A new entry to the Magic Formula® Investing (MFI) screens intrigued me.
It is intriguing for several reasons.
First, because virtually everyone knows of this company and has bought or used its products.
Second, because it has a business model that is simple enough for anyone to understand.
And third, because it fits not one, but TWO of the categories of stock that MFI inventor and hedge fund manager Joel Greenblatt (Trades, Portfolio) has written books about.
That makes it a priority to review in my book!
The stock is Time Inc. (NYSE:TIME). Let's take a look.
Have Your Read Any of These?
You've almost certainly heard of Time. Chances are, at some point you have read, purchased, or subscribed to one of their magazine titles. Time is the largest magazine publisher in the U.S. by audience and ad share. In fact, Time's readership is 25% larger than that of its closest competitor, Hearst!
Some of the company's largest titles include: Time - a general news weekly, People - celebrity news, Sports Illustrated - sports, InStyle - fashion, Entertainment - Hollywood news and gossip, Money - personal finance,Golf, Travel + Leisure, and almost 20 others in the U.S. alone. Time has over 100 million U.S. print subscribers and another 70 million online (there are mobile and tablet versions of all their U.S. titles). Time also publishes over 70 titles internationally and over 45 websites.
Time makes money in 3 ways. About 54% of sales are from ad sales, 34% are from circulation (subscription fees), and the remaining 12% are from various services such as fulfillment, marketing, and distribution for smaller publishers that lack scale.
Meets Not One, But Two Criteria Joel Greenblatt (Trades, Portfolio) Loves
We write about Time, of course, because it is a recent entry to the Magic Formula® screens, something Mr. Greenblatt describes in his book The Little Book that Beats the Market. And sure enough, it belongs there. Time's EBIT/EV earnings yield is an undeniably cheap 15.6%, and its return on tangible capital is a solid 77%. Time is a prodigious free cash flow generator, raking in over $400 million annually, and its 13.5% free cash flow yield is another indicator of how cheap the stock price looks.
What's more, Time's management has committed to pay a dividend of about 30% of free cash flow. At recent levels, that works out to about $1.04/share, which would be a yield over 4.5%. I have been unable to find any hard numbers on what exactly the company plans to pay, however.
The reason for this leads us to the second Greenblatt trait - Time is a recent spinoff from Time Warner (TWX), beginning trading just this week. Guess what? Spin-offs are one of Greenblatt's favorite hunting grounds for profits, as described in his first book You Can Be a Stock Market Genius. Spin-offs are often under the radar at first, and it can take a year or more for them to receive analyst coverage and the institutional dollars that follow.
Is Time a Buy?
All of this brings us to the key question: is the stock a buy?
Time's financial trends are uninspiring. The company has posted revenue declines of 7% and 2.5% over the past two years, with operating margins declining from 16.3% to 13% over that period. Like most publishers, Time is in a tough spot. Mobile readership is growing faster than web readership which is growing more than the declining print audience. Unfortunately, ad rates work in the opposite direction, with print rates being the highest. Additionally, the publishing business works on largely fixed costs, so lower a lower subscriber and revenue base leads to de-leveraging of costs (creating lower margins), and also can lead to lower ad rates as marketers reach fewer customers.
It should also be mentioned that Time's current earnings yield is a bit misleading. It does not include $1.4 billion in debt Time Warner is saddling the company with. When accounting for this, Time's earnings yield drops to 10.8%, still fairly cheap but now much more in line historically with peers like Meredith (MDP).
Ultimately, Time's spin-off will probably help facilitate a leveling-off of revenue and profitability declines, as layers of bureaucracy are removed, structural costs are rationalized, and the company pursues more title acquisitions. The stock should also find a comfortable ownership as the dividend crystalizes and we get an idea of share buyback plans.
That said, assuming very modest low single-digit growth, I cannot come up with a target price for Time that is much over $25. That gives prospective investors a decent 16% upside from here.