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Lee Enterprises Down 60% in One Month – CEO Buys 100,000 Shares – Safe and Undervalued?

May 05, 2011 | About:
Karl

kfh227

5 followers
Some of you know of Lee Enterprises (LEE). Many do not. Please do not be frightened by the next word. Newspaper! Yes, Lee Enterprises is a newspaper. It has some long term debt issues that need resolution. Specifically, $1 billion in long term debt that matures in April, 2012.

Lee is in a misunderstood industry that many term dead. Whenever someone is asked about the future of newspapers, the frequent response is that it is a horrible investment. When asked why, the common retort is simply that print is dead. People just repeating what the mass media has pounded into everyone’s heads. What I encourage everyone to do is read the reports and other available data from Lee and its competitors. Doing so will probably cause one to draw a different conclusion in just a handful of hours. Lee's investor relations page can be found here.

Lee has a few things that a value investor may like. It's financial statements are mostly attractive other than long term debt numbers that are a bit high. That is discussed later. What most miss is that it can be argued that Lee has a moat. When it comes to local news, this is not something major outlets (CNN, Fox News, CNBC, etc) cover. If you want local news in print, you need your local paper. The moat is not as great as it was 20 years ago but the moat is still there. The moat is in the local reporter reporting on your local high school sports teams. On recent weather in the area. On news of the local factories hiring or laying off. Listings for local apartment rentals. Ads for local businesses like the hardware store. The list of things that local news can provide that national news can not is endless. That is the moat that Lee has.

Also, many newspapers including Lee are creating or have created apps for various digital media devices such as the iPad and iPod and are experimenting with pay for content models within those devices. When thinking about tech and media, please remember that digital distribution is in its infancy. Digital media devices are very immature right now as is the level of knowledge in using those devices to generate revenue. In 10 years media devices will probably be of such a form due to maturing models that no one could have imagined them today. And as such, newspapers will mature in lock step and have a better understanding of how to survive in the era of digital media. While the future is not known, the possibilities both good and bad are endless. Print is a smaller foot print in Lee's business these days but the potential for Lee to make more money digitally is there.

Knowing all of this, Lee has gotten killed over the past month. It is down from about $2.80 a month ago to a close today of $1.17. it even dropped below $1 for a few hours. Mostly due to fears that the $1 billion in debt that matures in less than one year will not be refinanced. A deal was in place but Lee appears to have walked away from the deal due to unfavorable terms that Lee views as being caused by bad timing. The deal included new long term debt with 9% and 11% interest rates so this is understandable. These rates are much higher than that of the current debt structure. Lee currently has revenues of about $750 million a year and produces $100 million in Free Cash Flow.

Which leads to the CEO buying 100,000 shares. Lee's CEO has also recently purchased 100,000 of the 39.2 million shares outstanding (0.25% of all shares) which is encouraging. The future is not as dim as many think. The CEO also said the following in a recent letter to shareholders (May 5, 2011):

Dear Lee Stockholder:

As you may have seen in news reports, Lee has decided not to proceed at this time with our recently proposed private placement of bonds and stock totaling $1.055 billion as a way of refinancing our long-term debt.

In deciding to withdraw the proposed offerings, we concluded that market conditions were not sufficiently favorable at this time, primarily in light of recent bumps in the economy and a slowdown in revenue recovery for the industry and Lee. Perhaps because of these economic uncertainties, potential investors sought terms and conditions we believe were not in the best interest of Lee or its stockholders.

Refinancing our debt remains among our highest priorities. We will continue to pursue alternatives and fully expect to refinance our long-term debt before it matures in April 2012. We believe opportunities will improve in the coming months as our local economies regain steam and our revenue trend again turns upward. In the meantime, we continue to drive substantial cash flow and pay down debt rapidly. We are not, as some in the national media have imagined, staving off bankruptcy.

Full Release

Valuation wise, Lee has a market cap of $46 million right now. After debt restructuring, it is reasonable to think that Lee should be able to make over $20 million in FCF if not $100 million if the economy improves further. Lee has positive shareholder equity so to take a conservative view of value and simply say that Lee is worth 8x FCF or 8x $20 million, this $46 million market cap that currently has positiver free cash flow is potentially worth north of $160 million with 39.2 million shares. Lee has mentioned that share dilution is an option and the numbers tossed around hinted at 25% share dilution. So assuming share dilution would cause there to be 50 million shares, Lee is probably worth more than $3.20 per share ($160 million / 50 million shares) assuming that the debt refinancing does occur.

John Rogers is the only guru holding Lee. Rogers owns 7,437,607 shares (19% of all shares outstanding) as of 12/31/2010, an increase of 31.67% from the previous quarter. This position accounts for 0.34% of the $5.32 billion portfolio of Ariel Capital Management.

DISCLOSURE: The author of this article own LEE.

About the author:

kfh227
Karl is currently a software engineer in Connecticut with a bachelors of science in electrical engineering from Clarkson University. He has been investing since 2001 and interested in value investing since 2005. Karl is continually striving to learn more about investment.

Rating: 2.8/5 (11 votes)

Comments

mikewen
Mikewen - 3 years ago
What's the point to buy LEE when INTC, MSFT and many other high quality companies selling for higher cashflow yield? (When consider debt, cash. )

johnheiderscheit
Johnheiderscheit - 3 years ago


A few questions:

1) Lee has been exploring a first lien, second lien structure for rolled over debt. What is the current pricing for such deals?

2) Assuming that Lee pays 12% blended for the new debt (compared to the current blended 7%), how would this impact free cash flow?

3) Isn't Lee even at a $1 share price the most expensive of the major newspaper publishers on an EV/EBITDA basis.

4) If the equity has so much value, why is the current bank debt trading a discount?

5) Doesn't Mary Junck's purchase represent about 2.5 months of total compensation for her?

Thanks.
kfh227
Kfh227 premium member - 3 years ago
Well made points. I have an engagement tonight. I'll try to get back to these topics tomorrow.

As for MSFT and INTC, I would not ever consider them for investment. Their market is to quickly evolving. So I can't comment on that specific question.

I don't use EV/EBITDA. The math behind it doesn't seem very rational. I prefer FCF.

In short, FCF could get decimated by the new debt structure. Interest related costs could drop FCF to $50 million a year from the current $100 million perch. I think the $20 million number I mentioned is a pessimistic one. Some Googling on the deal that LEE walked away from will give more specifics. I can get them later. Even with the deal they walked away from, I still see FCF as being positive.

Junkck makes just shy of $1 million a year. $100,000 represents about 12% of her income. So 1-2 months of salary is accurate.

I'll try to work out the impact of FCF later on to more exacting precision. In short, I view interest expense being at about $100 milion a year given a 10% interest rate. 12% would be maybe $130 million a year. I'll have to look into the current debt structure in more detail. if interest expense is less than $30 million right now, FCF would be just about break even $100 million change drops FCF from $100m to $0m). The thesis in part expects better operating cash flows with an improving economy though. More details are needed.

Good questions.
kfh227
Kfh227 premium member - 3 years ago
I havn't gotten back to the questions, but I have thought about it alot. The unknown future risks are:

1) Will a refinance occur

2) At what interest rate

And how does this compare to interest costs in the past? Apply the delta to FCF of $100m and future FCF is estimated. I thought about this earlier and made some generalizations instead of just doing the math. This math is key to LEEs future. Sadly, if they could just get an 8% interest rate, LEEs future would be solid and the credit rating unjustified. But when talking 11-12% that credit rating would make sense.
johnheiderscheit
Johnheiderscheit - 3 years ago
Okay, well I am looking at LEE's $1.1 bil in debt this way. The bottom $400 million in quasi equity in the sense that to have a properly capitalized balance sheet in an industry the future of which is debatable to say the least you could have a max of 3.5x debt to EBITDA. That translate to $700 million in senior debt and $400 million in junior debt. Right now there is a significant spread between pricing in the junk bond market, which back near the 2007 peak, and pricing in the second lien/sub debt market, which has not reached the stage of froth.

So I figure the $400 million tranche is entitled to 16%. Some of that would be cash, perhaps a little would be PIK. But if you treat it as all cash to be safe you are looking at $64 million in interest there plus another $45 million on the senior for an extra $25-45 million relative to what they are paying now.

So the equity has some value in this scenario. But you have to discount that value by the risk of marked deterioration in the business over the medium term and the separate risk that they are unable to get a deal done at any price between now and next April.

Net net I think the LEE common today is worth $25-100 mil today, or 50 cents to $2. Personally I expect to see both prices before next April.
batbeer2
Batbeer2 premium member - 3 years ago
Personally I expect to see both prices before next April.

Yes. Management is right to walk away now. They may wish to recapitalise (dilute) if (when ?) it trades higher. IMHO it's a basket case..... you have a basket of these and you will do fine. My portfolio is too concentrated for this type of investment. I understand Conn's (CONN) better but I'm not long either one.

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