This Merger Could Produce Synergies and Hint at Things to Come

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The latest round of consolidation in the newspaper and broadcasting industries involves McLean, Virginia-based newspaper publisher Gannett (NYSE: GCI) and Dallas-based broadcaster Belo Corporation (NYSE: BLC). In addition to its potential arbitrage opportunity and attractive synergies, this deal is interesting from a "macro" standpoint. Although regulators and private firms have traditionally been reticent to mix daily newspaper operations and broadcasting functions under the same roof, the shrinking market for these traditional sources of information has rendered this somewhat unusual marriage more attractive.

Judging by investors' reactions to the news of the merger, the Gannett-Belo combination has a very high likelihood of going through in some form. After the announcement, Gannett's stock shot up by more than 21 percent. Belo added nearly 30 percent. Of course, there are plenty of reasons to be skeptical about the wisdom of a merger in an always-staid and often-troubled industry. Investors should investigate further before pulling the trigger.

Gannett, Belo and the Competition

Gannett is one of the publishing industry's most recognizable names. The company owns USA Today, and other prominent properties. With a diversified portfolio and a decreasing reliance on traditional print media assets, the company most closely resembles New York Times Company (NYSE: NYT).

These three firms have much in common. For starters, Belo and NYT have roughly equivalent valuations in the low nine-figure range: Belo's valuation of about $1.5 billion compares well to NYT's $1.6 billion valuation. Meanwhile, Gannett has a larger footprint of around $5.8 billion. In 2012, the larger firm earned about $460 million on $5.4 billion in gross revenues. NYT took in $154 million on total revenues of about $2 billion. For its part, Belo earned $101.5 million on revenues of $719 million to produce a more attractive profit margin.

Thanks to strong corporate governance and conservative growth policies, NYT has far less leverage than its peers. Its roughly even debt-to-cash ratio compares favorably to Gannett's 10:1 ratio and Belo's troubling 144:1 figure. It is likely that Gannett factored this unseemly debt pile into its offer for Belo. Despite its debt problems, Belo's price-to-book ratio far exceeds those of its peers. Its 4.72 figure is roughly 100 percent higher than NYT's 2.44 tally and Gannett's nearly identical 2.4 ratio.

How the Deal Is Structured

The terms of this merger are straightforward: According to the announcement, Gannett will issue cash payments of $13.75 for each outstanding Belo share. Although the deal's exact closing date has not yet been announced, it should be completed by the end of 2013. Obviously, such completion is contingent on shareholder approval votes and a customary review by the Federal Communications Commission. 

Gannett's offer represented a tremendous premium to Belo's pre-announcement share price. However, enthusiastic investors have wiped this potential arbitrage opportunity away. In fact, Belo's current share price of about $14.10 exceeds Gannett's offer price by about 2.5 percent. This may indicate that market players believe that a higher offer or bidding war could be in the cards. 

Legal Issues and Other Complications

At this point, there are no unusual legal issues or complicating factors that could delay or derail this merger. Although several law firms have launched preliminary investigations into the terms of the deal or issued warnings about the extent to which it undervalues Belo, the merits of these actions appear to be limited. However, it is certainly possible that persistent legal challenges could force Gannett to rethink its offer orcome back with a higher bid. Belo's troublesome debt situation makes such a move unlikely, but it cannot be ruled out entirely.

Synergies and Arbitrage

Assuming that the terms of the deal remain constant, a Gannett -Belo merger offers plenty of potential synergies. The deal will double Gannet's TV station count and turn the company into the fourth-largest American broadcaster. In addition, the firm's management team estimates that Belo will add at least $75 million in initial annual cost savings and synergies. In the out years, this figure could rise to $175 million or more. Moreover, Gannett's diversification drive is sure to please traders and fund managers who have soured on the publishing industry.

Investors should not discount the possibility of a restored arbitrage premium as well. If Gannett issues a higher offer or finds itself in the midst of a bidding war, a temporary drop in Belo's stock price could provide a suitable entry point for keen-eyed investors. Since this deal will not close until the waning months of 2013, there is plenty of time to position accordingly. 

Long-Term Outlook and Possible Plays

In sum, this deal offers an excellent growth opportunity for Gannett and should handsomely reward its long-term investors. However, it is entirely possible that Gannett will be forced to issue a more attractive offer for Belo's shares. While this would reduce the perceived value of the deal, it would provide an added sweetener in the form of a significant arbitrage opportunity. Investors who perform adequate due diligence may wish to play this situation with a long position in Belo at a lower entry point or a long position in Gannett at its current levels. 

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