From AJR,   January/February 1998

Expensive, Yes, But Well Worth It   

McClatchy's acquisition of Minneapolis' Star Tribune should turn out to be a wise investment.

By John Morton
John Morton (mortoninc@msn.com), a former newspaper reporter, is president of a consulting firm that analyzes newspapers and other media properties.     

Almost without fail, the price paid to acquire a large newspaper prompts gasps of astonishment. If the acquiring company is publicly owned, its stock price usually plunges.

That's what happened to McClatchy Newspapers recently when it agreed to pay $1.4 billion to buy Cowles Media Company, whose principal property is Minneapolis' Star Tribune. The company's stock dropped nearly 17 percent over the next two trading days, indicating that Wall Street, at least, thought the price too high.

Similarly, when the New York Times Co. bought the Boston Globe in 1993 for $1.1 billion, its stock price dropped 16 percent over the following month. Knight-Ridder fared somewhat better when it bought four Disney Co. papers, including the Kansas City Star and the Fort Worth Star-Telegram, last year for $1.65 billion; its stock dropped nearly 7 percent over the subsequent seven trading days.

So did McClatchy pay too much? The usual way of measuring the cost of a newspaper deal is to figure out how many times the acquired company's revenue and operating cash flow (income before deductions of non-cash charges like depreciation, interest and income taxes) can be divided into the acquisition price. Using figures from Cowles' most recent fiscal year, which ended March 29, 1997, McClatchy agreed to pay 2.7 times revenue and 18.3 times cash flow.

By comparison, the New York Times paid 2.7 times revenue and 15.5 times cash flow for the Globe, and Knight-Ridder paid 3.3 times revenue and 12.2 times cash flow for the Disney papers. This suggests that McClatchy paid a reasonable multiple of revenue aýd a high multiple of cash flow. One could argue that, since the Cowles deal will not close until well into 1998, a more appropriate comparison would use Cowles' figures for the 12-month period ending September 30, 1997. On this basis, the revenue multiple stays the same but the cash flow multiple drops to 14.9.

The trouble inherent in using Cowles' financial data to come up with these multiples is that Cowles is not a pure newspaper company, unike the Globe and the Disney papers. Most of Cowles' revenue and cash flow come from the Star Tribune, but the company also owns subsidiary companies that publish numerous special-interest magazines, business publications and books. These low-profit operations reduce the overall profitability of the company.

It is my understanding that the Star Tribune by itself has an operating profit before taxes of 20 percent or more, whereas the company as a whole had a profit margin of 12.3 percent in the first six months of 1997, compared with an average of 20.7 percent for the newspaper operations of all publicly held companies.

McClatchy plans to spin off the subsidiary companies as soon as possible, and it expects to receive a minimum of $150 million after tax. Moreover, McClatchy intends immediately to eliminate as unneeded Cowles corporate staff of 30 or so, which would cut operating costs by at least $2 million. And, being a much larger company than Cowles, McClatchy will be able to buy everything from paper clips to newsprint for lower prices, further reducing the Star Tribune's operating costs.

After making these adjustments, and taking into account the Star Tribune's expected profit growth, McClatchy figures that the cash-flow multiple it will pay will be reduced to 11 or 12. And it expects the Star Tribune's cash flow to suprass McClatchy's annual acquisition costs (mostly interest on money borrowed to make the deal) by the year 2000.

The impact on McClatchy's reported earnings per share is another matter, and it's the principal reason Wall Street hammered the company's stock price. McClatchy estimates it will take on $1.1 billion to $1.2 billion of goodwill in the deal, which is a noncash but nondeductible charge against earnings that must be amortized over many years. This will reduce McClatchy's reported earnings per share by about half in 1998 and lesser amounts thereafter.

What McClatchy is getting for this relatively temporary pain is a newspaper that does not need fixing. The Star Tribune has a well-deserved reputation for journalistic quality and a state-of-the-art printing plant, and it operates in a rapidly growing, prosperous market.

Newspapers of this size and quality in an attractive market rarely become available, and when they do they command a high price. The New York Times Co. has profited handsomely from its acquisition of the Globe, despite the price tag. Although it is early, I am certain that Knight-Ridder will similarly benefit from the Disney papers. McClatchy, too, paid a high price, but in the long run it will prove to have been well worth it. l