An Enterprising Value - Lee Enterprises

Given the current economic conditions and arrival of the internet, many predicted the collapse of small newspaper publications. Lee Enterprises (ticker: LEE) has opposed this viewpoint for many years. In fact, they have been free cash flow positive in each of the past 10 years! This has been done in part through cost cutting and improved advertising sales techniques.

This stock was found using the GuruFocus Discounted Free Cash Flow Screener. The screener estimates Lees value at $33.62 per share. Lee has an ROA of 1.4% and recently closed at $3.04. While the valuation may not be exact, the apparent value is worth a deeper look. A more detailed valuation is done at the end of this article.

The notion that the internet is going to destroy newspapers companies seems to be turning out to be a myth. According to independent research, it is estimated that Lee's newspapers and online sites reach approximately 68% of adults in its larger markets in an average week. The simple fact is that when local news happens, local reporters report it and local people read it. This is not something that will change. Whether it be a car accident, a tornado, or layoffs at a local employer, local reporters have to generate the news reports. What has happened with many print publications is that they are duplicated via an online presence. And the sustainability appears to be there.

Also, keep in mind that Lee is not simply newspapers. They also provide print publications such as car sale specific publications along with job opportunity specific publications and rental publications.

Regarding online content, Lee is the primary provider of local news in their markets. Lee online sites provide 43% of local news to citizens. While local TV station online content provides only 21%. The giants, Google and Yahoo only provide 12% and 9% of local new respectively. Those looking for local news on Google and Yahoo are often directed to Lee's online sites.

Lee also utilizes Yahoo's advertising engine. When reading articles about cars in a given market, Yahoo's advertising engine (which lee uses) will provide advertisements for local car dealers. So, the technology that is intended to deliver local advertising through digital means is beginning to mature.

While online content is free, Lee is testing pay-for online content in one market. Also, they are doing a trial with Kindle for pay-for subscriptions in their two largest markets. Other e-reader formats in addition to kindle are being investigated. What is happening to the newspaper industry is not the technological based extinction of it. It is simply being transformed by technology in a manner to diversify the method of content delivery. It is no longer the simple, boring toll bridge that many investors think of from the past. It is still a toll bridge of sorts though. If you want local news, there still will only be a few places to look in many towns and cities. And because of this, there is still a moat around local news providers.

Regardless of the delivery mechanism of the media, one thing has not changed. Lee's primary source has been advertising revenues. Within advertising, retail advertising (example: local businesses, brokerage ads, etc) is the top revenue generator. Classified ads produce the second most amount of revenue. The third greatest source of revenues is online ad revenue. Lee has teamed with Yahoo in order to help create targeted advertising within their online presence. Lee expects classified ad based revenue to improve with an improving economy due to an increase in the number of help wanted ads. Local businesses will also be more likely to advertise their services as the economy improves. The worse may be behind Lee and many other companies like it.

Regarding the possibility of paying for online content, Lee currently maintains a free content posture. There is no reason to think this will change as it would probably turn off the readers in the smaller communities it serves. Lee typically services small and medium sized end markets.

Lee has undergone several cost cutting measures. They have reduced the page size of their print publications which reduces manufacturing costs. The change in size has been warmly received by its readers.

The following charts summarizes the past 10 years of free cash flow data.



Lee has two classes of shares (A and B). The A shares are publicly traded and the B shares are equivalent (1 share of B is convertible to 1 share of A) with the exception that B shares have better voting rights (a single B share gets 10 votes). There are currently about 39.2 million shares of the A class and about 5.7 million shares of the B class for a total number of about 44.9 million shares.

The attractive thing to note is that LEE currently currently has market cap of $128 million. With $85 million in fee cash flows over the past 12 months, this means that LEE is currently trading at 1.5x ttm FCF. With multiples of 10x being more normal, Lee is worth of consideration based on this alone. Furthermore, over the past 5 years, Lee has averaged cash flow from operations of $155.25 million and capital expenses have averaged $25.5 million. This means that the average FCF over the past 5 years has been $129.75 million.

Lee has it's risks though. It has a lot of debt. Long term debt comes in at just over $1 billion. This is no small amount given the amount of free cash flow that Lee generates. Assuming Free Cash flows of $75 million, this is a total debt to free cash flow ratio of 13.3. It is preferred to keep this ratio lower. For example, Johnson and Johnson (ticker: JNJ) has long term debt to FCF ratio of about 0.5. This is an extreme case. But with JNJ, total liabilities are about $40 billion on $15 billion in FCF. That is a ratio of 2.6 and takes all liabilities into account, not just total debt. A similar story can be found by looking at Proctor and Gamble (ticker: PG). It is obvious with JNJ and PG that liabilities are insignificant. Lee however is putting its toes near the edge of a cliff. A reduced debt load would be preferred. This can be accomplished through paying off debt by raising capital. One way to raise capital is to issue new shares or to issue convertible debt. So, there is some risk of shareholder dilution.

Even with the debt load risk, local newspapers are going online and maintaining their moats. It is still hard for a competitor to break down the barrier to entry. With many small towns, there are typically monopoly's or duopolies. These outlets are the most popular ones for local news. Some forget that Lee Enterprises is a news outlet. The technological evolution that is occurring will not destroy Lee, it will simply change it. If looking for an investment, give Lee some consideration. It's not all internet based gloom and doom.

Valuation

Assuming that you no longer have a fear of newspapers in general, consider the following valuation. In doing this, two FCF numbers were used as a basis for future FCF assumptions. 2009 FCF was about $64 million. Over the trailing 12 months, FCF has totaled $85 million. FCF data for Lee can be found here.

To estimate future free cash flows, the lower 2009 level of $64 million was used. This is conservative since the more recent trailing twelve months of data is $85 million. The lower value is being used because the US economy has yet to recover We will ramp up to the higher level of $85 over two years. So, the starting points are $64 million for 2010, $73.3 million for 2011 and $85 million in 2012. The trailing twelve months is being used as the data sample 2 years out because by then the economy should be recovering or recovered by then.

To recap, the first 3 years of FCF are estimated at $64, $73.3 and $85 million (2010 – 2012). For years 2013 through 2019, FCF is assumed to grow at 6%. The Discounted Free Cash Flow Screener assumes growth of 8.9% for the first 10 years so the 6% growth is conservative in comparison. For this hand calculation, we are being more pessimistic. For years 2020 through 2029, FCF is assumed to grow at 4% each year.

By discounting the free cash flow estimates discussed above and adding on total equity of $37.6 million (80% of the most recently reported $47 million figure), the following valuations are determined. If a discount rate of 9% is used, Lee's value is estimated at $23.51 per share. If a discount rate of 11% is used, Lee's value is estimated at $20.05 per share. If a discount rate of 9% is used, Lee's value is estimated at $17.32 per share. With Lee currently trading at $3.04, perhaps now is the time to buy. The current share price represents a discount to intrinsic value of 82% relative to the even the lowest valuation of $17.32.

Important reading materials:

Letter to stockholders (July 31, 2009)

2009 10-K (December 11, 2009)

2010 slides from annual meeting (February 17, 2010)

In particular, the slides from above (February 17, 2010) provide a good way to get up to speed with Lee Enterprises.

Guru Information:

Lee Enterprises Inc. is owned by 1 Gurus. John Rogers owns 3,345,119 shares as of 03/31/2010, which accounts for 0.22% of the $5.24 billion portfolio of ARIEL CAPITAL MANAGEMENT LLC.



Lee Enterprises summary:

LEE ENTERPRISES, INC. is a premier publisher of local news, information and advertising in primarily midsize markets, with 50 daily newspapers and a joint interest in four others, rapidly growing online sites and more than 300 weekly newspapers and specialty publications in 23 states. Lee Enterprises Inc. has a market cap of $136.4 million; its shares were traded at around $3.04 with a P/E ratio of 6.7 and P/S ratio of 0.2. Lee Enterprises Inc. had an annual average earning growth of 5.9% over the past 10 years.

Disclosure: The writer of this article owns LEE stock.