Independent News & Media (INME.I) – Paper Profits
(This is the eighth installment in my series of case studies on the shares that make up my portfolio. To see the other seven articles, on Total Produce, Abbey, Glanbia, Irish Life & Permanent, Datalex, Trinity Mirror and Datong, click on the company names. To download a summary of how my valuations stack up against last night’s closing prices, click here)
Independent News & Media has leading newspaper and other media interests in Ireland, South Africa and Australasia. Buoyed by the success of the Irish and South African economies in particular, it enjoyed tremendous growth in the years following the millennium, with reported operating profits rising from €224.1m in 2000 to €349.2m in 2007. However, this profit rise did not correspond to a proportionate improvement in the balance sheet, as considerable investments in growing its operations and generous dividend payouts meant that reported net debt was little changed over the same period (from €1,500m in 2000 to €1,316m in 2007).
While the well-documented problems in the Irish economy certainly didn’t help, the group’s large debt pile proved to be especially problematic once the global financial crisis hit. Management responded with a number of decisive moves, including a €200m debt-for-equity swap, a €92m rights issue, the divestment of over €200m worth of assets, including the loss-making UK Independent Newspaper (sold to former KGB agent Alexander Lebedev) and INM’s stake in Indian publisher Jagran Prakashan, and a €30m share placing. These moves, and the deconsolidation of INM’s minority stake in Australasian publisher APN (which removed just over €500m of non-recourse debt from INM’s reported group debt), reduced INM’s reported net debt to €473.6m by the end of 2010. In the group’s most recent trading update (in mid-November), management said that it had cut net debt by a further €40m since the start of 2011.
Going forward the group has identified six strategic objectives. These are: (i) Maximise the asset base – the group has been closing loss-making titles such as The Sunday Tribune; (ii) Focus on Market Share – which the group is likely to be able to do given that its market leadership positions in most segments mean that it is set to be the ‘last man standing’ as weaker competitors exit a shrinking market; (iii) Operating Cost Reductions – these were -4.4% yoy in H1 2011; (iv) Digital Diversification – while progress has been made here, digital revenues still only account for 4% of group advertising revenue; (v) Free Cashflow Generation – the €40m of debt reduction guided for 2011 equates to about a third of INM’s current market cap; and (vi) Net debt reduction – taking the above guidance INM’s underlying net debt will have fallen by circa 25% between end-2009 and end-2011.
So, with good progress on the six strategic objectives identified above and the debt situation looking like it’s under control, everything’s rosy for Independent News & Media, right? Well, not quite. There remains the not inconsiderable problem of ongoing economic difficulties in its home market, while the elephant in the room is what I see as the terminal outlook for newspapers – a theme I’ve written about elsewhere. Circulations data from the National Newspapers of Ireland show that in the 5 years to H1 2011 Irish daily newspaper circulations dropped 12%, while over the same period Sunday circulations fell 22%. As noted above, INM’s market leading positions will help to ameliorate the effect of this as it will likely be the ‘last man standing’ in key segments. To illustrate this I note that its Irish daily broadsheet, The Irish Independent, has circulations of 134k, which is roughly equivalent to both of its broadsheet competitors – The Irish Times (101k) and The Irish Examiner (43k) – combined. Of the Sunday titles, INM titles commanded a 55% share in the H1 2011 circulations data.
Another dimension around INM is its share register. From 1973 to 2010 its biggest shareholder, and until 2009 its CEO, was Sir Anthony O’Reilly, who holds 13.3% of the shares in the group. One of O’Reilly’s sons, Gavin, is the current group CEO. The largest shareholder in the group today is another leading Irish businessman, Denis O’Brien. He has a 22.0% shareholding. O’Brien has been vocal in calling for change at INM for some time now. More recently another hugely successful Irish businessman, Dermot Desmond, has been adding to his stake in the firm. He now owns 5.75% of the shares.
In terms of the valuation, based on the price it closed at last night (22.5c) INM is capitalised at €124m. Management has guided a €40m yoy reduction in net debt in 2011, which puts that at €433m. The pension deficit at the end of H1 2011 was €127m. So INM has an Enterprise Value of €684m. Stripping out the value (using the current share price and exchange rate) of its 30.4% stake in listed Australasian media group APN (€126.5m) puts an enterprise value of €557m on its Irish and South African operations, which generated sales and EBITDA of €605.3m and €119.3m (after deducting common costs) respectively in 2010. The sales and EBITDA of these units are likely to have declined by mid-to-high single digits in 2011 (I estimate out-turns of €587.9m and €116.6m respectively for 2011).
I have touched on INM’s cash generation, which is likely to be impressive over the coming years given the group’s limited capex requirements and the absence of a dividend. The group cut net debt by €40m last year, and I see it reducing net debt by a further €50m in 2012. These are pretty material moves for a group with a market cap of only €124m, and you could see the equity part (currently less than 20%) of the enterprise value rise significantly as the group deleverages further. INM has no significant debt maturities until 2014.
On my valuation model I apply an EV / 2012 Sales multiple of 1.0x to the core (Ireland and South African) operations, which I think is very reasonable considering that these are market leading assets that are still generating operating margins in the teens despite extremely challenging economic conditions in Ireland. In addition, INM’s large exposure (I estimate that it will account for over 50% of underlying 2011 EBIT) to South Africa, gives me further confidence on that EV/sales multiple. I also value APN at its current market price despite the premium it would likely fetch in a formal sale process. INM has explored the possibility of selling it before. Stripping out my estimated end-2011 net debt (as guided by management) and pension deficit (holding the H1 2011 deficit steady) gives an equity value of €158.6m, or just under 29c a share. This suggests 28% upside from last night’s close. I have made no allowance for the possible intentions of one or more of INM’s largest shareholders – I see no value in me trying to second-guess that. I have also, for reasons of prudence, not factored in the chunky debt paydown I see in 2012 in the above valuation. Were I to use my estimated end-2012 net debt (€383m) this would take the valuation to 38c/share.
In summary, while I dislike the traditional print media space in general, I see value in INM’s portfolio of assets. Its strong cash generation should not be overlooked, and neither should the strong possibility of competitors falling by the wayside, thus allowing the group to pick up extra market share at no extra cost. The firm’s share register could also potentially throw up a few positive surprises in the coming months as well, as could the unlocking of value through the disposal of more assets, such as APN (I was interested to read that INM appointed an “experienced international investment banker” to its board before Christmas). While I believe that, on paper, there is better value elsewhere in the media space (Trinity Mirror in particular stands out in this regard), to me INM is worth a punt here.