Lee Enterprises is a newspaper company serving 52 markets in 23 states, with a print circulation of 1.3 million daily and 1.7 million Sunday editions. Digital (including mobile and tablets) audiences reached 22.7 million unique visits in January. That is down slightly from results of the first quarter 2011, when circulation was 1.4 million daily and 1.7 million Sunday readers, and it had 25 million unique visitors to its digital sites in March.
Many investors consider the newspaper industry moribund, reflected in Lee’s almost 95 percent stock decline over the last five years. But Buffett sees a bright future for the industry as well as a cheap stock.
Several months before Buffett bought Lee, the main concern for investors was its looming need to refinance over $1 billion in debt. A high interest rate would have dramatically reduced one of the most appealing things about the stock – significant and reliable free cash flow.
With $105 million in trailing 12 month free cash flow and a market cap of $52 million in May, Lee traded at a 0.50x TTM FCF. Free cash flow has averaged $105 million over the past five years.
However, Lee also has $1.08 billion in long-term liabilities and debt, with $94 million in cash that it just refinanced.
The debt seems to be held over from 2005, when the company entered an agreement to borrow up to $1.55 billion, most of which was used for the acquisition of Pulitzer Inc., an operator of 14 daily newspapers and 100 weekly newspapers, shoppers and niche publications. The acquisition made the company the fourth-largest U.S. newspaper publisher in terms of dailies owned and seventh largest in circulation at the time.
In May 2011, the company announced that it decided not to refinance through a private placement of bonds and stock due to unfavorable market conditions as a result of bumps in the economy and a slowdown in revenue recovery for Lee and the overall newspaper industry.
“Perhaps because of these economic uncertainties,” Lee Chairman, President and CEO Mary Junck said in a letter to shareholders, “potential investors sought terms and conditions we believe were not in the best interest of Lee or its stockholders.”
In the same letter, the company also said that it was using its substantial free cash flow to pay down debt rapidly, and it was not staving off bankruptcy. On January 30, the company did have to file Chapter 11 to get some debt holders to agree to its refinancing terms. Its refinancing agreement extended the maturities of its borrowing to December 2015 and April 2017. The company also issued 6,743,640 shares of common stock, resulting in a dilution of approximately 13 percent.
With debt of over $1 billion, Lee has a debt to free cash flow ratio of 9.52. This is not unusual for the newspaper industry. McClatchey (MNI), a competitor, has a debt to free cash flow ratio of 11.9 (using 2010’s free cash flow). Another competitor, the New York Times (NYT), has a debt/FCF of 14.9.
“This is the favorable outcome we fully expected, and it provides Lee with a nearly four-year runway to continue improving our balance sheet,” Junck said in a statement. This is assuming that the next four years are good for newspapers, which Buffett believes they will be. He bought 63 local U.S. newspapers in one week in May for $142 million, and the Omaha World-Herald for $200 million in November.
In a letter to editors of the swath of newspapers Buffett purchased, he reiterated that “Berkshire buys for keeps,” except when a business faces unending losses, which he acknowledged is a “remote prospect for virtually all of our dailies.” He went on to say, “Though the economics of the business have drastically changed since our purchase of The Buffalo News, I believe newspapers that intensively cover their communities will have a good future. It’s your job to make your paper indispensable to anyone who cares about what is going on in your city or town.”
Lee in many ways matches these criteria. In a survey conducted in 2011, 76.9 percent of respondents in the age group 18-29 said that they at least “use” the paper for some reason, followed 77.8 percent of 30-39 year olds, 82.5 percent of 40-59 year olds and 88.6 percent of those 60 and above.
“We have more journalists than all our competitors combined and provide news vital to our communities. Without us, most local news would never come to light,” the company said in a presentation.
Buffett got his shares of Lee as part of its bankruptcy because he bought $85 million in loans at a discount from Goldman Sachs in November which “were slated to be exchanged into junior debt and an at-least 4.1% stake in the company as part of its bankruptcy in January,” the Wall Street Journal reported in April.
If Buffett does buy more shares of Lee, he will have to pay significantly more as the stock price has jumped 19 percent since he disclosed his stake.
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