APN News and Media

It has been a while since I did a post on an Asian stock, partly because of the drought of Asian ideas. I do have a number of Hong Kong listed stocks on my watchlist, but they have yet to hit prices which I am comfortable accumulating. Nonetheless, it was a lovely surprise when I was clearing some of the old sell-side initiation reports when I came across APN News & Media. Technically, it's an Australia company. Depending how you see it, some people count Australia as part of Asia, but that's another post by itself.

APN is a media company which generates most of its revenue from advertising. If you have been following Australia media companies diligently, you will know that a lot of them are struggling. Advertising has basically flatlined since the financial crisis (see below).

Advertising Spendings	2008	2009	2010	2011	E2012	E2013	E2014
TV	3,729	3,484	4,056	3,950	3,911	4,090	4,145
Newspaper	4,117	3,471	3,665	3,374	3,007	2,776	2,554
Magazines	1,032	857	871	814	675	608	590
Radio	971	936	1,001	1,008	1,009	1,029	1,053
Outdoor	454	400	477	494	502	518	533
Cinema	96	89	99	79	87	88	90
Online	1,710	1,871	2,265	2,824	3,284	3,756	4,272
Print Directories	1,547	1,472	1,243	938	879	813	782
Total Ad Market	13,656	12,580	13,677	13,481	13,354	13,678	14,019
Growth %	N.A.	-7.88%	8.72%	-1.43%	-0.94%	2.43%	2.49%

Coupled with the onslaught from new media, such as the internet and increasing smartphone penetration, many of the old world media companies are dying. APN is one such company, deriving its revenue from newspaper/magazine publishing, radio networks and outdoor advertising. At its peak,  APN traded at around A$6 in 2006. Now its trading at A$0.26. 

Yeap, you didn't see that wrong. A$0.26. Thats a 95% fall from the peak. 

Other examples include Seven West, a media conglomerate with businesses ranging from free-to-air TV, newspapers and magazines, trading at over A$16 in 2007. Now, its trading at A$1.90. Ten Network, one of Australia's three commercial metropolitan free-to-air TV networks, peaked at over A$4.40 in 2005, now trading at A$0.275.

A year ago, when I saw the valuations on these companies, I thought they were cheap. The problem is, they only got cheaper. Without knowing anything about the businesses, one would have thought these companies came close to bankruptcy, having fallen that low. You would have thought these companies must be unprofitable, except that they are, although margins and revenues are shrinking. At one point in time, APN was paying a DPU of A$0.32, which is higher than its current share price.  Don't get me wrong, APN is a shrinking ice cube. There are risks involved with investing in such companies. Nonetheless, I feel the valuation now justifies putting on a small position. 

Income Statement (A$ 000)	2007	2008	2009	2010	2011	2012
Revenue from continuing ops	1,314,573	1,193,398	1,030,666	1,059,085	842,142	857,151
Other revenue and income	25,666	28,530	21,332	4,731	25,722	10,176
Revenue	1,340,239	1,221,928	1,051,998	1,063,816	867,864	867,327
Employee benefit expenses	(1,031,979)	(347,184)	(315,866)	(327,418)	(328,417)	(337,555)
Selling and production		(321,041)	(284,468)	(288,521)	(238,103)	(265,401)
Rental and occupancy expense		(174,567)	(163,805)	(162,180)	(54,746)	(63,572)
Deprec and amot		(40,956)	(40,767)	(38,900)	(29,874)	(30,959)
Redundancies and associated costs		0	0	0	(17,332)	(8,436)
Asset write downs and business closure		0	0	0	(18,298)	(7,344)
Loss on sale of property		0	0	0	0	(2,353)
NZ Herald relaunch cost		0	0	0	0	(2,939)
Other		(51,127)	(65,186)	(49,695)	(57,551)	(52,951)
EBIT	308,260	287,053	181,906	197,102	123,543	95,817
Impairment of intangible assets	0	(202,953)	0	0	(159,495)	(638,448)
Finance costs	(63,359)	(75,533)	(52,234)	(50,457)	(57,190)	(44,416)
Share of profits of associates and JV	6,829	6,484	3,254	3,002	5,807	9,155
Profit from discontinued ops	0	(2,954)	(1,830)	(4,862)	19,703	77,543
Profit before Tax	251,730	12,097	131,096	144,785	(67,632)	(500,349)
Tax	(45,723)	(6,275)	(14,624)	(30,061)	48,696	68,392
Net Profit	206,007	5,822	116,472	114,724	(18,936)	(431,957)

At first glance, the financials are horrendous. Revenue is constantly shrinking. EBIT has done nothing but shrink in the last six years. Net profit is distorted by a number of non-recurring restructuring and write-off expenses. The table below shows normalised numbers to give a clearer picture of APN's profitability.

(A$ 000)	2007	2008	2009	2010	2011	2012
Normalised EBITDA	308,260	328,009	222,673	236,002	189,047	147,848
Normalised EBIT	308,260	287,053	181,906	197,102	159,173	116,889
Normalised NPBT	251,730	218,004	132,926	149,647	107,790	81,628
Normalised Profit (20% tax)	201,384	174,403	106,341	119,718	86,232	65,302
Normalised EBITDA Margin	23.0%	26.8%	21.2%	22.2%	21.8%	17.0%
Normalised EBIT Margin	23.0%	23.5%	17.3%	18.5%	18.3%	13.5%
Normalised Net Profit Margin	15.0%	14.3%	10.1%	11.3%	9.9%	7.5%
CFO	211,327	173,942	119,374	165,245	123,063	87,274
CAPEX	(177,751)	(81,128)	(18,262)	(58,215)	(47,368)	(57,389)
FCF	33,576	92,814	101,112	107,030	75,695	29,885

Even after normalising for restructuring and non-recurring costs, all the various profitability metrics are declining. EBITDA and EBIT margins are at a historical low. APN currently has a market cap of AUD$170m. If post restructuring if APN can just maintain a net profit of AUD$65m, which is the normalised level in 2012, this is easily a PE 2.5x stock. Like all other media companies, it generates a decent amount of free cashflow which can go towards paying dividend. Shrinking margins is not their only problem. Their declining profitability has also affect the ability to pay their debt. 

	2007	2008	2009	2010	2011	2012
Short Term Debt	94,768	155,620	20,280	25,765	27,504	29,797
Long Term Debt	840,905	807,567	762,700	694,328	633,526	449,320
EBIT/Interest expense	4.87	3.80	3.48	3.91	2.78	2.63
Debt/EBITDA	2.75	2.76	3.37	2.78	3.37	3.10

Debt/EBITDA ratio and interest coverage ratio has been deteriorating despite total amount of debt shrinking from A$935m in 2007 to A$480m in 2012. The next major refinancing (A$400m) is expected in 2015, and APN has some time to reduce debt further using internally generated cashflow. The reason why I believe APN will mostly survive is because of their strength in outdoor and radio, which is highlight below. 

	2009	2010	2011	2012
Australian Regional  Media Revenue	272,195	288,036	276,002	248,760
New Zealand Media Revenue	321,498	320,077	301,067	287,360
Australian Radio Network Revenue	122,984	127,307	133,212	139,951
The Radio Network Revenue	84,709	85,682	86,712	86,708
Outdoor Group Revenue	229,280	237,983	263,740	110,485
Digital Group Revenue	0	0	11,661	55,311
Australian Regional EBITDA Margin	21.9%	20.8%	20.0%	15.5%
New Zealand Media EBITDA Margin	20.7%	22.3%	20.5%	16.6%
Australian Radio EBITDA Margin	35.5%	33.7%	35.7%	36.3%
The Radio Network EBITDA Margin	15.9%	15.0%	19.5%	17.4%
Outdoor Group EBITDA Margin	7.0%	12.1%	17.4%	17.7%
Digital Group EBITDA Margin	N.A.	N.A.	-35.1%	-1.4%

Above shows the segmental breakdown of APN's revenue and their respective EBITDA margins. 

(i) Australia Regional Media refers to APN's 12 Australian daily newspapers, over 56 non-daily newspapers and over 30 news websites. 

(ii) New Zealand Media refers to their publishing business in New Zealand, including seven daily regional newspaper, 35 community newspapers and magazines such as New Zealand Woman's Weekly and New Zealand Listener. 

(iii) Australian Radio Network refers to their radio network business in Australia. Similarly, The Radio Network refers to their radio network business in New Zealand.

(iv) Outdoor Group refers to APN Outdoor which is their outdoor advertising segment with operations in Australia, New Zealand and Hong Kong. 

(v) The Digital Group is a bundle of various different businesses including GrabOne - the no. 1 group buying business in NZ, online shopping club BrandsExclusive and digital retail advertising network CC Media.  

A few quick observations. The Australian and NZ newspaper/magazine publishing business are struggling. Not only are revenues shrinking, margins are also shrinking. Whereas, the radio and outdoor advertising businesses are fairly robust. Revenues grew slightly and margins are relatively stable. APN Outdoor Group revenue fell over 50% in 2012 because APN sold half the business to Quadrant Private Equity. The resulting JV, called APN Outdoor is valued at A$272m and carry A$110m in debt. APN Outdoor generated EBITDA of A$45.8m in 2011. Assuming the JV doesn't not have any cash on its balance sheet, the transaction occurred at 8.3x EV/EBITDA. This is pretty close to the valuation which Ten network sold its Eye Corp outdoor advertising arm for, at 8.1x EV/EBITDA in November 2011. We will refer to these levels as benchmarks when making our calculation for a target price later on. Their digital group segment was built up through acquisitions in 2011. It is growing very fast but has yet to be profitable. 

The "jewel crown" here is actually the radio and outdoor advertising businesses. Unlike newspaper or magazines, these are not under direct attack from digital media. Drivers still listen to the radio on their way to work. People on their way to work still take public transport, where they are exposed to APN's posters. While they may not be high growth assets, these businesses are relatively mature and are good cash cows. Managed properly, in an industry structure that is stable with little market share competition, they can throw out a lot of cash. Fortunately, radio and outdoor advertising in Australia is fairly stable. Given that these are old world media businesses, no single player has the incentive to sacrifice margins for market share. Most are focused on maximizing cash flow generated from the businesses.

Valuation

	2012 EBITDA (A$'000)	EV/EBITDA Multiple
Australian Regional EBITDA	38,655	3	115,965
New Zealand Media EBITDA	47,810	3	143,430
Australian Radio EBITDA	50,777	6	304,662
The Radio Network EBITDA	15,130	6	90,780
Outdoor Group EBITDA	19,553	7	136,871
CC Media	1,500	8	12,000
Grab One	N.A.	N.A.	12,800
BrandsExclusive	N.A.	N.A.	36,000
		Total	852,508
		APN debt	479,117
		APN Cash	20,338
		APN Equity	393,729
		No of shares ('000s)	661,527
		Target Price	0.60

Let's do a quick sum of parts here to see what APN is worth. Both the Australian and NZ publishing business are dying businesses. There is no pure play Aussie/NZ newspaper or magazine listed on the ASX. Without a comparable peer, they are valued conservatively here at 3x EV/EBITDA. Both the Australian Radio Network and The Radio Network (NZ) are stable, growing slowly and generating free cashflow. They are valued at 6x, slightly below APN's Outdoor Group. As for the Outdoor Group, we will use 7x EV/EBITDA, a slight discount to the 8.3x EV/EBITDA benchmark where Quadrant Private Equity bought 50% of the group. GrabOne and BrandsExclusive, part of APN's digital Group, are valued conservatively at acquisition cost - A$12.8m and A$36.0m respectively. There is no data on the acquisition price of CC Media. Hence, we will apply a 8x EV/EBITDA multiple. The resulting valuation excuse yields a target price of A$0.60, which is over 200% higher than the closing price of A$0.26 today. Experienced market participants will then ask, why is it so cheap? There is no free lunch in this world. Something is horribly mispriced usually is associated either with a lot of uncertainty over future prospects, or is irrationally and widely hated. 

This is why I think the company is trading at such low levels. First of all, the company has been shrinking over a long period of time. While advertising is a cyclical industry, there hasn't been any meaningful growth since a 8.7% rebound in 2010. Analysts estimate that we will either see a recovery this year or in 2014. APN's publishing business have high operating leverage. Because the majority of costs are fixed, any incremental recovery in revenue will be magnified in the bottom line. 

Secondly, there is a lack of leadership in the company. The previous CEO Brett Chenoweth, Chairman Peter Hunt and three other independent directors resigned in Feb 2013. This is in response to major shareholders, Independent News and fund manager Allan Gray Australia's rejection to their plan of raising equity financing to pay down debt. I too agree that this is a very short term solution which only serves to dilute existing shareholders, especially at such depressed valuations. Allan Gray is the Australian subsidiary of Global Fund Manager Orbis. Orbis is a long-only mutual fund manager which I respect. Both companies have newsletters on their website available for download. I highly recommend going through these newsletters to search for potential ideas.

Thirdly, the strength of their radio and outdoor businesses has been drowned out by their bleeding publishing business. Ideally, if APN could divest their publishing business, the stock should be re-rated. But, I suspect there may be few buyers for these assets and the prices they fetch will be quite poor. Not to mention, their debt ratios have not shown much improvement despite paying down debt over the years. Without any further asset sales, I imagine it will take APN quite a few years to pay down existing debt using their free cashflow. 

That being said, I believe APN is trading at a very attractive level. There is little threat of bankruptcy. APN has a good chance of survival, but the next few years will be tough as further restructuring is required to reduce costs and pay back debt.