Fitch: Newspaper Industry Doing Worse Than We Expected In '07

CHICAGO In its latest broad survey of the industry, issued Wednesday, Fitch Ratings says newspapers are doing even worse than it expected at the beginning of the year.

The only good news the credit ratings agency could find is not likely to cheer newspaper CEO: Fitch believes the current credit crunch will likely halt the highly leveraged transactions -- think Sam Zell's takeover of Tribune -- that could be risky for bondholders.

"Fitch's outlook for the sector remains negative," the agency said in a report by analysts Michael Simonton and James Rizzo.

Fitch began the year with a negative outlook on the industry, arguing that weakness in newspapers' high-margin classifieds would bring soft revenue and put pressure on profits. Through July, the agency said, the sector's performance has been weaker than it anticipated.

July results from publicly traded newspaper companies, in particular, "are obviously cause for concern," Fitch says.

Gannett Co. where USA Today ad pages fell 17% compared to last year, and real estate classifieds at its community papers plunged 20%.

Tribune Company, where help-wanted classified tumbled 19%, and real estate shrank by 24%. (Fitch has Tribune on a "Ratings Watch Negative," anticipating a further downgrading of its credit.)

The McClatchy Co., where real estate collapsed by 26%, and automotive plunged 20%.

Dow Jones & Co., where ad volume fell 20% on a 75% tumble in technology-related ads.

Newspaper industry ad weakness, Fitch concludes in a report subhed, is "More Secular than Cyclical" -- meaning much, if not all, of the declines will be permanent.

Fitch says it is true that the outsized declines in real estate are generally localized in newspapers serving markets such as California and Florida, where the housing bubble rose highest before bursting most dramatically. But that may not be the persuasive evidence of a cyclical downturn as it might first appear, the agency argues. Fitch notes that, broadly in the industry, classified revenues taken as a whole are down farther than real estate's contribution to total would suggest they should be.

Continued declines in retail, auto, and help-wanted at a time when "key economic indicators for the U.S. economy have been broadly healthy for most of the year and as such should be supporting the retail, national and other classified categories," suggest a so-called secular, or permanent, decline in the important classified revenue stream, Fitch suggests.

Fitch: U.S. Newspaper Outlook Still Negative

29 Aug 2007 12:51 PM (EDT) Fitch Ratings-Chicago-29 August 2007: Fitch entered the year with a negative outlook on the newspaper sector, expecting soft revenue and pressured profitability from weakness in high margin classifieds. Year-to-date (through July) operating performance for the largest newspapers has been weaker than Fitch initially anticipated. However, this weakness has been partially offset by a slight decline in event risk stemming from disruptions in the credit market that would likely make leveraged transactions less attractive. Fitch's outlook for the sector remains negative.

The high-profile declines from July reports that garnered headlines are obviously cause for concern:

--Gannett Co, Inc. (Not Rated): Ad pages down 17% at the USA Today and pro forma real estate classifieds at community newspapers down 20%.
--Tribune Company (rated 'B+', Rating Watch Negative by Fitch): Classifieds down 18% driven by real estate down 24% and employment classifieds down 19%.
--The McClatchy Company ('BB+', Stable Outlook): Real estate down 26%, Automotive down 20% and National down 19%.
--Dow Jones ('BBB+', Rating Watch Negative): Ad volume down 20% driven by a 75% decline in technology related ads. Classifieds down 14%.

Fitch continues to focus its attention on real estate advertising trends, cyclical and secular issues, pricing, costs and event risk, among others.

Advertising Weakness: More Secular than Cyclical

Real estate classified declines have been significant, and have generally tracked the widely covered slowdown in new home construction, particularly in formerly overheated markets such as California and Florida. (See Fitch's rating actions on homebuilders and the press release 'Challenging 2008 Will Have Repercussions For U.S. Homebuilders' published on Aug. 28, 2007.) Fitch recognizes there is certainly some correlation; for example, McClatchy earns less than 40% of its revenue from California and Florida, yet over 70% of its advertising declines in the second quarter were generated in these states. Similarly, Media General has seen classifieds drop more than 30% at its Tampa, Florida paper this year where the real estate market has been weak. These well-chronicled housing troubles and real estate classified declines have driven some newspaper industry participants and observers to assert that problems are largely cyclical.

It is noted that the average newspaper generates about 30% of its revenue from classifieds (some larger papers generate more); split relatively evenly among real estate, employment, and automotive. Assuming declines in real estate classified advertising are entirely related to the housing slowdown, that would translate into approximately 10% of an average newspaper's revenue stream enduring this cyclical housing-related pressure. While key economic indicators for the U.S. economy have been broadly healthy for most of the year (and as such should be supporting the retail, national and other classified categories), Fitch concedes there is likely some spill-over effect to employment, auto and retail categories in local markets that have been hard hit by the real estate downturn. Giving credit to some spill-over, it is not expected that more than 50% of an average newspaper's revenue stream (depending on its mix) is currently enduring cyclical pressure.

Further, Fiitch notes that while real estate classifieds relied heavily on homebuilders for revenue (new homes sold typically only represent about 10%-20% of total homes sold during a year, but Fitch believes homebuilders contribute a disproportionately larger portion of real estate classified revenue), some of the new home construction revenue stream should have been offset by the significant increase in homes on the market. Unsold home inventory has risen since the beginning of the year by over 33%, or more than 1 million to 4.59 million according to the National Association of Realtors. Days on the market is up as well, meaning a given ad should generate more revenue over its life.

Fitch believes that since many of the overheated markets are also regions of high broadband penetration, that sellers, buyers and their agents are more likely to use the Internet to identify opportunities and transaction counterparties. As participants gain comfort with online media they will be less likely to return to the print product in the future. In Fitch's view cyclical pressure is exacerbating secular issues, meaning that even if economic factors are causing much of this downturn, secular factors could make these declines permanent. (Employment print classifieds did not rebound as would have been expected following declines in 2001 and 2002.) An economic downturn would place incremental pressure on newspaper advertising revenue.

Prices, Costs & Event Risk

Through the first few months of the year, ad volume (pages) was generally down more than ad revenue, indicating that newspapers were still wielding some pricing power over their remaining advertiser base. Fitch has maintained that as a premium priced-medium with a declining audience, newspapers could not count on sustaining this near-term pricing power going forward. There's some evidence in the most recent reports that certain papers have had revenue declines in excess of volume declines, meaning that the pricing power may have already evaporated. Although Fitch expects newspaper web sites to capture some shifting ad dollars, with the proliferation of emerging media (which grant advertisers many new alternatives for reaching their fragmenting audience bases) prices will likely remain under pressure.

Newspaper operators have received relief on newsprint costs, have scaled back delivery boundaries to reduce transportation costs and have been very tight on labor-related costs. This focus on costs is viewed as positive for the industry, but Fitch remains cautious that labor costs could be much more difficult to reduce going forward as change-averse cultures and union affiliations could obstruct meaningful additional labor-related cost-cutting.

Finally, in Fitch's view, concern related to event risk in the industry has diminished somewhat in the near term. Stock prices have been down for several years, but with the turbulent credit markets, Fitch believes that companies that did not already pursue highly leveraged acquisitions or leveraged recapitalizations are less likely to pursue those types of transactions in this funding environment. That said, longer term shareholders will likely continue to place pressures on these companies and event risk will remain a key component for newspaper company ratings considerations forward.

For additional information on Fitch's approach to the newspaper and broadcasting industries, see the Fitch releases 'U.S. Media & Entertainment Regulatory Register - Spring 2007' dated March 22, 2007; 'U.S. Media & Entertainment LBO's - Voting Structures, Valuations, and Proforma Leverage May Limit Significant LBO Activity' dated March 15, 2007; and 'U.S. Newspapers and TV Broadcasting Outlooks Remain Negative in 2007' dated Jan. 18, 2007, all available on the Fitch Ratings web site at 'www.fitchratings.com'.

Contact: Michael Simonton +1-312-368-3138, Chicago; or James Rizzo +1-212-908-0548, New York.

Media Relations: Brian Bertsch, New York, Tel: +1 212-908-0549.

Fitch's rating definitions and the terms of use of such ratings are available on the agency's public site, www.fitchratings.com. Published ratings, criteria and methodologies are available from this site, at all times. Fitch's code of conduct, confidentiality, conflicts of interest, affiliate firewall, compliance and other relevant policies and procedures are also available from the 'Code of Conduct' section of this site.

Disclaimer: Opinions posted on Free Republic are those of the individual posters and do not necessarily represent the opinion of Free Republic or its management. All materials posted herein are protected by copyright law and the exemption for fair use of copyrighted works.