You all might not remember, but I wrote about Yellow Media back in 2011. The maker of the Yellow Pages was barely profitable, paying a hefty dividend (it was 20% at one point), and its debt load was bigger than my failure at Dance Dance Revolution at a Korean arcade the other night. It was not pretty. Me, I mean. But also the debt.
I decided to avoid the stock, for those reasons, even going as far as taking a shot at it when I talked about stretching for yield. And I turned out to be right, because in 2012, the company finally bit the bullet and filed for bankruptcy protection. Well, sort of. The company and debt holders came up with a deal to convert $1.5 billion worth of debt into new equity, all but wiping out existing equity holders (they got about 10% of the company, compared to 80% for the debt holders). The company then did a big-ass consolidation of shares so there’s currently only 27 million shares outstanding, along with a few million warrants and convertible debentures.
So now it’s back, and a lot leaner than before. It’s still sitting on $575 million worth of debt — part of which is offset by $146 million in cash — but it’s in a lot better financial shape. Hell, you could almost argue it’s in great financial shape. And considering how much press the decline of the Yellow Pages part of the business gets, it’s still remarkably profitable.
Since Yellow Media emerged from it’s creditor protection period at the end of 2013, let’s take a look at how much money it’s made each quarter. Keep in mind that Yellow Media’s shares trade at $17.65 each.
- Q1 2013 – $1.64
- Q2 2013 – $1.50
- Q3 2013 – $1.24
- Q4 2013 – $0.92
- Q1 2014 – $1.22
- Q2 2014 – $1.01
Based on the last 4 quarters of earnings, the company trades at a annualized rate of just four times earnings. That’s crazy cheap.
But is it for a reason? Well, yes. Check out the revenue numbers during that time.
- Q1 2013 – $253M
- Q2 2013 – $243M
- Q3 2013 – $237M
- Q4 2013 – $238M
- Q1 2014 – $223M
- Q2 2014 – $220M
It’s pretty easy to see the problem. At this point, approximately half the revenue comes from sources other than the traditionally big, bulky phone book business. Yellow Media owns a bunch of different websites, including YP.ca, Red Tag Deals, and a few others I’m too lazy to look up, but are kind of big Canadian deals.
First, let’s talk about the viability of the Yellow Pages. So far post-restructuring the company is renewing customers at approximately a 85% rate, as well as signing up approximately 15,000 new ones per year. Let’s assume conservatively that they’ll continue to renew at an 85% rate, and not sign up anyone. What do the numbers look like after a few years?
- 2014 – 265,000
- 2015 – 225,250
- 2016 – 191,462
- 2017 – 162,743
- 2018 – 138,331
Let’s stop there, and assume that in 5 years the Yellow Pages business will be cut in half. This is also assuming the company doesn’t sign up a single new customer.
Yellow Media is very vocal in pointing out that half of its revenues come from the digital side, which seems like a good transition. Except it doesn’t actually break down the margins from the digital side. For me, that’s a giant red flag, and shows that digital margins are 14 different kinds of terrible, and at best the digital side of things is breaking even.
It’s hard to predict any earnings growth from the digital side, so let’s assume that earnings are cut in half over the next five years from the decline in the print business. That puts earnings at the $2.25 to $2.40 per share range, giving the stock a future P/E of eight. That’s… not bad, actually.
There are a few risks, of course. Print revenues are declining by 20% a year (partially offset by converting these print customers to digital customers, which is where I got the 85% renewal rate), and there’s always the risk that they could fall faster. There’s also the risk of more cities passing bylaws to not allow the company to distribute physical phone books. The company has long-term contracts with every major phone operator in Canada except Bell, which expires in 2016.
And, of course, we still don’t know if digital makes any money, and much to do with the economics behind it. We all know there are a whole bunch of profitable websites out there, but just how much of Yellow Media’s digital revenue comes from its websites and how much comes from selling ads to yellow page customers remains to be seen. Because as the Yellow Pages business declines, folks aren’t going to care about maintaining a digital presence on the website. They’ll just go away.
The company also trades at right around book value, but that’s pretty much meaningless. About 75% of the company’s assets are intangible. Sure, the Yellow Pages has a brand, but just how valuable is it? Is it worth $1.3 billion? I doubt it, but that’s the reality in investing in a company like this.
Anyway, I’m not about to buy Yellow Media anytime soon. At $17.65, I’m just not that excited. But would I look hard at it if it dropped to $10? Hell to the yes. It’s on my watch list, anyway.