We've been hearing a lot about the death of the traditional media, with particular emphasis on print media. It seems that the newspapers and magazines are struggling, cutting back and sometimes going under. The generally credited causes are the collapse of advertising revenues and shrining readership. That sounds like a death spiral. Is that the real story? What is killing the newspapers? It's time for a bit of accounting, and that means reading some of the most fascinating, but boring, material on earth, corporate financial statements.
Let's start with the Journal Register. They just filed Chapter 11 a few days ago taking the New Haven Register and 19 other daily papers with them. Lucky for us, the Journal Register was publicly held, so we can look at their 10-Q quarterly filing with the SEC and do some forensics.
There are two main parts to a 10-Q, or annual 10-K filing. There is the balance sheet which gives assets and liabilities, and there is the operating statement which gives revenues and expenses. The balance sheet is the cumulative summation of the various operating statements, or it should be. If it isn't you have to do the whole mess over again.
Bankruptcy is often discussed in terms of assets and liabilities. For the Journal Register, these looked fairly good. They were down 10% from the previous year, to $842 million from $932 million, but the balance sheet still looked credible. In practice, bankruptcy is what happens when a financial entity is required to make a payment, and they can't. They don't have the cash. They don't have something to sell or hock. They don't have anyone who will lend them anything. Smart creditors look at the balance sheet, which tells what the company owns and owes, and at the operating statement, which tells where the company gets its money and where its money goes. The operating statement for the Journal Register didn't look too bad:
Item | March 30, 2008 | April 1, 2007 |
Advertising | $76M | $86M |
Circulation | $23M | $23M |
Printing | $4M | $5M |
REVENUE | $102M | $114M |
Newsprint, ink and printing | $9.5M | $11.5M |
Wages and benefits | $45M | $48M |
Depreciation | $4.8M | $4.6M |
Other | $15.8M | $16.3M |
SGA | $18M | $19M |
EXPENSES | $93M | $100M |
This statement shows profits of perhaps $9 million, or about 9% of revenues. That's more than you can get on a CD. Why were they facing bankruptcy with that kind of profit margin?
Let's start by looking at where their money is coming from. Advertising was a big chunk. That's down from the previous year, but still substantial. Circulation, from subscribers and newstand sales, was flat. The commercial printing business was down, but still making money. Even depreciation was pretty even. The newspaper business might not be the goldmine it once was, but these numbers look fairly good.
Now consider where there money was going. Salaries and employee benefits were nearly half of this. They had already been doing some cutting with a smaller payroll, to compensate for falling advertising revenue, but this doesn't look like the statement of a firm near death. They had also been cutting production and marketing costs. That selling, general and administration, SGA, is a big part of the newspaper business, but at about 20% of expenses, it wasn't out of line.
Now, an accountant can go on about depreciation for hours, but all I can say is that four or five million dollars charged towards replacing equipment is not out of line. The $15 million plus figure for other is curious. There isn't a lot of explanation on this, save a footnote to a sub-table that mentions that changes in this value result from consolidation of facilities, a reduction in rates at certain properties and the elimination of "total market coverage". This suggests that other includes rents and facilities among other items. In any event, this is not the straw that broke the camel's back.
So far the statement of operations looks good, but then there is the next line in the statement. Wham, an impairment charge of $95.4 million! Yoicks! What on earth is that? I'll let the Forbes Investopedia say it for me:
"Impairment charge" is the new term for writing off worthless goodwill.
This charge reduces the value of goodwill to the fair market value and represents a "mark-to-market" charge.
Balance sheets are bloated with goodwill that resulted from acquisitions...
It's doubtful that very many corporate managements will face reality and take their medicine. Compensation packages will incite managers to delay the inevitable as they hope for a stock market rebound that will boost fair value.
Managements that bite the bullet and take an honest all-encompassing charge should be viewed more favorably than those who slowly bleed a company to death by deciding to take a series of recurring impairment charges, thereby manipulating reality.
This entry dates from 2002 in the wake of the dot-com bubble, but is as relevant as ever. The Journal Register bought other newspapers during its glory days, and in the process, racked up a lot of goodwill on its balance sheet. This goodwill increase in corporate value isn't the result of a management theory, like synergy or excellence assessment. Goodwill falls out of the mathematics of joining corporate operations, particularly if both firms are profitable. It is based on the purchase price of the property, pricing being an excellent form of valuation in most circumstances. Unfortunately, there are circumstances where the price of an entity is much higher than its value, at least in the long run.
After each merger, the Journal Register's balance sheet looked great. Unfortunately, the overall business has weakened, so that the good balance sheet grew increasingly out of line with the combined company's actual valuation. All that goodwill wasn't showing up in their share price, or in their liquidation value. They may have paid a reasonable price when they expanded, but it retrospect, it appears they may have overpaid. They have to adjust their balance sheet, and to do this, they have to charge the adjustment as an expense in their statement of operations. (Blame those clever Florentine accountants back in the Renaissance for this.)
As Forbes noted, good managers will take the hit in one big lump, and hope to ride things out. As it turned out, the Journal Register couldn't take the hit, not in the current business and market climate. It was killed by its own mergers and acquisitions. Yes, a faltering newspaper business didn't help, but the newspaper business itself was still profitable. The newspaper holding business was apparently less so.
Let's look at another newspaper. How about the venerable New York Times, another newspaper holding company.
Item | September 28, 2008 | September 30, 2007 |
Advertising | $398M | $465M |
Circulation | $226M | $223M |
Other | $63M | $66M |
REVENUE | $687M | $754M |
Raw Materials | $63M | $59M |
Wages and benefits | $148M | $163M |
Other | $111M | $110M |
SGA | $321M | $342M |
EXPENSES | $677M | $726M |
In some ways this is a more dramatic story. Their advertising revenues are dropping quite seriously. To compensate, the Times, and its fellow newspapers have been cutting back on their news gathering and feature operations, but look at that SGA. It's down $20 million, but the costs of selling, general and administration are larger than all the other expenses combined! It is closer to 50% of expenses as compared to perhaps 20% at the Journal Register. I have no idea of where all that money is going, but it probably isn't going to Maureen Dowd.
Then, let's move one line down in the operating statement, and there it is, a $160 million impairment of assets charge. As with the Journal Register, this means that the appraised value, based on what the stock exchange or liquidator's auction would yield, of the New York Times has fallen well below the balance sheet stated value. As Forbes would have put it back in 2002, using a term in increasingly common today, it was time to mark to market.
There are two ways to look at this. One way is to argue that the newspaper business is collapsing, and perhaps try to blame the bloggers. Revenues are falling. Expenses have to be cut. Expectations have to be lowered. Another way is to argue that easy credit and optimistic accounting created a high apparent corporate valuation, and that valuation gave the managers the ability to expand their company by buying other companies. Thanks to goodwill and other accounting artifacts, everything looked hunky dory. Unfortunately, the party is over, and it is time to return to earth.
We might ask, is there still a newspaper business? These 10-Q filings show that there is. It is possible to buy newsprint and ink, hire reporters, sell ads, edit a newspaper, print copies, sell them to homes and at newstands and make a profit. The problem was with the newspaper holding business. Ten or twenty years ago press consolidation might have made business sense. Today, consolidation is stressing and destroying newspapers.
How bad is it? Let's look at Rupert Murdoch's News Corporation. This is a much bigger company, and it includes cable and satellite networks and other operations, perhaps even a big chunk of the Republican party. The News Corporation's filing didn't break out the cost of newsprint, but here is what they did offer in their February 2, 2009 10-Q:
Item | December 231, 2008 | December 30, 2007 |
REVENUE | $7.9B | $8.6B |
Operating | $5.2B | $5.4B |
Depreciation et al | $148M | $163M |
SGA | $1.6B | $1.4B |
EXPENSES | $6.9B | $7.0 |
Revenue is down nearly a billion dollars for the quarter. Expenses are shrinking more slowly. Their SGA is reasonable, especially when compared with the New York Times. If we stopped here, we'd think business looks pretty good, what with profits of nearly a billion dollars, and that's just for three months. If you move down one more line, whoomp, there it is, $8.4 billion dollars in impairment charges. I don't know who came up that term, but if he's charging royalties, he's been rolling in it lately.
To be fair, Dow Jones & Company, of the Wall Street Journal, had no big impairment charges this last quarter. They were making money, perhaps $24 million a quarter, and even paying half of that sum in income tax. They did sell six small local papers with operating margins of about 20%, and took various charges and tax benefits accordingly. That 20% margin is telling. Why sell businesses that are making that much money? There is a good chance they want them off the books for other reasons.
Actually, the Dow Jones filing was rather readable as these things go, and chock full of juicy details above and beyond the basic filing requirements. That, and the fact that they are making money and avoiding impairment charges, suggests that the folks doing their business strategy and accounting are not the folks who write their editorial page. (Of course, they may just be better at hiding things. Time will tell.)
But for each Dow Jones, thre are all too many Gannets. Gannet expensed an impairment charge of nearly $2.5 billion. The entire business is under pressure from falling revenues and a weak investment climate. There is the slow trickle of retrenchment punctuated by the collapsing beams of impairment charges.
What can we expect in the future? Right now we are a lot of companies revaluing their assets, marking to market, and taking those impairment charges. Back in the mid-1980s there was an article in the journal Science on the costs of the Soviet empire. The Soviet Union had stopped making money on its empire in the mid-1970s. Sixteen years later it was an ex-empire.
A sensible newspaper holding company will yield to the market. When it makes sense to merge companies, merge companies. When it makes sense to split them up, split them up. Dow Jones & Company is divesting. My guess is that we'll be seeing a lot more of that in the future. Given the real costs of news gathering and reporting, as opposed to the huge costs of maintaining a news empire, we may even see a new emphasis on the newspaper business.