USA TODAY Co., Inc. (TDAY) Earnings Call Transcript & Summary

Good morning, everyone. We're very fortunate to have Michael Reed, CEO of Gannett, with us this morning. Michael, thank you for joining us.

Thank you.

So the legacy firm you ran, New Media, you've spent many years, I mean, as many have followed you, consolidating newspapers, bringing out synergies. The strategy worked really well. Your synergies were achieved. Your top line fared better than most peers in the newspaper industry. And then last year, you did a big acquisition, right, acquiring Gannett. Why you think this -- why was this acquisition a better course of action for your shareholders as opposed to the sort of the old New Media that I knew that would sort of focus on smaller transactions and tuck-ins as opposed to this transformative transaction?

Yes. We did have a lot of success acquiring smaller groups of papers and consolidating them in, realizing synergies, growing EBITDA and free cash flow. And we did have a strategy around revenue that produced results that were better than the rest of the industry, however, they were still down, right? And so what we really realized in late 2018 is that we've built the best house in a pretty bad neighborhood. And our upside for the year was pretty limited. And part of -- if you remember back 5 or 6 years, part of the acquisition strategy and realization of synergies was to be able to grow EBITDA and free cash flow so that we could provide near-term returns for shareholders. It was kind of a bridge towards fixing the top line, and we realized that was taking longer on the digital side than we had hoped. And so what we really realized in 2018 as we needed to -- we needed scale, and we needed a bigger, stronger bridge in terms of cash flow to quicken the time period required to get to revenue flat and then revenue growth. And so the Gannett acquisition really provided us the bridge with the synergies that we'll talk about today. And it gave us the scale we needed, we believe, to grow all of our different digital businesses, whether they're consumer-related or business-related faster, in enough size to mitigate the print advertising revenue decline. So that's really why we did the deal.

Okay. So is it -- let me -- I just want to unpack that. So is the idea that by doing a big deal, you're getting potentially so much synergies that it buys you more time until the top line can potentially improve? Or is it more a function of just the quantum of the assets that you have at your disposal to exploit the digital properties that you have? Is that -- or is it both?

It's not that it buys us more time. What it does is -- the $300 million synergy number out there executed in 2 years. For us to do that with small deals, we'd have to do too many deals. So we couldn't get a $300 million-type synergy bridge with doing small deals. We had to do a big one. And that -- but the scale, the reach we have in terms of audience, in terms of the number of markets and the number of businesses for which to sell our technology service products and our consumer content products was very appealing in terms of increasing the volume of revenue we get from the digital, which would then put us on a path, we think, in the next 3 years to be revenue neutral.

Okay. So would you characterize it as digital properties on each side, on the legacy Gannett side, the New Media and digital properties on the New Media -- legacy New Media side that helped legacy Gannett? Or is it more...

Yes.

It is?

That's exactly right. There are things that Gannett was selling on the digital side very successfully that we weren't, and so we can leverage those into New Media. And then there are things New Media was doing on the legacy side that Gannett wasn't that we can leverage across.

Are there overlap in those assets or really just true greenfield opportunities?

Well, there are overlap in certain products of digital marketing services. A lot of what we created with ThriveHive is also there in ReachLocal, but there are things they were doing with WordStream, SweetIQ and ReachLocal that we weren't. There were things we were doing with UpCurve and ThriveHive that they weren't. So there was some overlap and then there was true greenfields as well.

Okay. That's great. Now one of the things that I found interesting, as I was going back just looking at the filings, is that over the last 5 years, you've been steadily increasing your stake. You now own, I think, about 915,000 shares, which makes you, I don't know, 70 basis points of the entire firm. You're a Page 1 holder. And you just keep increasing your personal stake in this firm as opposed to selling. So can you talk a little bit about that? Because it seems like you have quite a bit of conviction on sort of the relative value of the equity today vis-à-vis what you think the underlying value is.

Yes. Sure. And I think it's important for investors to know that these shares were purchased by me. They're not awards or grants or anything like that. They're just -- it's my money that's been invested in the company. I think the way I look at it is my money, where can I invest it and get the most return for myself. And with an industry right now, the newspaper industry is one of the more disliked industries in the investment community in the country, if not the world. And so that has caused probably more pressure on the equity than is warranted and has undervalued the company. And as everybody knows, sometimes when you have a hated industry or a hated company, where there's some part of the narrative that's misunderstood, that then there creates the greatest opportunities. And so I believe that's the case here. Almost -- nearly 50% of what you just mentioned, 915,000 shares, nearly 50% of that, just under 50% I've purchased since the Gannett deal was announced. And we had a lot of pressure, a lot of selling on the stock, which I thought was completely unwarranted. And so when I look at just the pure numbers, I look out 3 or 4 years and see a company that's going to have a valuation somewhere between $4 billion and $5 billion, and I see debt pay down to somewhere just approximately $1 billion. And so I see market cap of $3 billion to $4 billion, which puts the share price $25 to low $30s versus $6 today. So I'm like, that's a pretty attractive return on my money just from a price appreciation standpoint. But while I write that up over the next 3 or 4 years, I clip a 12% dividend yield. That's pretty good. I'm not going to get 12% dividend yield in very many places other than probably some REITs, right? So I can collect a great yield, and I think I quadruple my money. So -- and I have some influence over how the company actually does. I think we're building a great team, and so I have a lot of confidence in our plans. And so I want to put my money where I think I can earn the most for myself.

Okay. Can I just push back a little bit on that or at least probe because there was a time, I don't remember exactly what year it was, but I'm going to say maybe it was like 2015 and the goal was, and correct me if I'm wrong, sort of in 2 years the plan was to go to, call it, minus 4%, minus 5% revenue growth to sort of flattish. And it didn't happen. And now we sort of have revenue declines. And I don't know what's inside your internal model that sort of pins out that sort of upside, but I would suspect that undergirding that is some belief that the top line is going to get less bad, right?

Yes, for sure.

And so what is it -- what -- and so past isn't indicative of the future, right? But a cynic would say, what is it that's so different? I mean, we all know Google and Facebook are out there, they continue to hover up ad dollars. Why in the world did you believe that the next few years is going to be so different than the past few years when your forecast in the past wasn't accurate? And yet you're putting your own capital to work under the belief that in fact it is different. So can you just unpack that a bit?

Yes, for sure. I think there -- I would say there are 3 primary categories that lead me to feel comfortable that the revenue trends will improve over the next 3 years, rather dramatically versus where they were. The number one is let's just look at Print Advertising. Print Advertising is the major declining category, and that continues to become just a smaller piece of the overall revenue pie. So its impact on total revenue declines continues to be minimized. And in 3 years, we see Print Advertising only being 15% of total revenue.

3 years, 15%?

So 85% of our revenue will come from other sources. So that's point number one. Point number two is subscription income is 40% of our revenue, just about in the high 30s, something like that. And our digital subscriber base is growing at 50% in both companies, and that's paid-only digital subscribers growing at a 50% clip. We intentionally at legacy New Media, and we talked about this on our earnings calls about a year ago, switched strategies a little bit to work more on volumes and retaining customers versus pricing, and that's had a negative impact on revenues in the near term because we're not increasing prices to offset secular declines, but we're focused on total volumes. And we've actually seen in New Media over the last year total volumes be flat, which has been a great win in terms of our strategy and our outlook for the long-term future, however, it's had a negative impact on revenue. As we bring that strategy and merge it in with Gannett, we'll have a couple more years of negative declines in circ revenue. But in 3 to 4 years, we see paid-only digital subscribers being more than 50% of the total subscribers to our newspaper, so being bigger than print in the next 3 to 4 years. So we see the circulation category revenue stabilizing along with volumes. And so that's bucket number two, and that's 40% of our revenue. And then the third piece is that when I look back to 2015, when you're talking about, we were seeing great growth in our digital marketing services business, ThriveHive. And we continued to see that over the years. It slowed a little bit as we got bigger, instead of 50%, it was up 30%. But it's now, in the combined companies, a $500 million to $600 million revenue stream. So at 25%, 30% growth, we're going to generate substantial revenue upside that will start to really mitigate this Print Advertising decline. So when I look out 3 years, and I see that $500 million or $600 million revenue stream turning into about $1 billion, the growth from that business will offset the print declines. And so those are the 3 ways -- those are the 3 primary kind of big picture areas where I see. There's a lot of smaller things we're working. We're growing a great Events business, which we've taken from $0 to $60 million over the last 3 years, and we see that business growing from $60 million to a couple of hundred million over the next couple of years, and that -- so that will be great. The new operating company's CEO, we hired Paul Bascobert, has a vision on creating a local marketplace that connects businesses and consumers, and no revenue in our past or in our projections around that, but that's a potential revenue stream. So there are ancillary things we're working on that I think will help fuel the overall revenue improvement. But I think the 3 buckets I just went through are things that give me the most confidence.

That's super helpful. Now you used the acquisition of Gannett as an opportunity to resize the dividend. When the Board was deliberating where to take the dividend, what were some of the sort of elements that went into the quantum of reduction? And what made you comfortable with the current dividend? And does the current -- I sort of described this, I'll just tell you -- to investors, I say, there was a time when the legacy New Media had a -- it was a robust dividend. But as you guys did acquisitions, you used the cash flow and the increase in the cash flow to raise your dividend, and you raised and raised and raised. And so I almost sort of look at it as like a reset of the narrative that could be the point that's going to be the springboard for very significant equity appreciation over time. That's how I sort of describe it to investors, it's just a reset. But what's different this time is that if you reset that dividend to its current level, and you said it's a 12% yield today, I don't think your yield ever got to 12% under the legacy New Media, right? I mean, it was always much lower than that, probably -- it was probably 7%, 6%, 5%, something like that, okay. So my question is: Do you agree with this idea that if you're a new equity investor and this could sort of be a reset to the old New Media, right, that raised its dividend over time? And second, how did the Board come to the decision to size the dividend at its prevailing level?

Yes, sure. I mean, I do believe it's a reset. I -- let me just take you through the discussions that we had at the Board level and how we arrived at the number. And some of what we learned with legacy New Media is exactly the things you're talking about. In legacy New Media, we had targeted a 40% to 50% payout ratio. And at times, more early than late, we were at 40% and later on, we were at 50%. What I learned is, as we were doing acquisitions, we were raising capital along the way of doing acquisitions and returning capital to shareholders with the dividend. And part of the thesis that we talked to investors out from the beginning was doing acquisitions, growing free cash flow and growing the dividend. We executed on that for 5 years. What I found over that period of time is a payout ratio above 40% and as it neared 50% gave no equity appreciation at all, in fact, it had the opposite effect. So when at times where the payout ratio was 40%, we had actually more lower yields, dividend yields than at 50%. And so when we had these discussions at the Board level for the new company, we looked at it and said, we can't really use 40% or 50% as the target payout ratio because we're not giving any real credit in the share price for that level of dividend. So we targeted 30% of 2020 free cash flow, and we thought that might be a good place to reset it. And we didn't anticipate at all the stock price being the $6.

Me either.

To be honest, I thought the stock price would be $12 to $15, and the yield would be 5% or something like that. So -- but we didn't set the dividend based on what we thought the yield was going to be, we set it based on free cash flow of the company...

That makes sense.

...which is about a 30% payout ratio, and it is what it is now. But to me, that's an opportunity for investors to lock in a pretty significant yield.

Okay. Can you talk if you're an investor and you're sort of potentially enticed by the prevailing dividend yield and you sort of pencil out all the math and get comfortable with it, probably the one thing you're going to be worried about is a potential cut to the dividend. So can you spend a little bit of time and just talk about what sort of risks there are to a dividend cut and specifically on the covenant itself? Can you just unpack that a little bit?

Yes, yes. Absolutely. So let's look at it in 2 ways. One is there's a credit agreement that has a provision in it that says if leverage in any particular quarter is over a certain amount, then the lenders can shut off the dividend for that quarter. So that's one thing. Away from that, we don't see any risk to the dividend. The payout ratio is low at 30%. We have a great synergy number -- a great synergy opportunity that's probably conservative. And we haven't made any promises or guarantees to increase the dividend. So as I look out past 2020, '21, '22, the payout ratio comes down even from 30% to a lower payout ratio. So when you just look at it from that perspective, there's no risk. To the downside, there's really only risk that we actually increase it if the share price warrants. We're not going to increase it if the share price is $6. But -- so let's go back to the credit agreement for a second. The credit agreement has quarterly leverage tests that are not events of default that would allow the lenders to actually take control of the company. They're just simply tests that govern how we can make restricted payments, and dividends fall in restricted payments basket. As we modeled out this deal over 5 years, which is the term of the credit agreement, we did the model by quarter. We were -- we thought took a fairly conservative approach, and we layered in no reductions to debt other than through cash flow payments and we'll talk about it today. But I think we have real estate and other things. We already made a debt payment that was unexpected. So when we -- so we laid it out by quarter, and then we worked with the lender to find quarterly leverage numbers that gave us, we thought, very adequate cushion to never have to worry about the lenders coming in and shutting, saying you're not going to pay the dividend. So we did a model. We thought we had some opportunities to outperform the model, especially with debt pay down. And then we set a quarterly test that's comfortably above where the model said we were going to be. And then one point about this, though, is our view of this loan is it's really bridge financing, and we don't anticipate it being in place past 2021. And our goal is to grow EBITDA, pay down debt, refinance this facility at the end of 2021, when leverage is around 2x EBITDA. And that would take that issue off the table completely by the end of 2021. Obviously, we have a lot of coverage and cushion in those tests right now, and we anticipate taking that thing out by the end of 2021.

Okay. So how should investors -- so you've got a model that you think you can sort of begin to pay down debt very quickly. 2021, you said move from this existing sort of bridge loan and then sort of go refinance it at potentially lower rates. The question I have is: In your base case assumptions, do you have assumptions about disposing of real estate or newspaper properties in that base case? Or is that more just an option that you could exercise if something goes wrong with the top line or something goes wrong with synergy realization?

Yes. So in our -- in the model we did for the deal, so the model we shared with our Board and what we used as a company to underwrite the deal, did not assume any asset sales in either real estate and/or properties. So anything we do in that regard is upside to reducing leverage, paying down debt. We will pursue real estate sales. We did pay back in the fourth quarter 30 -- about $36 million in debt, which was not in the model. It was unexpected and had nothing to do with EBITDA-producing assets. We announced in the press release on Tuesday, yesterday morning, that we have another $30 million of real estate under contract. So our primary goal is to sell real estate, which doesn't have any impact on EBITDA, and we see over the next couple of years, that could be $100 million-type opportunity.

On top of what -- the stuff you've already announced?

On top of the stuff we've already announced.