Tuesday, October 21, 2008

Fat newspaper profits are history

Despite mounting declines in sales and circulation in recent years, most newspapers today still generate profits surpassing those of many Fortune 500 companies. But the fat profits are coming to an end, because newspapers are running out of ways to cut costs.

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.

16 Comments:

Anonymous Anonymous said...

A very nice piece of work. I have pointed to this article and added some additional comments (my own opinions) to add some spice to your analysis.

Stephen Arnold, Beyond Search

5:41 AM  
Anonymous Anonymous said...

There is still plenty of room for newspapers to cut, and that is in the ranks of middle-management. Chains could do something creative by appointing a regional overall editor and getting rid of individual editors at the head of their newspapers. There is a lot of money to be saved by thinning out the ranks of executive editors, assistant managing editors, associate managing editors, and managing editors. Many that I know have their own secretaries, so there are savings to be made in reducing office staff. Then there are the bloated copy desks. Billy Dean Singleton got in hot water suggesting these activities could easily be off-shored, but I believe he was talking about trends already underway, not something in the distant future. We are heading back to the story-book days of one editor (very harried) per newspaper, and a reporting staff that will be pressured to produce pristine, error-free copy.

7:12 AM  
Anonymous Dave D. said...

..." we have yet to identify any institution that can fulfill the vital role..."
...You're using it. When Newspapers abandoned that " vital role " to join ( rejoin ) the political and social battles, they ceeded their moral authority to others more trustworthy and reliable. The net will fill the need; cheaper, better and quicker. We don't have a free press. They are in thrawl to their partisan passions and have sold out their trust. The sooner that wreckage is cleared off the information highway, the better.

7:27 AM  
Anonymous Anonymous said...

Hey, Alan, a couple of months ago you speculated that MNI was being lined up to be taken private. It was about $11 six months ago, but is now about $3. So how cheap do these stocks have to become before the owners decide they are better taken back by the families, or taken private? I like McDonald's quarter pounders, and once a week buy two for dinner. If I put that $10.42 weekly expense into MNI stock instead, I could get almost four shares at the current price. Would I be healthier in the future with that sort of purchase?
P.S. An associated thought, but how long before these newspaper giants are delisted and put on the pink sheets with other failed stocks because they can't keep the price at a level needed by the NYSE?

7:32 AM  
Blogger Richard Wakefield said...

Perhaps we should start the newspaper profit analysis with the appropriate numbers. According to the U.S. Census Bureau 2002 Economic Census, total newspaper publishers' revenue was $46.2 billion. Circulation revenue was: print, $10.6 billion; internet, $0.1 billion. Advertising was: print, $30.8 billion; internet, $0.3; other media, $0.3 billion; preprints and similar items, $2.0 billion; printing for others, $0.9 billion. The balance was a collection of relatively small items. The above numbers include all newspapers: "daily" and "other than daily". Going forward, according to the Service Annual Survey published by the U.S. Census Bureau, newspaper revenue was $48.4 billion in 2004, $49.7 billion in 2005 and 48.9 billion in 2006. According to the "U.S. Government Quarterly Estimates of Quarterly Revenue for Selected Services 2nd Quarter
2008", newspaper revenue was $46.4 billion. That looks like about a $10 billion dillerence in revenue between the number shown on your graph and the Quarterly Estimates number. How does that affect your EBITDA?

9:31 AM  
Anonymous Anonymous said...

Never made sense, slashing staff at the same time these places needed to be developing additional platforms. Increase the workload of those remaining just to maintain the ailing status quo, when they should have been hiring to develop their Web sites, video production and so on.

Did these folks flunk out of the Acme Business School advertised on matchbook covers?

12:11 PM  
Blogger Newsosaur said...

Per the comment from Richard Wakefield above, I always use the sales data compiled by the Newspaper Association of America, unless otherwise indicated.

The NAA sales data is the most detailed, goes back the farthest in history and, I hope and pray, is reasonably consistent from year to year, enabling the fairest possible comparison.

2:39 PM  
Blogger Richard Wakefield said...

The Newspaper Association of America Advertising Expenditures Estimates series includes not only payments to newspapers for advertising exposure but also payments to third parties for ad preparation and support: ad agencies, commercial printers, etc.
Historically, the revenue number reported by the U.S. Census Bureau is 60% to 65% of the NAA Expenditures number.

I apologize for an unclear statement in my prior post: the $46.4 billion in the quarterly report to which I referred is the 2007 total newspaper revenue according to the U.S. Census Bureau.

Using your reporting structure, I'm estimating 2008 at $38 billion and 2009 at 34 billion holding circ constant at $10 billion.

There's a detailed forecast of the NAA Ad Expenditures series at www.glenncoconsulting.com. It is a work in process. The support behind the forecast is slowly being posted to the site.

4:43 PM  
Anonymous Evil Pundit said...

"... 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."

I have yet to identify any newspaper that fulfils this role.

The assumption that newspapers contribute something worthwhile to the community is common among journalists, for obvious reasons. But like many beliefs held by journalists, it is wrong.

Newspapers have never been efficient reporters of truth, or bastions of community. They have instead been privileged voices, lecturing the masses with their opinions, many of which are demonstrably at variance with reality.

After newspapers die, the Internet will provide a better service than newspapers ever could. It already is -- it's just that many people have yet to catch up.

5:51 PM  
Blogger Newsosaur said...

Per the second comment from Richard Wakefield, most industry analysts operate off the NAA figures. With all due respect, I think the Commerce series is incorrectly titled.

8:52 PM  
Anonymous Robert Ivan said...

"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." The reason this didn't happen is the same reason it's still not happening.

I run a newspaper industry blog focusing on innovation, convergence, and transformational technologies. I have a very hard time finding source material on a regular basis.

The newspapers never thought they needed an internal R&D department and now that they do, almost none have the money to do it. They are riding down the backside of a steep sigmoid curve while trying to launch new products.

Anyone with business acumen would know the time for this is long overdue, for many papers perhaps impossibly so.

Right now the best situation for newspapers to be in is a small niche market with few competitors or part of another diversified company like: washington post or news corp.

Robert Ivan
Metaprinter.com

11:51 PM  
Blogger rknil said...

Wow -- the approach of obsessing about tiny design details in the print editions didn't work.

Who could have imagined that method failing, I ask you?

10:09 AM  
Blogger Doug Poretz said...

I come from a different perspective and offer a somewhat different view. For aboutn 40 years, I have been involved in public relations and, to a lesser degree, advertising, interactive, etc. I believe we are about to see a major change in the way enterprises communicate their messages, and this will have an impact on all aspects of the communications business and our culture.

As a result of the global economic environment, the forthcoming political change, and the new communications infrastructure, there will be the emergence of a new culture shaped by messages for politcal support as opposed to the messages of "Buy Me" that have innundated the consumer since Post World War II.

If there is any interest, I have posted a complete article at www.deathoftime.com -- see the first article titled "The Message Is The Medium."

4:34 PM  
Anonymous Anonymous said...

In my opinion, without the crippling debt caused by the big mergers and buyouts, many local newspapers would still be some of the most profitable enterprises in a region--while still able to retain significant local coverage.
With the advent of computers (and the innovations this has brought) and the explosion of information available via the internet, the manpower needed to produce a newspaper has dropped significantly in the past 15 years.

Historically profit margins in newspapers were artificially high because they enjoyed an advertising monopoly.
Had the current newspaper moguls not gone on a buying binge-- paying inflated prices for the properties and betting the good times would continue to roll, the local newspaper would likely still be a solid fixture in each community. While the profit margins would probably be down today due to the changing advertising landscape, they would still be better than experienced by many other businesses.

Perhaps we would be better off if MNG and similar groups collapsed more quickly, paving the way for a new newspaper era, especially for those niche local papers--like the sad now unheralded and eviscerated San Mateo County Times, and others across Northern California.
Unfortunately until MNG and its ilk goes away--as seen this weekend at the Eureka Reporter, the market can't handle multiple competitors in the same market.

11:52 PM  
Anonymous Anonymous said...

So true, so informative, such a loss. While there is something to be said for the digital age, there is something to be said for the ink on your hands after reading an American institution. Coming from a small circulation, daily, community newspaper, I agree with others comments that there is too much management, to many compliment positions and too much waste. Not enough ingenuity and they can't see the past the end of the cigars they smoke in their closed door "meetings". Change is constant, change is coming, change is necessary and scary. Cut a day off your printing (give up Monday for a better Tuesday), reach those that newspapers have ignored for the last 1/4 century (the 18-34 year olds), hook kids while they are young....That is the future. Without that, we will all be reading on our paper on the net.

9:04 AM  
Blogger Tiffany C said...

Very interesting, thanks for putting this out there in a clear way.

8:47 PM  

Post a Comment

<< Home