Tribune Spin-Off Highlights Why Buffett Still Loves Newspapers

​Tribune Publishing (TPUB) is trading at a substantial discount to fair value. TPUB is currently trading at $18.53. I believe fair value is between $28-37 per share.

The Opportunity:
TPUB was spun out of the Tribune Company with a separation date of August 4th. The when-issued shares began trading on July 24th at $25.50 per share and, perhaps not unexpectedly, are currently trading < $19. Like many spinoffs, TPUB was most likely not an attractive asset to current Tribune shareholders. First, the renamed Tribune Media sports a market cap of > $7 billion, whereas Tribune Publishing’s market cap is just under $500m or less than 10% the size. Second, Tribune Media retains the sexy broadcasting assets as well as retains ownership over the real estate holdings. In classic spinoff fashion, I believe there has been non-fundamental selling pressure since the July 24th when-issued date. This presents a compelling opportunity to scoop up shares TPUB at a very attractive multiple of ~4.9x EV/EBITDA.

The Valuation:
In his excellent book, Deep Value, Tobias Carlisle notes the single most important factor in determining what Graham called “satisfactory returns” is not surprisingly, the price you pay: the lower the EV/EBIT or EV/EBITDA multiple, the better the subsequent returns. In fact, revenue growth and margin trends can even be negative for one simple reason: reversion to the mean.

TPUB is a cheap stock, both on an absolute and relative basis. If we make some necessary adjustments for the changes in affiliate agreements and real estate expenses post spin, TPUB has reported EBITDA of $135, $155, and $155 in the 2011-13 period with margins improving from 7.4% to 9.1%. I assume the Company will report ~$155m in EBITDA again in 2014 (and I think there are reasons for this to improve moving forward). If we apply a 6.5x EBITDA multiple, TPUB is worth $28 or 54% more than its current trading price. (CRT research estimates 2014 EBITDA at $174m, well above my estimate) As a reference point, comparables such as the NYT, AHC, NWSA and MNI are trading at 7.7x, 7.6x, 5.7x and 7.7x EV/EBITDA.

Furthermore, I expect TPUB to generate between $40-50m in FCF, which more than supports the annual dividend of $.70 per share (~3.8% yield). The first quarterly dividend is expected to be distributed in Q4’14. TPUB has $350m in 7-year maturity debt @ Libor + 475 and a currently unused ABL facility with a 5-year maturity of $140m. The leverage ratio is a manageable 2.3x.

The Business:
Of course there is uncertainty around print readership and print advertising trends. In particular, print ad trends continue to be negative and it’s probable that this revenue line is in long-term terminal decline. However, the current level ($860m) and the decline rate suggest the time period is beyond the scope of the investment period of 5-10 years. And while print readership trends are also challenged, TPUB, like many other traditional publishing companies, has finally found itself ahead of the curve. TPUB has successfully used price to offset some/all of the volume declines. Circulation revenues are ~$430m in revenues.

As an independent company, TPUB should be in position to accelerate its transformation from print-to-digital. The Company successfully introduced pay walls in 2011 at several of its major properties and is rolling this out to all its properties. Moreover, the LA Times website redesign, which makes greater use of native advertising techniques, video and pictures has seen a > 30% increase in page views recently. These design enhancements are also being rolled out across all properties. TPUB has the premier brands in its respective markets–of its 10 major newspapers, 6 are #1 in print readership and 7 are #1 in digital with a total of 92m monthly uniques. Digital revenues reached $190m in 2013.

And although TPUB has done an admirable job cutting costs–~$250m since 2011, much work remains to create efficiencies and right-size the company for its digital future. As a standalone company with an incentivized management team, I expect the Company to capture revenue and cost opportunities faster than in past years. It’s important to understand that each paper within the Tribune family is profitable.

The Industry
Moving forward, I expect the publishing industry to experience consolidation. In the past year, several companies have or have announced plans to spin out their publishing assets, including: News Corp., Time Warner, E.W. Scripps will merge with Journal Communications and then spin their publishing assets and Gannett. M&A will be an important component of increasing shareholder value. TPUB can more easily accomplish this as an independent company. In fact, TPUB has already acquired a couple small papers that backfill in a couple of its current markets.

Recent Updates
TPUB released an 8-K this morning providing greater clarity around the company's adjusted EBITDA. http://www.sec.gov/Archives/edgar/data/1593195/000. The TTM adjusted EBITDA through Q2'14 is $177.4m. This does not include the full-year EBITDA accretion from the 2014 acquisitions, primarily the Landmark Media properties (The Capital and Carroll County Times)​.

​After speaking with the VP of IR recently, I wanted to update a couple key points regarding my thesis:

1. EBITDA forecasts - 2014 adjusted EBITDA should be ~$175m

2013 EBITDA of $235m -$28m for rental leases to Tribune -$17m for the modified CareerBuilder economics -$20m for modified Classified Ventures affiliate agreement (post-GCI purchase) +$5m public co. costs (were paying Tribune $30m, but will only incur $25m as independent company) +$3-5m from Landmark acquisition (note: annualized benefit is north of $10m).

Tribune should generate EBITDA in the low $180m in 2015

2. Cost opportunities

There are several areas the company where the company can continue to realize substantial cost savings (low-hanging fruit). For example, centralizing purchasing (historically each local paper was responsible for many purchases), contracts with RR Donnelly and/or Quad Graphics for nich publications can be scaled, and technology costs such as data lines. The cost savings are in the tens of millions of dollars.

3. Revenue opportunities

The biggest opportunity is pushing digital subscriptions. Tribune is far behind the leaders in the industry in the number of digital subscribers it has across all its papers. The company has the analytics to know what content should be put behind the paywall to drive deeper penetration of digital subs. It is in the process of doing this across its various papers.

Yes, its true newspapers are fighting an uphill battle against declining traditional ad revenue declines. However, TPUB's margins are several hundred basis points below many of its peers and in some cases even more than several hundred behind. I expect management to focus aggressively on improving these margins. The opportunity to drive margin expansion coupled with the low valuation makes TPUB a compelling idea here.

Summary
TPUB is an undervalued asset that is meaningfully mispriced after its August 4th spin out from the Tribune Company. The recent selling pressure is not related to fundamentals; it has more to do with “distributing shares to the wrong people” (Joel Greenblatt, You can be a Stock Market Genius).

Although management has a presentation available http://www.sec.gov/Archives/edgar/data/1593195/000... it has yet to hold a conference call or provide forward-looking guidance. I expect has more information comes to light, the sell-side picks-up coverage, and the selling pressure from the spin releases, TPUB will re-rate higher.