch's leadership a revitalized Dow Jones would achieve maximum earnings market share;
(5) the number of shares outstanding would remain constant at 82.1 million.

THE ECONOMICS DON’T MAKE SENSE?
This table compares my 2010 Dow Jones forecast based on these assumptions with actual results in 2006. Group revenues increase from $18,625 to $22,467 million. DJ's share of group revenues increases from 9.6% to 22.4%, driving sales revenues up from $1,784 to $5,023 million by 2010. With profit margins held constant at 51% of sales, gross profits increase from $879 to $2,450 million in the forth year. With Mr. Murdoch pouring money into enterprise marketing, SG&A expenses nearly triple from $652 to $1,902 million.

The last three lines in this table are where it gets really interesting. Earnings (EBITDA) nearly double from $245 million to $548 million, driving EBITDA per share from $2.99 to $6.67, while the SG&A expense to revenue ratio increases only about 4%.

THE MOMENTUM EFFECT
How can Dow Jones become so radically transformed under Mr. Murdoch's leadership that it's 2010 stock price is $118? By becoming what Professor J. C. Larreche of the INSEAD Business School in Fontainebleau, France calls a "momentum-powered firm."

It all comes down to delivering more compelling values to its advertisers, its readers, employees, partners and shareholders -- and focusing on those that deliver the greatest equity to Dow Jones & Company. More on Professor Larreche's book on "The Momentum Effect" in later posts.

~V

Comments

[Victor Cook, Jr., New Orleans, Louisiana]

Joe,

I agree with you. My "Hidden Value" column was intriguing. I might even add, surprising. When I read about Mr. Murdoch's $60 a share bid, like most everyone else, my first thought was "irrational exuberance!" That's what motivated me to apply the enterprise marketing framework (EMF) to his offer.

The first thing my EMF requires is selection of the members of a strategic group. This is a tricky process and, ultimately arbitrary, as you suggest. On the first page of Chapter 3 I warn the reader:

"Sometimes even the most astute financial managers forget that performance is relative. Unfortunately, identifying competitors is not as easy as the airline example in the last chapter suggests. The answer to the question, who’s in my strategic group, depends on a lot of factors."

One of the most critical of these factors is who asks the question. For example financial managers and marketing managers often have entirely different competitors in mind. CFOs may think first of companies with which they compete for capital. Since capital markets are global, the CEO of AT&T may include France Telecom in the list of competitors even though the French monopoly has few North American customers. AT&T and France Telecom only compete for capital today. Maybe they'll compete for customers tomorrow.

Fortunately, the results are quite robust across groups with different membership as long as they have a high degree of market commonality and resource equivalence. Translation? The group members share one or more customer bases, though their products may be quite different, and their pockets are of similar depth. If you're interested in the details of how I use financial accounting data to define group membership see my audio slide show "Who's in My Strategic Group?" It runs about 11 minutes: http://breeze.tulane.edu/cookchapterthree/

Forecasting trends is equally tricky. No one knows what the sales revenues of the combined group will be in 2010. All I can do is explain how I came up with an increase in CAGR from 3.8% to 4.8% if Mr. Murdoch were to succeed in his bid for Dow Jones.

First, let me be clear. This is not a forecast of DJ's sales from 2006 through 2010. The company's revenues actually declined 31% from 1997 through 2006. It's a forecast of the group's revenues. And the other three companies experienced significant top line growth. GCI was up 70%; TRP was up 105%; even the Gray Lady's revenues grew by 15% over the decade. Add them all up and group revenues increased from $2.7 to $5.5 billion.

Second, I expect the performance of DJ under Mr. Murdoch's leadership will boost sales of the other three companies in the space, just as his acquisition of Fox did earlier.

Third, my results are not much different at 3.8%. DJ's maximum earnings market share drops from 22.4% to 20.9%. And the nominal value of its 2010 stock price falls from $118 to $110.

You put you finger on the biggest wild card in this deck: competitors certainly "would not stand still for such a dramatic shift in share." But, I must ask you in return: what can they do to stop an invigorated Dow Jones & Company driven by an increase in enterprise marketing resources from $653 million to almost $2 billion?

As to whether Mr. Murdoch has more experience in the entertainment business than in newspapers, I don't know. But if that's true, is it necessarily a disadvantage in the wild world of media in the 21st century?

Thanks for your thoughtful comments.

~V

[eyeonmedia]

While the "Hidden Value" column was intriguing, the "Sense" column has a number of significantly flawed assumptions. Here are some major problems: First, the assumption that the "Group Revenues" will be higher by 2010 is not substantiated by current or anticipated industry trends, including the 2007 YTD results; indeed, it is likely to be lower. Second, the change in market share makes no sense, since Dow Jones competes directly with the rest of the arbitrary "strateguc group" in only a few revenue areas and, even if this "Group" were a true market segment, the competitors would not stand still for such a dramatic shift in share. Third, Murdoch's prowess has been much stronger in the entertainment business than in newspapers, and will he be around in 2010?