It’s A Year On From When McClatchy Closed Its Knight-Ridder Deal, So Was It The Smart Thing To Do?

Judging by what has happened to McClatchy’s share price since the buy was first announced, Wall Street has voted with its feet against the deal. True, newspaper shares in general have taken a beating in the past year, but since March 13, 2006 when McClatchy announced the deal until Wednesday’s close the shares are down a massive 48% -- hardly a vote of confidence.

But there are signs that the so-called smart money now believes the shares, fluctuating between $26 - $27 (they closed Wednesday at $26.96, up 0.6% on the day) are a good buy. Ariel Capital Management (ACM) has spent the last few months doubling its stake so that it now holds 22.4% of the company, making it the second biggest shareholder behind the McClatchy family. And the third biggest shareholder is none other than Private Capital Management (PCM), the Florida based investment group that was most influential in forcing Knight Ridder to sell itself in the first place.

Take PCM’s 17.9%, add the ACM 22.4%, and add to that the 5.7% holding accumulated recently by the Chicago hedge fund Citadel Investment and you have just three shareholders with 46% of the company.

ftm background

In Just Two Months, McClatchy’s Dumping Of 12 Poorly Performing Knight Ridder Newspapers Is Showing Itself To Have Been Very Smart. Four of Those Newspapers Are Already In Serious Trouble
McClatchy was the only newspaper group willing to buy the 32 Knight Ridder newspapers in one deal and didn’t really have to pay a premium. What McClatchy didn’t tell Knight-Ridder executives or their bankers, however, was that they were going to onward sell 12 of those newspapers considered to be in poor performing markets.

McClatchy Taught The Big Newspaper Chains A Powerful Lesson: Keep The Best and Leave The Rest. And That Wall Street Likes!
US newspapers chains are trying to sell their worst financially producing newspapers and for once they are getting high marks from Wall Street.

Gary Pruitt Says It Would Have Been Inconceivable A Few Years Ago To Have Bought Knight-Ridder For Such A Low Price. Wall Street Says McClatchy Would Have Done Better Buying Its Own Shares and Calls The Newspaper Industry “A Stinker”
Gary Pruitt is fond of telling people that he made a great financial deal in buying Knight-Ridder’s 32 newspapers for “only” $6.3 billion including debt assumption – such a low price would not have been possible just a few years ago when newspapers were in favor with Wall Street. But Wall Street has its final say – the money would have been better spent on McClatchy buying its own shares.

A High Price For Knight-Ridder Sale Would Have Signaled A Bright Future For Newspaper Valuations, But McClatchy Paid Practically No Premium And Yet In The Intervening Weeks Its Shares Have Dropped 12% To A Four-Year Low. What Does That Tell You?
Most observers seemed to think that McClatchy did OK. It bought Knight-Ridder for $4.5 billion representing a dollar or two a share over its stock market price, and then said it was only keeping the 20 newspapers that showed real growth and it was dumping the rest, and that sale, after tax, would reduce the total transaction to around $3 billion.

Lee Bought Pulitzer Last Year for 13.5 times Earnings Yet McClatchy Paid Just 9.5 times Earnings For Knight-Ridder. What Does That Tell You About the Value of Newspapers Today?
That someone, it happened to be McClatchy, paid about $67.25 a share for Knight-Ridder -- some $4.5 billion plus absorbing K-R’s $2 billion of debt -- was about what the markets expected. But where was Gannett and all those private equity companies that were expected to put in bids? The word is they dropped out, which gives as good an indication as any that newspaper valuations are not what they used to be.

Could this be déjà vu again? With Knight Ridder it took three shareholders holding around 36% of the company to pressure Knight Ridder to sell itself to enhance shareholder value. With these three owning 46% is it going to be the same scenario again?

No, because this time there is one big difference. Whereas Knight Ridder had only one class of shares and had no real protection against a shareholder revolt, the McClatchy family’s B shares carry 10 times the voting power of the A shares held by other shareholders. In other words, the McClatchys hold absolute power and no one is going to force them into a sale if they don’t wish to.

So, if that’s the case how come there are at least two big shareholders who have been busy adding to their holdings in the last weeks. Could it be they actually believe the worst is over for McClatchy, that things are on the right course, and given some time the shares are going to recover quite nicely?

Those shareholders are not alone. Just last week Wachovia Securities analyst John Janedis raised McClatchy from “market perform” to “outperform” because the company has been steadily reducing its debt taken on from the Knight Ridder buy – one purpose of its December fire sale of the Minneapolis Star Tribune.

But not everyone on Wall Street agrees. Peter Appert, media analyst at Goldman Sachs, has put a “sell” on McClatchy because the company has little to fall back on except newspapers – the “all the eggs are in one basket” argument.

What is interesting in following the McClatchy share price is that March 13, 2006, the day it announced its Knight Ridder deal, was the last day the shares were in the 50s where they had been for the year until then. The day after the deal was announced they fell to $49.43 and stayed in the 40s until June 23 when they sank into the 30s – it took just 14 weeks for the shares to fall 20%, and that occurred just four days before the deal actually closed – not a very positive Wall Street view.

The next important day to mark is August 2, 2006, when McClatchy announced that it had completed the sale of the 12 newspapers it didn’t want to keep and got a total $2.078 billion for them – basically the same amount as the debt assumption --meaning, without taxes taken into account, that the 20 newspapers it kept were costing it $4.5 billion.

The shares rose on that news and closed the day at $43.65. and they basically fluctuated between the high 30s to the low 40s for the rest of that year, but by mid January, 2007 they had fallen permanently into the 30s and by mid April they were into the 20s where they are today.

It’s one thing to make the analysts happy by paring down debt, as McClatchy is doing – last week it sold Newscom which it co-owned with Tribune -- but it still begs the question, “Where’s the Meat?” and CEO Gary Pruitt was quite forthright in the Mid-Year reviews in saying these are difficult times and they appear to be continuing.

Pruitt said that May advertising revenues dropped 11.5% on the back of a 10.4% drop in advertising revenues. And he predicted that June will also be bad, but perhaps not as bad as May. As for the rest of 2007, “business trends remain unclear”.

So with that kind of environment McClatchy is doing what every other newspaper group is doing – cutting costs to the absolute bone because the group’s primary business plan is to maintain operating cash flow as high as possible and that means with revenues down so much cost cutting continues with a vengeance. “We will remain focused on reducing operating expenses and mitigating the impact of the advertising trends on our cash flow,” he said.

And he pointed out the cost-cutting has been to good effect. “Our cash expenses through May were down 7.7% on a pro forma basis (to last May). Through the first five months our operating cash flow is down only 1.1% and our EBITDA margin has grown to 24.3% from 23.1%.

He has also signaled that either he has better terms with his CareerBuilder partners Gannett and Tribune or he is looking to sell his share of the online classified web business. “We are currently discussing with CareerBuilder changes that need to be made to make it more equitable. We're also exploring other opportunities." And he continued, “We would prefer to stay with CareerBuilder ... but we have to consider all options, which would include selling our share. But we would prefer not to."

So, was it smart for a newspaper company not to diversify and instead buy more newspapers? The answer depends on whether one believes newspapers will ever return to their former glory days of 20% plus margins. Much of Wall Street’s money says those days are not coming back – even if Dean Singleton at MediaNews and Pruitt say they believe the downturn is just “cyclical” -- but even so newspapers should still achieve margins in the low teens which really is something a lot of other businesses wish they could achieve.

With the shares in the 20s there are obviously some investment groups who see this as a buying opportunity, but they are doing that based on faith in the McClatchy management since with the dual share system they don’t have power to persuade a board of directors to take really drastic steps like trying to sell itself.

And who would buy anyway? Let it not be forgotten that when Knight Ridder went under the hammer only McClatchy made a bid for the entire company. Maybe the really smart money is looking for the family to take McClatchy private, something the company says isn’t currently on its plate. But then, it has been known for tableware to be changed.