Double Bankruptcy to Merger?

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Near-simultaneous bankruptcy filings by two once-proud publishers of printed telephone directories have renewed investors' hopes that their beaten-down stocks can continue to offer some value. In fact, the news that Dex One (NYSE: DEXO) and SuperMedia (NASDAQ: SPMD) had used the Chapter 11 process to expedite the merger that they arranged last August sent their shares soaring by more than 10 percent. Of course, this follows several years of poor performance that had seen shares of both companies slump by more than 95 percent.

A merger-in-bankruptcy transaction would be a huge boost for both of these companies. With the printed-directory segment of the business information industry in terminal decline, it is doubtful that either of these companies would come out of the Chapter 11 process intact. Judging by the reaction of their secured creditors, this transaction is wildly popular. Investors should take steps to position themselves out in front of this deal and perform careful due diligence to determine if the situation offers the potential for long-term growth as well.

About SuperMedia and Dex One

Dallas-based SuperMedia is a directory publisher that prints yellow pages, white pages and combination editions for residential and business customers across the United States. It generally distributes its products for free through the U.S. Postal Service or direct delivery services. As such, SuperMedia relies on advertising revenues and listing fees for the bulk of its revenues. The company also runs a digital advertising division through Superpages.com. This digital arm offers a wide range of online listing and marketing services, including virtual directories, business homepages and SEO services. SuperMedia earned $223 million on $1.4 billion in gross 2012 revenues.

Cary, North Carolina-based Dex One also operates a nationwide directory printing operation. In addition to these standard services, it also maintains a robust online presence across several information-aggregation online platforms. These include DexKnows.com, Dex Mobile and CitySearch. Dex One also provides a range of other online marketing and information-aggregation services as well as a branding and SEO operation. Like SuperMedia, the company has struggled to monetize these services in recent years. Dex One earned $62.4 million on $1.3 billion in gross 2012 revenues.

Competitors

These companies' two biggest direct competitors are both privately held. However, the two also indirectly compete against a wide range of digital and print-media advertising firms, including Interpublic Group (NYSE: IPG). New York-based Interpublic operates as an advertising agency and serves a variety of companies on a global basis. In recent years, it has moved decisively into digital media and now regularly runs multimedia campaigns for its clients. Unlike Dex One and SuperMedia, Interpublic also executes large-scale media buys and provides public-relations services. With over 40,000 employees and annual revenues of $7 billion, Interpublic is far larger than the other two companies.

When comparing Interpublic to Dex One and Supermedia, the key is sales growth (or lack of it).  Interpublic, even though sales were flat in the last year, had the best growth in revenue.  Dex One and Supermedia lost 14.4% and 18.8% of sales in the last year, respectively.  An investor can speculate on what happens to the Dex One and Supermedia merger and bankruptcy, but an investment in Interpublic is certainly a more conservative bet.  It has had consistent revenue over the last 3 years and relatively consistent earnings.  Operating margins are around 10%, and much of the annual cash flow has been going to share buybacks.  The close to doubling of long-term debt in 2012 should be a concern though.  Management seems to like the stock at a PE of 12, and maybe investors should too.  

How the Deal Is Structured

Under the terms of the deal, the newly merged company will be known as Dex Media and trade as "DXM" on the Nasdaq Exchange. Current Dex One shareholders will receive 0.2 share of Dex Media for each Dex One share that they own. At Dex One's current share price of $1.65, this values the new company at about $8.25.

Meanwhile, SuperMedia shareholders will receive 0.4386 share of Dex Media for each SuperMedia share that they currently own. At SuperMedia's current share price of $3.67, this would value Dex Media at roughly $8.37. As such, SuperMedia holders would receive a premium of about 1.5 percent relative to Dex One shareholders.

Since this is not a typical merger, it is important to note that it could close relatively quickly. The management teams of both companies have expressed optimism that the deal can be finalized at a creditor meeting on April 25, 2013 and closed shortly thereafter.

Legal Issues, Complications and Industry Outlook

The complex nature of the bankruptcy process would normally serve as a major hurdle for an expedited merger. Indeed, one of the principal catalysts for this transaction is the fact that Nasdaq has threatened SuperMedia with de-listing as a result of its bankruptcy filing. In the event that the merger cannot be completed, SuperMedia will be forced to trade on the OTC markets. However, this might actually serve as an impetus for the two companies to get a deal done at any cost.

It may be more salient to note that SuperMedia and Dex One have both filed for bankruptcy in the past. This has given many investors pause and may serve to quell any post-merger rally. Given the nature of the industry in which the two companies operate, the newly merged entity might quickly face some problems of its own.

It goes without saying that the telephone directory business is in trouble. If Dex Media wishes to survive as an independent concern, it will need to revamp its business model and fully embrace digital advertising and promotion. This will take tremendous vision and may be painful to execute. On the other hand, the two companies may benefit from the restructuring of their sizable debt burdens. Although it is unlikely that the bankruptcy process will eliminate any of Dex Media's debts, it could buy the company some much-needed time with its creditors.

In sum, investors who wish to play this merger should purchase SuperMedia and pocket a small arbitrage premium. If the bankruptcy process leaves the new company in a better financial position than either of its component firms, it could create long-term value for investors as well. However, such an outcome is contingent on a successful reworking of the business's core services and functions. This is not yet assured.


Mike Thiessen has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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