Saturday 4th March 2017
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Not only has Fairfax media, which is Australia’s oldest media company, rationalised extensively and changed the orientation of its business model, but it has successfully challenged the more dominant Realestate website in the major markets of Sydney and Melbourne. Key in this regard has been Fairfax Media’s ability to leverage its combined print/editorial digital strategy that differentiates it from the competition. While the latest reorganisation of Fairfax Media’s reporting structure will not solve the company’s problems in and of itself, it does in our view provide a clearer picture of how management is seeking to create shareholder value going forward. As was evident in Fairfax Media’s recent results release for 1H17, the company is continuing to face a combination of structural and cyclical headwinds, with even Domain Group having succumbed. In fact, Domain Group’s latest results are symptomatic of the broader challenges facing Fairfax Media, with the 12.8 percent decline in the segment’s EBITDA for 1H17 attributed to both cyclical and structural headwinds. While the 11.3 percent decline in Domain Group’s traditional advertising revenue was more than offset by a 15.3 percent increase in digital advertising revenue, the earnings benefit of this was more than accounted for by higher operating costs. The key point to note here is that the 19.2 percent increase in Domain Group’s operating costs in 1H17 was the result of Fairfax Media’s ongoing investment in digital-related staff, technology and product. To management’s credit, Domain Group was able to offset the 11.3 percent decline in Domain Group’s print-related advertising revenues with an 11 percent decline in print-related operating costs. At any rate, the fact that management expects cost growth at Domain Group to moderate to around 13 percent in 2H17 is somewhat comforting, particularly given the segment’s operating track record to date. Looking further ahead, management’s decision to separate Domain Group from Fairfax Media should also help to the extent that it will bring a sharper focus to the respective businesses, while also enabling the market to more accurately ascribe a value to each business. Judging by the relative and absolute gains in Fairfax Media’s share price over the last three months, these potential benefits do not appear to be lost on the market. Using realestate.com.au as a proxy, this implies a market value for Domain Group of circa $2 billion. Given that this accounts for the bulk of Fairfax Media’s current market capitalisation, this means that the company’s shareholders are essentially getting the remaining assets (i.e. publishing, Macquarie Media and Stan) for free. The challenge of course is working out what the inherent (or intrinsic) value of Fairfax Media’s traditional media (i.e. publishing assets) and other digital media assets is. While Fairfax Media’s 1H17 results indicate to us that Macquarie Media is performing well, it is a relatively small part of the overall pie, having reported a 9.6 percent increase in EBITDA to $13.3 million in 1H17. Unfortunately for Fairfax Media’s shareholders, the remaining pieces of the puzzle are less clear cut. In terms of 1H17, we note that while Fairfax Media was able to grow its publishing-related EBIT, this was due largely to a lower depreciation and amortisation expense on the back of recent adjustments (i.e. write downs) to the carrying value of traditional assets. Looking at the EBITDA line, the publishing business actually went backwards in 1H17, with all key business units contributing to the lower result.
Unfortunately for Fairfax media’s shareholders, the cyclical and structural headwinds that are putting downward pressure on the company’s revenues (and EBITDA) appear to be unrelenting. This was confirmed by management at the 1H17 results, with revenues down 10 percent in January as a result of a “slower than usual start across the media sector”, and down 6 percent in the first two weeks of February, albeit with some early signs of improvement in new real estate listings.
Fairfax Media’s shares are currently trading at 15.0 times FY17 earnings and 2.25 times book value with a prospective dividend yield of 4.3 percent. While these metrics do not appear cheap at face value, it is the cyclical upside to earnings and the inherent strategic value in the asset mix that makes Fairfax Media an interesting investment proposition. Add to this Fairfax Media’s positive technical overlay, and we believe there are multiple reasons to expect the stock price to trend higher.
The release of Fairfax Media’s 1H17 results does little to change our view that the company’s shares represent an interesting opportunity for investors. While not without its risks, we believe that the proposed spin-off of Domain Group will bring into sharper focus the value inherent in Fairfax Media’s remaining assets. While the traditional publishing business remains under immense pressure, it is worth more than Fairfax Media’s current market capitalisation implies.
James Lennon is a senior analyst at investment research and funds management house Fat Prophets.
Disclosure: Fairfax is held within the Fat Prophets Concentrated Australian and Small/Midcap Portfolios.
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