Here’s A US Newspaper Horror Story – Since The Day McClatchy Announced Its Knight-Ridder Purchase Its Shares Are Down 69% Whereas The Dow Jones Averages Gained 17%

For what was once considered the high-flier of US newspaper companies – everyone else’s revenue would drop but McClatchy always seemed to increase earnings – it has been a horrible climb-down since it bought the Knight Ridder newspapers last year.

Its closing share price on the day it announced the buy, March 10, 2006, was $53.24. On Tuesday it closed at $16.73 – a 69% fall. By contrast, the Dow Jones Averages closed March 10, 2006 at 11076.34 and closed Tuesday at 13,307 – a 16.8% increase.

McClatchy paid $6.4 billion for Knight-Ridder, before selling off 10 newspapers it didn’t want for a net of about $4 billion for those it kept. Its capitalization at Tuesday ’s close was just $1.37 billion.

And what does CEO Gary Pruitt have to say about that? He told analysts last month, “We are disappointed in the share price – no doubt about it. I know the shareholders are very disappointed and I’m sorry we haven’t done better.”

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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.

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The prognosis is that things won’t get better any time soon. Usually if there is a revaluation it is done at the end of the year, but in making the changes now McClatchy is acknowledging publicly that things have gotten so bad that to abide by accounting rules it has to speed up the calendar for its revaluations. That’s about as clear a sign one can get from a company that it doesn’t think its business is going to improve quickly.

The lead paragraph in its flagship Sacramento Bee newspaper summed it all up, “By swallowing a $1.52 billion non-cash accounting charge, the McClatchy Co. on Thursday acknowledged its troubling near-term prospects and the diminished value of a prized acquisition.”

Pruitt told shareholders, “We do not know when this downturn will end, and we do not have visibility beyond the fourth quarter.”

Apparently Moodys Investors Service doesn’t think advertising is going to pick up any time quick and warned it was reviewing McClatchy’s debt rating, with an eye to putting it even further into junk territory. It said McClatchy faces, “ongoing pressure on the company’s cash flow from declining advertising revenue that contributes to the $1.5 million write-down of newspaper assets in the third quarter, and the resulting challenge to reduce leverage to the ranges originally incorporated in the Ba1 rating,” that is already one grade below investment quality.

Fitch Ratings maintains a pretty negative view on US newspaper valuations, saying they will continue to be pressured by advertising dollars moving to the Internet. It believes those markets, and this could just as well apply globally as well as just within the US, that have a high penetration of broadband connections and more competition for eyeballs will continue to see print disproportionately negatively affected whereas those markets that don’t have high broadband penetration (on a global basis think India and China) will continue to see print doing just fine.

McClatchy has been hit particularly hard by the mortgage crisis. The worst two affected markets are Florida and California and that is exactly where McClatchy has some of its prime newspapers.

The group is also disappointed by its online operations with the Q3 results showing that online advertising had increased a “mere 1.4%, totaling $41.6 million.” Online national advertising was actually off $2.7 million, with online classifieds increasing 4.8 %( $1.5 million). Online automotive was up 20% (print automotive was down by about the same percentage) and online employment ads increased just 1.7% compared to print’s employment ads dropping 22.4%.

McClatchy has two classes of stock with the McClatchy family owning the controlling B shares so there is no chance of what happened to Knight-Ridder happening to McClatchy. Its largest outside shareholder is Ariel Capital Management of Chicago and it says McClatchy remains fundamentally a sound company and the non-cash write-down does not affect its stability. “This does not change our valuation or the day –to-day running of the newspapers, said Ariel analyst Chris Watters. We believe in Gary … Nothing that came out today changes that.”

When McClatchy bought Knight Ridder and then sold off the newspapers it didn’t want there was general agreement that McClatchy had done about as well as it could, paying rock bottom for the Knight Ridder papers and getting good prices for those it sold on. But a year later and Ariel portfolio manager John Miller observes, “Looking in hindsight …it’s obvious that they overpaid for the acquisition.”

As part of the Knight-Ridder deal McClatchy took a 49.5% stake in the Seattle Times. At the end of last year McClatchy valued that holding at $102.2 million, and then in late June it lowered it to $89.9 million. But now it has really bitten the bullet, lowering the valuation on its books to only $19.1 million, that’s down 81% within a year!

The Blethens family that owns the controlling 50.5% of the newspaper had actually rejected a Knight-Ridder offer in 2000 of $500 million plus $200 million in assumed debt.

Today the Blethans may well say the valuation of their 50.5% is much higher than the $19.1 million McClatchy places on its minority share – the majority share holder has all the decision-making power and that counts within a valuation -- but its nowhere near the $700 million Knight-Ridder offered seven years ago and is yet another example of how newspaper valuations have fallen.

And remember it was only last December that McClatchy surprised just about everyone by selling its largest newspaper, The Minneapolis Star Tribune, to private equity firm Avista Capital Partners for $530 million -- less than half what it paid the Cowles family just eight years previously. The company could count on an additional $160 million tax loss bringing the sale’s value to $690 million but that’s still way off the $1.2 billion it originally paid.

At the time Pruitt explained, “The Star Tribune did very well for a few years (it’s estimated McClatchy got about $1 billion in cash flow during the good times), but recently it has lagged in performance. Large Metro papers have underperformed smaller ones because they’ve been more dependent on classified ads, which have already been most affected by the Internet. The Star Tribune suffered from that.”

And then in January the New York Times Company bit the bullet, taking an $844 million pre-tax charge by writing down the value of the Boston Globe and the Worcester Telegram and Gazette. It had paid $1.1 billion for The Globe in 1993 and $295 million for Worcester in 1999, so the write-down reduced the combined value of those investments by 59%.

Still, there are those who apparently believe the drop in newspaper share prices make for good buying opportunities. Brandes Investment Partners, one of Gannett’s largest shareholders, says it has doubled its ownership stake and now has 11.25% of the company compared to just 6.6% six months ago. It started investing with gusto in February and has added another 10 million shares since. It says it now owns about $1 billion of Gannett stock and it says it applies “long-term perspective to both investment portfolios and management of our business” which Gannett will hopefully translate into no pressure to sell itself as institutional investors forced the Knight-Ridder sale.

And what other big newspaper company does Brandes have a big holding? Yes, McClatchy.

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Here’s A US Newspaper Horror Story – Since The Day McClatchy Announced Its Knight-Ridder Purchase Its Shares Are Down 69% Whereas The Dow Jones Averages Gained 17%

McClatchy has filed papers with the Securities & Exchange Commission that it is writing down the value of the company by some $1.52 billion ($1.38 billion after tax considerations) reflecting the huge drop in its share price and the diminished value of the newspapers it kept from Knight-Ridder.