Competing for Customers and Capital

The Bad and The Good News About Newspapers: GCI, DJ, NYT & TRB

First the bad news: in 2006 alone GCI, DJ and TRB management under-invested in new media options to the tune of $2.3 billion. To put that number in perspective they actually spent $4.9 billion. If they had optimized they would have spent $7.2 billion. Only the New York Time Company (NYSE: NYT) came within a stone's throw.

Now the good news: two of the three underperformers will have new owners in December 2007. And by all accounts at least Mr. Murdoch, if not the others, will join Mr. Sulzberger as an owner with the digital committment to put his money where his mouth is.

BACKGROUND
This is the 4th post in my series on The Times and its peers. In the first post of this series, "The New York Times Co: Public Trust vs. Maximum Earnings," I found that, contrary to popular belief, over the ten years from 1997 through 2006 The Times managed to maximize earnings and at tne same time preserve its public trust as the newspaper of record. In the second post, "The New York Times Company: Enterprise Marketing and The Bottom Line," I concluded that Mr. Sulzberger could have it both ways. He could monetize the editorial content of the newspaper by charging for The Times Reader while keeping an even more interactive nytimes.com free of charge. By 2010 this strategy might double EBITDA as a percent of sales. Applying the last multiple to those earnings suggested a stock price of $87 in 2010.  In the 3rd post, "The Rough Rider and The Gray Lady: Pennies for Dollars?," I concluded that:

If Mort Zukerman's conclusion is correct that he and other media owners including Arthur Sulzberger and Sam Zell are substituting pennies for dollars their combined market cap won't appreciate at all. In that case it looks like NYT will trade at around $28 in 2010. If the other three owners in this group manage to maximize earnings like the NYT did in 2006, together they can jump start all four members of this group into becoming profitable new media companies.

The purpose of this post is to document the systematic under-investment of these newspapers in their search to become new media companies. And assess its effect on revenues and earnings.

ENTERPRISE MARKETING EXPENSES
There's a huge difference between "micro marketing" and "enterprise marketing." The first is advertising and promotion expenses. The second is selling, general administrative expenses. Which includes advertising and promotion expenses, but also sales force, research and development as well all salaried employee expenses.

The SG&A expense category includes almost all the expenses that influence the customer experience. In marketing-speak, this is where the money behind every customer touch-point gets counted. Whether it’s the cost of an insert received with an invoice, or a phone conversation with a customer service rep, or the lead story in DealBook or MarketWatch covering something the CEO did or said. If you want to dig into the details on this topic check out my audio slide show "Enterprise Marketing Expenses."

THE BEST KEPT SECRET
Here's the best kept secret in financial management: the correlation between sales revenues and selling, general & administrative expenses for a large sample of companies is 0.96 with a standard deviation of 0.07. Which one causes the other really isn't relevant. Because sales and selling expenses move in lock step. There are few exceptions. And newspaper publishing is not one of them. This table reports the correlation coefficients for each company:

High correlations like this are why I call these enterprise marketing expenses: almost every line item in this account has the potential to influence how consumers, advertisers and investors perceive a company. As a result many of the expenses contribute to the creation of intangible assets that may one day end up on a company's balance sheet.

ENTERPRISE MARKETING EFFICIENCY
Here's something that's even more surprising. While sales revenues and enterprise marketing expenses move in lock step, some companies are far more efficient than others. I capture these differences with a metric I call the marketing efficiency ratio [MER]. This is the ratio of a company's actual spending to the level of spending necessary just to support its current market position.

On the one hand, if actual enterprise marketing expenses are greater than the theoretical level necessary to maintain current share of revenues, its EMR is greater than 1.0. In this event the company is spending more than necessary to maintain its current share of revenues. As a result it is relatively less efficient than its peers.

On the other hand if the EMR is less than one, the company is spending less than necessary to maintain its current share of revenues. In this event the company is relatively more efficient than its peers.

The New York Times is the most inefficient company in the group. Averaged over the decade, management spent 1.76 times more than necessary to maintain their share of revenues. Dow Jones is a close runner-up, spending 1.46 times more than necessary to maintain share of revenues. Gannett management was by far the most efficient, spending just one-half the amount theoretically required to maintain its share of revenues.

AN INTUITIVE TAKE ON MARKETING EFFICIENCY
Market share attraction [MSA] theory says that, on average, in a competitive market a company will attract revenues in direct proportion to the share of expenses incurred in serving that market. The popularity of this model is based on several characteristics: it's logically consistent; it derives from four simple axioms; its parameters can easily be estimated; and it seems to outperform both linear and multiplicative models.

Market share attraction theory also provides a more intuitive take on enterprise marketing efficiency. The result is portrayed in the following chart for the Tribune Company for 1997 through 2006. The vertical axis in this chart is TRB's share of revenues [SOR]. The horizontal axis is TRB's share of selling, general & administrative expenses [SOS].

Beginning with 1997 in the lower left-hand corner of the chart, TRB captured 21% of group revenues with a little over 20% of SG&A expenses. In all but two years TRB's share of group SG&A expenses tracks right along the diagonal dotted line. In short, the Tribune's data fit the theory almost perfectly: the company's SOS is proportional to its SOR. Corresponding intuitively with its mean marketing efficiency ratio of 1.0

A pattern similar to the Tribune's market share attraction exists for the other competitors. Except that in GCI's case the numbers track high high above the diagonal line of proportionality: its SOR is significantly greater than its SOS. Just as the New Yiork Times is far below, reflecting its enterprise marketing inefficiency.

An interesting investigation into the properties of the [MSA] model is available in the 2001 paper "Why is Five a Crowd in the Market Share Attraction Model: The Dynamic Stability of Competition" by Paul Farris and his coauthors. Their analysis assumes that firms maximize earnings by optimizing their own spending based on competitors' last-period budgets and the MSA model. Market share attraction theory is the engine that drives maximum earnings market share discussed in my book Competing for Customers and Capital.

A DECADE OF NEGLECT
Perhaps the most important point of this story is the ten years of systematic under-investment by these four companies in their market. As the shift from old to new media progressed over the years from 1997 through the present, sales revenues of all four companies were far below their optimal level. The following table tells the story in a vivid four color image.

Actual cumulative sales revenues from 1997 through 2006 are reported for each company (by ticker symbol) and for the group in the first (blue) line of this table. Optimal cumulative sales revenues appear in the second (green) line of the table. The third (red) line is the difference between optimal and actual revenues.

The four companies actually generated a total of $161.5 billion in revenues. If all four companies had optimized revenues – spending up to the point that the earnings from the last dollar of revenues were equal to the SG&A expenses of producing it – group revenues would have been $238.7 billion.  That's a short-fall of $77.2 billion, or nearly 50% of their potential.

Dow Jones was the worst offender in percentage terms generating actual revenues that were nearly 100% below optimal revenues. As Mr. Murdoch said in his pre-merger interview with Wall Street Journal reporters:

The Journal has had no money spent on marketing that I'm aware of for years. I imagine whatever we do would take the profit down in the short term… I mean of the Journal… It's got to have money put back into it, particularly on the digital side.

This conclusion is true of all four companies. Even the New York Times, which finally managed to optimize revenues in 2006, fell 38% short over the decade. And so did GCI and TRB where management continued the decade of neglect right through 2006.

How much money needs to be put back into Dow Jones? The following table provides a perspective on the magnitude of the challenge. The layout is the same as the previous table, except cumulative selling, general & administrative expenses – what I call "enterprise marketing expenses" – are reported here.

Over the decade management of the Dow Jones Company actually spent $6.64 billion on SG&A expenses. The optimal level of spending was more than double that number: $15.16 billion. Mr. Murdoch appears to understand the magnitude of the challenge he faces with Dow Jones. In his interview with Journal reporters he also said:

We've got to find new ways and new business models to get revenues. Or else the world is going to be owned by Google. I was asked at this investment thing I had to go to, what competitors I see I would have in five years time. Globally. I said I'm sure they'll be a lot of them. I know one is Google. It's just getting so strong, so powerful. And I know the guys, and like them. They're friends of mine. But it is a big fact of life.

TRB spent only one-quarter of its optimal SG&A over the decade. Perhaps this is why Sam Zell went motorcycle riding instead of attending the Tribune's first director's meeting. Maybe Mr. Zell didn't want to face the refrain of his highly leveraged buyout. In The New Yorker story on the "Rough Rider:"

His friend Stuart Sloan said that he has dropped out of Zell’s Angels because he feels that, at his age—he is sixty-four—it is too dangerous. But Zell, who skipped his first board meeting as a Tribune director last May to go on a Zell’s Angels trip in Switzerland, relishes the adventure and the all-male camaraderie.

The Gannett Co. was the second largest under-investor in this peer group. Over the decade the company spent just over $10 billion while it should have spent nearly $20 billion. Given this evidence one has to wonder if Craig DuBow has any idea of the costs associated with the ambitions he articulated in his December 5, 2007 press release:

Our overall corporate strategy ... is to build a robust digital business while supporting and enhancing our core. That digital business now is taking a clear and exciting shape. Here’s what I mean: Gannett has made dramatic changes in its operating structure, its newsrooms, its mindset and its culture in less than 18 months. We truly have become more nimble, innovative and customer-centric. Those changes are driving us as we implement a more focused digital strategy. The focus, simply put, is this: Gannett will become the digital destination for local news and information in all our markets. We will scale that content nationally whenever possible.

The Times suffered the least from neglect, spending "only" 52% below optimum over the decade. Does systematic under-spending depress earnings as well as sales? Of course. But, at this point the critical question is what management will do in future years.

YOU CAN'T COST-CUT YOUR WAY TO THE FUTURE
In this digital age shifting the source of our news from old to new media vehicles is a given. But the challenges lay only half way in the technological domain. Newspapers are now faced with a fierce global information market where the variety and number of competitors is unparalleled. The options are seemingly infinite and what one firm does effects the performance of all the others. This analysis doesn't tell management which options to choose. But it does measure the potential value of getting it right. And shows that newspaper owners can't cost-cut their way into their digital future. What do you think?

Thanks for visiting,

~V

The Rough Rider and The Gray Lady: Pennies for Dollars?

In Connie Bruck's New Yorker profile the Rough Rider, Sam Zell told told her:

“I’m a great believer in maximization. That’s my whole life, and it has always been my life.”

In case you didn't know, this is the guy who soon will close the deal on the Tribune Company (NYSE: TRB). Though Ms. Bruck's profile provides few clues on what Mr. Zell might actually do with the Tribune, she does reports that:

… Maggie Wilderotter, who … has sat on the boards of three of Zell’s firms, said that she had spoken with him many times about Tribune Company before he made his bid, and that high-minded considerations played no part in his thinking. … “His thought process throughout this whole thing has always been about the business proposition. I never, ever heard Sam say, ‘I’m doing this because I love the Chicago Tribune,’ or ‘I’m committed to the city of Chicago.’ It would have been totally out of character.”

So, why does it matter to The New York Times Co (NYSE: NYT) what Sam Zell is likely to do with the Tribune? That question is the focus of this analysis, which is based on my book Competing for Customers and Capital.

BACKGROUND
In the first post of this series, "The New York Times Co: Public Trust vs. Maximum Earnings," I found that over the ten years from 1997 through 2006 The Times managed to move toward maximum earnings and at the same time preserve its public trust as the newspaper of record. In the second post, "The New York Times Company: Enterprise Marketing and The Bottom Line," I concluded that Mr. Sulzberger could have it both ways. He could monetize the editorial content of the newspaper by charging for The Times Reader while keeping an even more interactive nytimes.com free of charge. I predicted that this strategy likely would double the company's EBITDA as a percent of sales by 2010 . Furthermore, applying the 2006 earnings multiple suggested a 2010 price of $87.  But I cautioned the reader that this price was contingent on two outcomes: that The Times management maximized earnings and correctly anticipated the enterprise marketing expenses of its peers.

RISK-ADJUSTED DIFFERENTIALS
The risk-adjusted differential [RAD] is a well behaved measure of a company's performance that captures the interaction between the demand for its products and the demand for its stock. For an overview of this measure see my Marketing Science Institute report "Marketing's Impact on Firm Value: The Value-Sales Differential."

What makes the RAD well behaved? It's a standard normal variable with mean zero and standard deviation one. So, any given company can be compared "apples-to-apples" with its peers if they serve similar customers and have comparably deep pockets. In my book I argue that you can't assess market performance without running the RADs.

The following chart shows risk-adjusted differentials on the vertical axis for The New York Times Company in a strategic group with The Tribune Company, the Gannett Co. (NYSE: GCI) and Dow Jones (NYSE: DJ). On the vertical axis in this chart RADs range from +5 to -5. The series begins with the 1st quarter of 1997 (designated 7.1 on the horizontal axis) and runs through the 4th quarter of 2006. It is not a happy picture. NYT is in the red the entire time.

Throughout the 40 quarters investors discounted the market cap of the NYT relative to its market power. In all but 12 quarters the company's RADs were less that -2. This means investor discounts are statistically significant at the 95% confidence level.

WHO HURT THE GRAY LADY?
Which of the three competitors did the most damage to the Gray Lady? The following table of correlation coefficients provides an answer. Surprisingly it's not Dow Jones.

DJ and NYT risk-adjusted differentials are positively correlated at the 0.5 level (in green). It was TRB, soon to be owned by the "Rough Rider," that did most of the damage with a negative correlation coefficent of -0.6 (in red). The following chart shows the association.

 

In the first quarter of 1999 (designated 9.1 on the horizontal axis) the Tribune was instrumental in driving the NYT risk-adjusted differential down to -5. This is why what Sam Zell does with the Tribune should matter as much to The Times management as what Rupert Murdoch does with Dow Jones. But TRB had some help from GCI as this following chart reveals.

ARE DJ AND NYT COMPLEMENTS?
The associations between NYT and TRB are even more dramatic when the underlying variables are examined. These variables are share of revenue [SOR] and share of value [SOV] in the strategic group.

The NYT's share of revenue correlation with TRB's over the forty quarters is -0.9. When TRB's share of revenues goes up, NYT's goes down. The NYT-GCI share of revenue coefficient is -0.5 while against DJ it's +0.8 (note that + sign).

The NYT's share of value correlations over the same period exhibit a similar pattern: the correlation between NYT's and TRB's share of value is -0.5; against GCI it's -0.3; against DJ the share of value coefficient is +0.6.

In the minds of advertisers and investors The New York Times and Dow Jones appear to be complements ... not substitutes.

PENNIES FOR DOLLARS?
There are two additional steps in the competitive pricing of NYT: (1) forecasting the strategic group's market cap in 2010 and (2) forecasting the company's share of that market cap. 

The forecast of market value for this strategic group, caught in the midst of a tectonic shift in the competitive landscape, cannot be a time-series exercise. Time is of the essence, but not as an independent variable in a regression equation. Rather the 2010 market cap of these companies depends on the business proposition each one executes in their effort to reinvent the market.

Currently investors are not too hopeful: the combined value of the group plunged 62.4% from $52.5 billion in December 2003 to $19.7 billion on November 30, 2007. And the opinions from management are mixed. In her November 24, 2007 post Dianne See Morrison asked this question: "Are US Media Owners Substituting 'Pennies for Dollars' Online?"

That was the woeful conclusion of Mort Zuckerman, publisher of the New York Daily News and US News and World Report, according to the detailed minutes of a recent inquiry into media ownership by the UK House of Lord's Communications Committee released Friday. In September, the committee visited the U.S. and the offices of its major media owners, regulators, and media groups looking at the state of newspapers, broadcasters, radio and online. The minutes show an industry at a turning point, with media owners both hopeful and despondent of the future. One theme that consistently arose was whether or not the Internet represented a boon or bane for media owners and if the Web could ever be channeled for profit.

FORECASTING STOCK PRICE
The equation to forecast share of value is simple: [SOV] equals the NYT's risk-adjusted differential [RAD] multiplied by its Risk, then added to its maximum earnings market share [SOR hat]. For an explanation of this equation you might what to review my audio slide show "Competitive Stock Valuation:"

Let's take a first cut at re-pricing NYT by using the forecast (from my last post) of its maximum earnings market share in 2010 – that was 26.7%; its enterprise marketing risk over the previous forty quarters (2.0 not reported earlier); its risk-adjusted differential in the 4th quarter of 2006 (-3.0 from the chart above); and the combined market cap on November 30, 2007 ($19.7 Billion from above). The following table reports the results for risk-adjusted differentials ranging from -5 to +5 . NYT's market cap is SOV times group market cap. Price is Market Cap divided by the number of shares outstanding (143.85 M).

If Mort Zukerman is correct concluding that he and other media owners like Arthur Sulzberger and Sam Zell are substituting pennies for dollars -- their combined market cap won't appreciate at all. In that case it looks like NYT will trade at around $28 in 2010. The other three owners in this group could manage to maximize earnings like the NYT did in 2006. Together they could jump start growth in group revenues so that its members become profitable new media companies with increasing market caps. Got any ideas on how they might do that?

Thanks for visiting,

~V

The New York Times Company: Enterprise Marketing and The Bottom Line

When was the last time you were faced with a choice between strategic business alternatives that appeared to be mutually exclusive – "A" or "B" but not both? This seems to be the problem facing The New York Times Co (NYSE: NYT) in searching for ways to monetize its content online. If, however, Mr. Sulzberger were to a look at his choices through the lens of enterprise marketing he might discover "A" and "B" aren't mutually exclusive after all.

What's so special about looking through the lens of enterprise marketing? Two things come to mind. First, an enterprise marketing analysis optimizes the cost of all the expenses that influence how investors, customers, and consumers perceive a company and its products. Second, the competitive risks of a strategy are built into the analysis from the very first right up through the last step.

COMPETING FOR CUSTOMERS AND CAPITAL
Most economists assume it's not possible to operate as a public trust and -- at the same time -- maximize profits. My last post, "The New York Times Co: Public Trust vs. Maximum Profits," showed that in the case of The Times this assumption did not stand up to the data. The company remained a public trust and maximized profits in 2006. The purpose of this post is to further that conclusion by documenting how a reconciliation of the strategic alternatives faced by The New York Times Co. leads to an EBITDA of $7 a share by 2010. When you consider the company earned just under $2 a share in 2006, hitting this earnings target presents management with no mean feat.

This analysis goes back to the original post in a series on newspapers that began on June 3, 2007 with "Dow Jones: Anomaly or Hidden Value?" In that article I placed The Times in a strategic group with Dow Jones (NYSE: DJ), the Gannett Company Inc. (NYSE: GCI), and the Tribune Company (NYSE: TRB). A strategic group is a set of companies that share a customer base and have comparably deep pockets. In newspapers the “shared customers” are advertisers. This report is based on the same 10 years of financial accounting data I used in that earlier post.

IRRECONCILABLE DIFFERENCES
Anthony Bianco's cover story of Business Week on January 17, 2005 titled "The Future of The New York Times" quotes John Battelle, a co-founder of Wired, with an apparently irreconcilable strategic choice:

The business model that seems to justify the expense of producing quality journalism is the one that isn't growing, and the one that is growing -- the Internet -- isn't producing enough revenue to produce journalism of the same quality.

In the same story he reports that "... disagreement rages within the company over whether NYTimes.com should emulate The Wall Street Journal and begin charging a subscription fee. Undoubtedly, many of the site's 18 million unique monthly visitors would flee if hit with a $39.95 or even a $9.95 monthly charge."

For years management has been working on a product that delivers enough value to sell profitably online. In October 2001 The Times launched the Electronic Edition -- an exact replica of the New York City print edition. I subscribed to it, then let it expire. That version preserved the exact look of the print edition, which was great. But that facsimile format made it very cumbersome to manage on a computer screen. You could zoom in, but then you lost the most of the content. Moving from one page to the next, even on a broadband connection, took a few seconds. You could move only one page at a time, but you couldn't actually turn the page. That edition is still available with these same shortcomings at $14.99 a month. For this post I renewed my subscription. Nothing has changed. You can't even turn a virtual page electronically!

A BIG MISTAKE
If you subscribe to the Sunday Times you probably noticed recently the insert Introducing Times Reader promoting A new way to experience The Times. The Times Reader lacks the look of the electronic facsimile, but it features high level functionality. Like automatic scaling of text and images to fit your screen even when you change font size. And you can move from section to section and back with one click. It does not include some very important stuff from the company's main web site NYTimes.com. All the web logs and interactive features are excluded. Yet this brilliant, if accidental exclusion, completely differentiates the Times Reader.

Apparently management does not hold this view. When you go to the Home Delivery link on NYTimes.com (and enter your ZIP code) you will find the Times Reader is promoted as a "$169 Annual Value ... free to Subscribers." There goes $14.08 a month down the drain. Big mistake!

A DOTCOM BY ANOTHER NAME ISN'T THE SAME
I was raised in a family of newspaper non-readers. Probably because we lived on military bases around the world where home delivery was out of the question. So I never learned to ignore printer's ink on my fingers, the piles of old newspapers, and the uncertainties of home delivery. I never regularly read a newspaper till they created NYTimes.com. For years it's been my home page. While I don't have to put up with the shortcomings of print editions, the NYTimes.com has problems of its own. First, there's the formatting. Enlarge the type face and everything goes out of whack. Second, getting from one section to another requires too many clicks. Third, finding yesterday's news in archives is a pain in the neck. And if older than yesterday's news there's an extra charge.

I happily will keep my subscription to the Sunday Times at $6.50 a pop (I've learned to deal with a newspaper once a week!). And I'll subscribe to the Times Reader at their advertised price of $14.08 a month. I suspect a large percentage of the 18 million unique monthly readers of the NYTimes.com will do the same. If, over time, even 30% of those 18 million monthly visitors subscribe to the Times Reader at $14.08, the income from it will match the $890 million earned from sales of the Times Newspaper in 2006. The 70% who don't, won't know the difference. And ad revenues won't fall because those who subscribe to the Times Reader will still visit NYTimes.com for its blogs and other interactive features. In fact, free of its editorial responsibilities, the NYTimes.com can be enriched with even more interactive features. 3D Cross-Word puzzle anyone?

A good friend of mine loves reading the newspaper: every day, every page, front to back. She loves the printers ink and saves the old papers for other uses. For which she has many as a 2D artist. To her there's also something special about turning the pages. Reminder to Mr. Sulzberger: the Times Newspaper won't go out of style anytime soon.

INVIGORATED INCOME STATEMENT
The financial impact of monetizing The Times high quality content on the Times Reader isn't just volume. It's also gross margin. In 2006 the Times Newspaper had a gross margin of 53.5%, down from 64.5% in 2000. The cost of moving content to the reader probably is very small: maybe 10% at the outside. When the volume of Newspaper and Reader equalizes, combined gross margins will be about 68%.

The following table presents the actual (2006) and Pro Forma (2010) income statements that lead to EBITDA per share of $7, along with the percent changes in each line item.

These results assume strategic group revenue increases at the same modest 3.8% CAGR of the last decade, growing from $18.6 billion in 2006 to $21.6 billion in 2010.  Actual market share of 17.7% in 2006 jumps 9 points to maximum earnings market share of 26.7%. The marginal value of a share point increases dramatically as a result of higher gross margins, making it profitable to buy more share points. The effect of modest growth in group revenue combined with a 50% increase in market share drives revenue up 75% from $3.29 to $5.76 billion by 2010. And larger gross margins mean relatively lower costs of production, up just 19%.

The financial impact of this strategy really kicks in with gross operating profits, which increase 124% from $1.760 to $3.936 billion in 2010. The SG&A expenses required to support a 27% market share nearly double. But earnings nearly triple from $294 million to just $1.05 billion. EBITDA per share hits $7 while earnings to revenue double. SG&A to revenue increases only 12%. The Times Reader not only makes NYT much more profitable, it's also more efficient to deliver.

WHAT'S THE NYT PRICE IIN 2010?
A simple way to estimate NYT's price is to multiply its 2006 Price/EBITDA ratio of 12.3 by forecast earnings in 2010. This suggests a price of $87 in current dollars. Remember, that $7 earnings figure assumes management continues to optimize its SG&A expenses every year just as they did in 2006.

The NYT price also is contingent on the actions of competitors. Since Dow Jones soon will be under new leadership, with deeper pockets and an equally powerful brand name, the valuation of NYT must take DJ and its other competitors into account. That's exactly what the competitive stock valuation model in my book Competing for Customer and Capital is designed to do. In the next post in this series I'll apply that model to valuation of the NYT. We'll see if it adds enough information over and above that contained in the P/E ratio to make it worth the extra effort.

The Times Reader solves the problems of both the paper and online editions. It's my ideal product. It also can solve the company's problem of monetizing its content online. The solution is simple: charge separately for The Times Newspaper, Electronic Edition, and Times Reader while keeping the NYTimes.com free.

~V

The New York Times Co: Public Trust vs. Maximum Earnings

In his 24/7 Wall Street post on Friday November 16, 2007 Douglas McIntyre published the latest of many unsettling predictions about the future of newspapers:

There is little left for the newspaper industry other than to cut people. Paper and delivery costs have already been taken down. The costs of printing and production cannot be brought lower. That leaves headcount.

While he didn’t say so, this conclusion speaks directly to The New York Times (NYSE: NYT) because of what its most vocal critic sees as the companies prolific spending on, among other things, headcount. That critic, Mr. Hassan Elmasry of Morgan Stanley (NYST: MS), blames the company’s ownership structure on management's freedom to engage in this "overspending." In his October 17, 2007 post "Morgan Stanley Walks Away From New York Times Fight" on BloggingStocks, Tom Barlow wrote:

The Global Franchise fund, which looks for undervalued but world-renowned brands, spent the first part of 2007 in a full-court press, attempting to change NYT's direction. Among Elmasry's concerns were (in his view) overstaffing, the cost of a new headquarters, a flawed internet strategy, and too-generous option grants.

The reason for the New York Times "curious ownership structure" is the belief that newspapers in a democracy are a public trust. In the May 13, 2007 edition of The Becker-Posner Blog Professor Posner wrote:

The idea is that if people unrelated to the founder … controlled the newspaper, they would manage it with the aim of maximizing profits and thus would give the consumer what he wanted rather than what he needed in order to be an informed citizen.

This belief, of course, implicitly assumes it's not possible to operate as a public trust and -- at the same time -- maximize profits. The purpose of this post is to show that in the case of the Times this assumption does not stand up to the data. The company remains a public trust while maximizing profits.

MAXIMUM EARNINGS MARKET SHARE
In a post on June 3, 2007, "Dow Jones: Anomaly or Hidden Value," I placed the Times in a strategic group with Dow Jones (NYSE: DJ), the Gannett Company Inc. (NYSE: GCI), and the Tribune Company (TRB). A strategic group is a set of companies that share a customer base and have comparably deep pockets. In newspapers the “shared customers” are advertisers. This report is based on the same 10 years of financial accounting data I used in that earlier post.

Maximum earnings market share occurs when the marginal cost of the next share point is equal to its marginal earnings -- net of “enterprise marketing expenses.”  For the details on accounting for these expenses see my book Competing for Customers and Capital. In the newspaper industry enterprise marketing expenses are listed in the income statement as "Selling, General & Administrative expenses." Most of these expenses fall into the category of “headcount.”

The following chart compares the NYT's maximum earnings market share with its actual market share from 1997 through 2006. In 1997 the company's maximum earnings share of the group's $12.9 billion revenues was 30.5%. Its actual market share was just 22.2%. Conclusion? In that year NYT management was seriously under-spending on enterprise marketing.

But by the close of business in 2006 management had successfully driven their revenues and expenses to the point where the company’s maximum earnings market share (17.2%) and actual share (17.7%) were separated by only 50 basis points. How did they pull this off?

The following chart reveals the truth about the management of earnings and expenses at the NYT. The company's marginal earnings per basis point (that's 1/100th of a share point) were $0.72 million in 1997, when its marginal cost per basis point was just $0.57 million.

By the close of business in 2006 NYT’s management had brought their marginal earnings and expenses into near perfect alignment at $1 million per basis point.

THE NEWSPAPER OF RECORD
There's a simple analog to the incremental cost per basis point that's a lot easier to calculate and understand. It's the average cost per dollar (CPD) of revenue.

This table shows a side-by-side comparison of the CPD for each of the four companies in this strategic group. In 1997 it cost the NYT 35¢ to generate $1 in sales revenue. That was twice what it cost GCI. Over the next nine years the NYT cost per dollar increased to 45¢, while GCI remained unchanged at 16¢ per dollar. By 2006 NYT management spent almost three times as much to generate a dollar of revenues as CGI and far more than either DJ or TRB.

While the critics call this overspending, the Times management probably would call it brand building. What did the company spend the "extra" money on? Some clues are given in Anthony Bianco's cover story of Business Week on January 17, 2005 titled "The Future of The New York Times:"

[Arthur Sulzberger] reinvented the "Gray Lady" by devising a radical solution to the threat of eroding circulation that had imperiled the Times and other big-city dailies for years. Sulzberger changed the paper itself by spending big money to add new sections and a profusion of color illustration.

At the same time, he made the Times the first -- and still the only -- metro newspaper in America to broaden its distribution beyond its home city to encompass the entire country. Today, nearly 50% of all subscribers to the weekday Times live somewhere other than Gotham.

In the mid-1990s, NYT Co. became one of the first Old Media companies to move into cyberspace ... Today, NYTimes.com consistently ranks among the 10 most popular Internet news sites ...

Did this spending actually build the brand? A study published in August 2007 by the Joan Shorenstein Center on the Press, Politics and Public Policy on "Creative Destruction: Exploratory Study of News on the Internet" found that:

Brand-name newspaper sites are gaining audience. Their traffic in April 2007 exceeded their April 2006 traffic by more than 10 percent, which corresponds to an average gain of nearly a million unique monthly visitors (page 7).

Building the brand's reach and supporting the company’s worldwide reputation as the newspaper of record is far more important then making sure last quarter earnings per share meet analyst's expectations. It is all the more important since management was able at the same time to maximize earnings. This is an achievement unmatched by the other newspapers in this group. In 2006 the Times relative earnings productivity [REP] was -0.1% -- meaning the company's actual earnings were only 1/10th of 1% less than maximum potential earning. In the same year the relative earnings productivity of GCI, TRB and DJ were -7.4%, -8.2% and -27.0% respectively.

ALL THE MONEY IT’S FIT TO EARN
In 1997 the company’s management fell $63 million short of maximum EBITDA. But by the close of business in 2006 actual and maximum earnings were exactly equal at $264 million.

The downward trend in the Times earnings is severe and reflects the hard times also suffered by Dow Jones. Given that fact, if you will forgive me a paraphrase of the Times masthead, the company is making all the money its fit to earn while continuing to build the brand in a harsh environment.

INVESTOR MYOPIA
Anthony Bianco's cover story is perhaps the most comprehensive, unbiased account to date of the Times performance under the leadership of Arthur Sulzberger, Jr. That article sums up the two major issues affecting its future today -- economics and politics:

In essence, Sulzberger is doing what his forebears have always done: sink money into the Times in the belief that quality journalism pays in the long run. "The challenge is to remember that our history is to invest during tough times," he says. "And when those times turn -- and they do, inevitably -- we will be well-positioned for recovery."

Investors continue to discount the company’s stock in part because of Mr. Hassan Elmasry's "full-court press." His battle with the Times over ownership structure and spending clearly took its toll on the stock. Now that this two year assault is settled, there remains the deeper issue highlighted in the Business Week cover story: the ideological divide within the country.

What a growing, or at least increasingly strident, segment of the population seems to want is not journalism untainted by the personal views of journalists but coverage that affirms their partisan beliefs...

Does all this add up to a case of investor myopia? What do you think?

Thanks for visiting.

~V