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Pixelating the Old Gray Lady

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One of the classic acoustical signatures of early morning in New York City's boroughs is the rumbling of heavy New York Times Co. (NYSE: NYT) delivery trucks dropping off bound stacks of the paper to neighborhood delis and bodegas. In recent years, as the economy has waned and more readers fire up a tablet while pouring their first cup of java, the presence of these once ubiquitous trucks has diminished. The Old Gray Lady is down -- approximately 49% from an early 2010 peak of $14.67 -- but, intriguingly, not nearly out.

At its height in the early-to-mid 2000s, the New York Times Co. produced annual revenue of over $3 billion and net income in good years of as much as $300 million. Annual revenue has declined to a range of $2.3 to $2.4 billion over the last three years. Profits have diminished as well -- last year the Times posted a net loss of approximately $40 million. As it ostensibly withers on the vine, the company's surprising ability to control production costs has been overlooked. The following table demonstrates how well the Times is able to match its raw materials and labor costs to the yearly demand for its papers. In the five years from 2007 to 2011, annual revenue fell 27%. Yet gross margin actually increased, from 78% to 80%.


<img height="275" src="http://finosus.com/blog/wp-content/uploads/2012/07/NYT-Gross-Margins.jpg" width="670" />
Such control over margins will enable the Times to thrive if it can figure out how to increase its topline revenue.

The Rise of Digital Circulation
According to the Audit Bureau of Circulations (Gogol or Kafka anyone? I checked; the organization indeed exists), the Times increased its total 2011 circulation by 73% over the prior year. This rise was driven by online subscriptions, a new component of the storied paper's P&L: the Times launched its digital content paywall in March of 2011. While the magnitude of the reported percentage rise in total circulation may be somewhat misleading, as the Audit Bureau appears to count bundled print and digital packages as separate subscriptions, it is difficult to deny that the new revenue stream has been beneficial to the Times. In one year, the combined digital subscriptions of the New York Times and its two most prominent siblings within the Times Company, the International Herald Tribune and the Boston Globe, have grown from zero to 472,000.

Digital Advertising is Replacing Print Advertising
Advertising in printed newspapers has languished with the general economy, and its long-term resilience is questionable. Lower circulation figures in the newspaper industry roil already seasick advertisers, warding them from committing their spends to a medium that reaches fewer people every year. For the Times, as print advertising has declined, digital advertising revenue has trended up, and should continue to grow as advertisers seek to reach the Times' growing online reader base. In the first quarter of 2012, digital advertising reversed its trend and exhibited weakness, declining 10.3% versus the previous year's first quarter. However, this result was primarily due to softer cost-per-click advertising revenue at the About Group (a Times company that owns the "about.com" site).
 
According to the Times' Q1 SEC filing, most of the digital advertising slump occurred in January and February, with March resuming the growth trend. Advertising statistics for the second quarter of 2012, due out later this month, will be of interest to those who are curious about the Times' potential as a value investment.
 
Decisions and Debt
Publisher Arthur Ochs Sulzberger Jr. has received some well-deserved criticism as of late for questionable decision making. The most puzzling apropos-of-nothing action occurred in December of last year, when Sulzberger abruptly dismissed long-time CEO Janet Robinson from her post. For a dose of gossipy summer beach reading, you can find more detail here. Robinson was the champion and prime proponent, amidst much internal hand-wringing, of the successful metered digital paywall system that is belatedly being copied by other major papers. Seven months later, the Times has yet to appoint a new CEO.
 
And yet we can find recent evidence of timely and effective business decisions as well. In 2009, when credit markets were choked and the Times found itself facing a huge liquidity crunch, the company turned to the savvy Carlos Slim, a major shareholder, and borrowed $250 million at an interest rate of 14.05%.  I personally no longer wonder why Slim is the world's richest man. In August of last year, having stabilized its cash flow (which in most years is quite decent), the company swallowed a $27 million penalty and prepaid the issued notes out of available cash. The subsequent reduction in interest expense has rewarded the income statement, but more importantly, the prepayment throws into relief how strong the company's working capital picture is relative to its peers.
 
Comparing the Time's current ratio trend over a two-year period versus Gannet (NYSE: GCI), The Washington Post (NYSE: WPO), and The McClatchy Company (NYSE: MNI) highlights the company's strength of current position as it fights to maintain print subscribers and grow digital subscribers:

<img src="http://media.ycharts.com/charts/045e3e71b9100e44c175ffd90a380310.png" />

NYT Current Ratio data by YCharts

Without the burden of the debt payments, it should be noted that the Times' free cash flow is improving -- it generated $74.65 million in free cash flow for the trailing twelve months ending March 31.

Fighting Trim

Industry changes have forced the Times to grapple with a central thesis: its value is not encapsulated in the flagship newspaper, but in its tradition of producing quality content. It is a respected source of news and commentary that users will pay a premium for worldwide. It enjoys a deep network of national and international bureaus. The company enjoys a loyal readership, and name recognition enough to attract new audiences with the right tools. This realization has spurred the Times to trim non-core holdings including smaller regional papers and an interest in the Boston Red Sox, as it seeks to clarify its business model.

Rather than acquiring non-core companies to build a hodgepodge of supplementary revenue (a weakness of this company in the past), management appears to be honing in on widening the Time's distribution platform over computers, tablets and mobile devices. Two weeks ago, the company allowed limited content to be available via Flipboard, the magazine-style news aggregator. NYT digital subscribers now don't have to go to the Times' home page to find its articles, a much appreciated convenience. The agreement with Flipboard benefits the Times as non-subscribers will have access to limited free content, and so far, free NYT articles have a sticky quality when it comes to conversions to paid subscriptions.
 
Within the last two weeks the company also launched a Chinese language site: cn.nytimes.com. The site for now offers translated articles from the Times, with some content produced in China via local freelancers. The newspaper has reporting depth in China, with bureaus in Beijing and nearby Hong Kong. Both the Flipboard deal and the China Times site are relatively low-investment, high-return propositions. Look for more of these distribution innovations in the near future.  

Pixelation

I like to think of the trend toward digital content as a pixelation at the Times. Pixelation in an image occurs when, intentionally or unintentionally, the individual pixels that compose the image become visible. In the world of newspaper printing, you want as sharp and clear a photo as you can achieve on rough newsprint stock. In the digital sphere, aesthetics are prized, but not at the expense of easy and quick access to information. As the Times pushes its digital strengths, it will experiment with different distribution models. It is learning to live with a little pixelation in its storied picture, making pragmatic decisions between tradition and exploiting the evolving marketplace for news and other branded content services.

Currently, despite the ever-present danger of the bottom falling out of print sales, the company is taking the right risks to steady itself and grow.  Stay tuned to the next earnings report, due out July 26, and the third quarter 2012 report as well. Join me in searching for increasing digital subscriptions and continued control of operational costs. If these trends continue, the Times may be a story worth participating in.


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