WE ALL know that traditional media is dying, right? Therefore traditional media companies must be bad investments. Not so fast – I think there might just be an opportunity amid the gloom.
The funny thing about so-called conventional wisdom is that it often assumes without checking. And yes, you open yourself up for ridicule by going against the crowd, but that's when you often find mispriced opportunities.
I've been intrigued recently at the overwhelming doom and gloom that's been heaped on the publisher of this website, Fairfax Media (ASX: FXJ).
The elephant in the room
There's no avoiding the fact that traditional media has been under siege from 'new media' over the past decade. Whether we're talking about mainstream newspaper publishing or free-to-air television, the new entrants in the media space have been making life tough.
There are many, many more options for news and entertainment these days, and that means many more places for advertisers to spend their money. Whereas the major metropolitan news services – think the 6pm nightly news and daily newspapers – once benefited from being able to aggregate a large audience to one of only a few places, the internet primarily has put a world – literally – of information at our fingertips.
Not only do consumers not have to wait for tonight's news or tomorrow's paper, but they can access a broad range of local and international news and opinion sources. On top of that, the casual reader or viewer can go past whatever is on the box or in the paper to social media, YouTube and thousands of other potential distractions and entertainment options.
Putting the past behind us
Now that we've purged all of that, we can look at the business that remains in front of us. The past decade doesn't matter for potential new investors – only today's share price and the business's future.
To imagine that future, we can start with the most recently announced results. Revenues were down 6 per cent on the previous year – not great, but not disastrous, and still at a respectable $2.3 billion. Reported profit was woeful, as the business took huge non-cash charges on large swathes of its intangible assets as well as cash impacts for restructuring and redundancies, while even underlying profit was down 25 per cent.
There's no mistaking the trend – and almost all of the business's divisions are suffering. But while Fairfax's metropolitan newspapers get all of the headlines, it's the regional papers and its Trade Me interest that earn the bulk of Fairfax's underlying profits – almost 60 per cent in fact. The metro mastheads are only responsible for just under 20 per cent of Fairfax's profits – still sizeable but relatively small.
A knockdown price
At the current price of around $0.38, the company is valued at only 4.4 times last year's underlying net profit. If profits were to somehow halve, Fairfax would still only be trading at 8.8 times profit.
Now of course, the business isn't without risk. With such significant overheads and a thin profit margin, the company is in a vulnerable position. If it can't stabilise revenue or remove costs at a rate that keeps up with the revenue declines, the underlying profit could conceivably evaporate entirely. Large businesses with big cost bases often struggle to stay afloat with even minor revenue losses for exactly that reason.
There's reason for confidence, however. Trade Me is a larger and growing piece of the Fairfax pie, meaning the declining pieces necessarily have a progressively lower impact on the business. We've also been through a significant advertising slump in the past few years, and I think we'll see a slow recovery moving forward – good news for revenues. Additionally, while the overall business underlying profit fell 25 per cent, its largest business – regional media – fell "only" 10 per cent.
Things aren't going to get miraculously better for Fairfax Media any time soon. Circulation will remain under pressure, advertising will be a tough market for a while yet, and old businesses have a tough time removing costs.
Still, paying less than 4.5 times underlying earnings isn't particularly demanding, and the trailling dividend, while far from guaranteed into the future, is currently yielding 7.9 per cent, fully franked.
Fairfax Media isn't a lay down misere for investors, but a risk-tolerant investor who can see a place for traditional media mastheads (both metropolitan and regional) in a new media world could do worse than taking a closer look.
If you're still not convinced, Warren Buffett has been buying regional newspapers for his company, Berkshire Hathaway. That's not a guaranteed "buy" signal, but when the Oracle of Omaha is finding value, there are worse places to look than in the same backyard.
The Motley Fool has just released a brand NEW special free report. BusinessDay readers can
Scott Phillips is a