Fat newspaper profits are history
After producing operating earnings at an average rate of 27.3% between 2000 and 2007, the industry’s margin this year may average no better than 20%, says William Drewry, a managing director of the global media group of the UBS investment bank. Average earnings before interest, taxes, depreciation and amortization (EBITDA) were 24.6% in 2007, according to UBS.
Assuming the industry this year generates $40 billion in ad sales and $10 billion in circulation revenues, EBITDA of 20% would carve $3.7 billion, or, 27.2%, off the approximately $13.7 billion in profits that newspapers collectively realized in 2007.
A profit plunge of this magnitude would be a big problem for such companies as GateHouse, Journal Register, Lee Enterprises, McClatchy, Media General, MediaNews, Minneapolis Star Tribune, Morris Publishing, Philadelphia Media Holdings and Tribune, which each loaded up on debt during the halcyon days of the credit market to fund ambitious acquisitions.
They and their lenders were counting on continuing rich profits to pay off the debt. But those expectations have been dashed by the rapid and unprecedented secular decline in newspaper advertising sales that commenced in 2006 and has gathered momentum ever since.
Now, publishers are trapped between funding their debt and sustaining the massive, inherently inefficient infrastructure required to produce content, sell ads and manufacture newspapers.
To date, most publishers have elected to buttress their profitability as much as possible by attacking the two most elastic expense categories: staffing and paper consumption. But this short-sighted effort may be compromising the quality of the core product to such a degree that it actually may speed the decline of the industry as publishers attempt to transition to a new, more sustainable business model – assuming one is out there.
For all that ails them, most newspapers at the moment remain remarkably profitable enterprises. But they are running out of the quick fixes that have plumped their bottom lines despite the historic contraction in advertising demand.
When the quick fixes are exhausted, as they soon will be, then profits will plunge and publishers will have little, if any, spare cash left to fund the strategic print and interactive strategies that otherwise would enable them to reinvigorate their weakening franchises.
As proof of the industry’s amazing power to produce profits, you need look no further than its performance in the first three months of this year. Despite a 14.4% drop in industry-wide print advertising revenues in the first quarter, the average operating profits of the seven largest publicly held newspaper companies fell only two percentage points to 17.6% from 19.5% in the same period, according to Fresearch.Com.
To put this in perspective, Journal Register Co., a publisher that already has defaulted on its reckless debt, still generated a 16.9% operating margin in the last 12 months. That surpasses the margins in the same period of such companies as Exxon (15.7%), General Electric (14.2%), Boeing (8.7%), Wal-Mart (5.8%) and Amazon.Com (4.7%).
With sales decaying at an accelerating rate for the last 36 months, the industry’s earnings have been preserved only through the down-sizing of staffing and newshole, the two expenses that can be most readily mitigated in a time of diminishing revenues and rising expenses for everything from newsprint to health insurance.
In their efforts to cut expenses, publishers most prominently targeted payroll, which historically has represented half of their costs. Publishers have trimmed staff to some extent at almost every level and several newspapers have cut costs dramatically by outsourcing such functions as customer service, advertising composition, printing and delivery.
Next to payroll, newsprint, which traditionaly represents 20% of epenses, is the next biggest cost for a newspaper. Many publishers have reduced the ratio of news to advertising in an effort to offset a 28.9% increase in the cost of this essential commodity in the last 12 months.
While shrinking demand for newsprint ordinarily would lead to lower prices, the paper mills have been aggressively slashing production capacity to keep prices high, shutting inefficient plants or using their remaining factories to produce other types of paper. Given this behavior, it is reasonable to expect that publishers will get no relief from escalating newsprint costs.
Unless a publisher does something radical like finding a neighboring newspaper to print or deliver his newspaper, most of the rest of the costs associated with running a newspaper are fixed and beyond his control.
Even when expenditures are reduced by slashing payroll, newshole or outsourcing copy editing and page layout to an offshore vendor, these one-time savings cannot be replicated in subsequent years.
In the face of future inflation on almost every front, profitability can be sustained or increased only if sales grow. Flat or declining sales inevitably will result in ever-lower profits. And a rapid deceleration of sales like the one that has been under way since 2006 will result in an accelerating decline in profitability.
A case in point is the McClatchy Co. As its sales fell 15.2% in the first nine months of this year, its EBITDA dropped almost twice as fast to 17.5% from 24.6% in 2007, wiping out $166.4 million in operating profits from one year to the next.
This sort of thing not only rattles investors on Wall Street – that’s why newspaper shares are trading at all-time lows – but also imperils a company’s ability to repay its loans on a timely basis. Foreseeing the shortfall in earnings this year, McClatchy renegotiated its loans to gain more time to repay its debt. Unless the company can stimulate its sales and radically reduce expenses, however, it, like most other publishers, could be on a trajectory to insolvency.
The bitter irony for the newspaper industry is that the desperate reductions in staffing and newshole are compromising dangerously the quality of the products that built each of its valuable franchises. The compromises, which typically dismay most loyal and discerning newspaper readers, are likely to speed the declines in circulation and sales that are the root cause of industry’s faltering profitability.
Thus, publishers are caught in a vicious, downward spiral with no easy way out.
But, wait, it gets worse.
Not only are publishers running out of additional ways to shrink newspapers and the staffs who produce them, but they also have been left with increasingly meager human and financial resources to throw at the only thing that can save them:
Developing portfolios of multiple, targeted print and interactive products that will acquire new audiences, tap into fresh advertising dollars and, thus, diversify their revenue and profit base away from a once-lucrative but increasingly threatened business model that has not materially changed in 250 years.
If newspapers had invested in new products even a modest fraction of the bodacious profits they reaped in the last decade and a half, they might have invented anything from MarketWatch to Yelp to Google.
Instead, publishers concentrated on accelerating profits to lift the stock prices that determined their bonuses and/or borrowed what proved to be dangerously large sums of money to buy more of the newspapers they regarded as perpetual money-making machines.
The newspaper industry is far from alone in suffering today for the smugness and greed that suffused the extended age of irrational exuberance that began with the Internet bubble and climaxed in the credit-default flop.
But newspapers are unique institutions. While life will go on if any given bank, shoe store or auto dealer fails to emerge from the economic miasma, we have yet to identify any institution that can fulfill the vital role played in every community by an independent, economically healthy, properly staffed and professionally edited newspaper.
Although the economy will recover in the fullness of time, there are very real doubts about whether newspapers still have the time, resources and ingenuity to migrate to a viable new financial model to assure their long-term survival.