Newsletter Value Investor Insight carried an interview June 30th with Thomas Russo, who oversees $3 billion in assets at Pennsylvania-based Gardner Russo & Gardner, and whose original fund has returned an average 17.4% annually since 1984, vs. 12.4% for the S&P 500, according to Value Investor Insight. Here’s the segment of the interview in which Mr. Russo discusses his position in McClatchy Corp, which was trading at $39.70 at the time of the interview:
You’ve been doubling down on your investment in McClatchy (MNI). Why?
TR: The market just savaged the shares after the announcement of the acquisition of Knight-Ridder. An already pure-play newspaper publisher buying more newspapers was not something the market wanted to hear.
I’ve owned McClatchy for some time and am very impressed with their management. They understand the way to succeed in their core newspaper markets is to focus on local content, and I think they do that as well or better than anyone. They’ve created a suite of non-newspaper services – like direct marketing and door-to- door promotions – that give local advertisers added opportunity to reach their target audiences. They have also developed across their various markets a robust, fast-growing online operation. As the stock has fallen from around $53 prior to the acquisition announcement to around $40 today, I’ve increased my position by roughly 50%.
Do you not ascribe to the view that newspapers are in inevitable decline?
TR: This is a case where I believe the market is overreacting to snippets of information and by extending recent trend lines into the future forever. One snippet is that Warren Buffett has spoken recently about the decline in the quality of newspaper franchises. He’s right, but just because a franchise is less great than it once was doesn’t mean these aren’t still very strong franchises. I’m perfectly willing to invest in franchises that are still good, but less good. The dark-spirits business has fallen in that category. The U.S. tobacco business has fallen in that category.
There is no better source for local news and information than newspapers, which can cover the local market in ways national outlets can’t. Consumers care an awful lot about local information and I don’t expect that to change.
In the specific case of McClatchy, the market gives the company no credit for what I believe will be real upside from running the Knight-Ridder papers better. McClatchy is just a more skilled operator than Knight-Ridder was. People say the margins on the papers McClatchy is keeping are already high, so there’s little incremental upside. [Note: McClatchy has agreed to sell 11 of the papers it bought from Knight-Ridder, in what it perceives to be less-attractive markets.] But that ignores the incremental profitable business McClatchy can generate from reenergizing newspaper ad sales efforts, expanding online efforts and increasing their non-newspaper advertising options in former Knight-Ridder markets. It will also be interesting to see what happens with the one-third interest in CareerBuilder.com, the online jobs site, they acquired from Knight-Ridder.
Gannett and Tribune own the other two-thirds of it, and have the right of first refusal to acquire the Knight-Ridder stake. I don’t expect them to exercise that right – which would cost $350-400 million – but if they did, I think McClatchy could turn around and do a deal with Monster, Google or Yahoo’s HotJobs that would replace any lost revenue from the CareerBuilder stake. That just further reinforces for me the long-term value of the local franchises newspapers have.
So with the market’s expectations currently so low, what do you see as the upside for McClatchy shares?
TR: I think the company will have close to $5 per share in cash earnings by 2008 – from a pre-acquisition level of around $3.40 – just from extracting incremental profits from the new papers and from paying down debt. If they’re able to do that, I would expect a more reasonable P/E of 12x on the shares, which would result in a $60 price. An added kicker is that I expect the company will commence buying back a meaningful number of shares as long as they trade in the single-digit P/E range.