Description

**I intended to post this prior to results this morning, but turned into a busy week. No change to my view presented. Numbers were stronger than I expected - 2021 was a 10% beat. Digital is strong as my analysis suggests, and print declines better. 2022 looks v conservatively framed now based on the revenue growth and £2m cost savings outlined which I think can outstrip cost inflation. Happy to discuss in the comments**

National World is an under-the-radar UK micro-cap whose shares present an attractively valued (<7x P/E ex cash) opportunity to gain exposure to the third largest newspaper publisher in the UK. An experienced management are leading the transformation of the business from print to digital, and a shift away from ad revenue towards subscription revenue. Importantly, NWOR comes without all the legacy liabilities which plague print publishers – no pension, no printing assets, and no debt (£22m of net cash). This results in attractive fundamentals – strong free cash flow and returns – and puts them in a prime position to consolidate the print and digital market, where their peers are hamstrung by onerous liabilities and competition issues. The shares have been heavily impacted by read-across from peer Reach, which we think has little relevance to NWOR given the structural differences. At 25p, the fully diluted market cap is £71m, enterprise value £49m. There are numerous levers for value creation which management can pull over the short, medium, and long term.

Description

In January 2021, National World completed the reverse takeover of JPI Group assets – the third largest publisher of regional newspapers in the UK, from which NWOR are building a multi-platform publishing business. NWOR will pay a total of £10.2 million (£5 million deferred to March ‘22 and ‘23) for assets which in 2020 generated £88/7.7 million of revenue/ EBITDA, respectively, and expected in excess of £9m EBITDA in the most recent financial year.

JPI Group was part of Johnston Press which went into administration in November 2018. The trading assets, comprising national newspaper ‘the I’, and several local titles and publishing assets, were acquired by JPI Media who immediately instigated a sales process. The I and the physical printing operations were sold to dmg media, leaving the regional newspaper business which was acquired by NWOR. The acquired portfolio included 135 publications and websites, including thirteen regional and city daily newspapers and over 100 other franchises in print/ online, of which many have now been consolidated as part of the £5m cost saving programme. Heritage titles include, The Scotsman, The Yorkshire Post, The Portsmouth News, The Sheffield Star, The Belfast Journal, The Derry Journal, and newly formed digital only NationalWorld.com and regional spin offs of this platform (LiverpoolWorld, Manchester World, etc).

Investment thesis

1.   MANAGEMENT: proven operators in the space with a respectable track record of creating value

NWOR is led by David Montgomery (exec chair), Vijay Vaghela (COO), and Mark Hollinshead (CCO). All have considerable media experience and David and Vijay have worked together before on former venture, Local World which was a regional news consolidation play (David CEO, Vijay as shareholder appointee), which was exited to DMGT/ Reach in 2015 generating a c4x return for investors in c2 years. Prior to this, David founded Mecom which grew through acquisition into a significant European publishing business, but this ran into problems caused by the financial crisis with declining print and ad revenues combined high fixed costs and high and mis-matched debt. We do not think that these issues will replicate in NWOR. Vijay’s career has been in media and for the most part with the Mirror/ Trinity Mirror and then Reach. His knowledge of every facet of NWOR and print media generally is impressive and our referencing routinely described him as the best in the sector. Mark Hollinshead (COO) has also spent his entire career in media with the typical British print publishing names.

This is an exceptionally experienced management team with credentials which are tricky to find in micro-capitalised businesses. They are well incentivised, owning c10% of the shares outstanding.

2.   STRATEGY: dual strategic focus (print + digital combined with ad revenue + subscription revenue) reduces risk and maximises cash flow for reinvestment

NWOR is setting out to replicate the Local World strategy but with greater scale, across more platforms and with more significant technological scale to drive improved efficiencies.

Management de-centralised the operating structure of the JPI business, returning editorial and commercial autonomy to the regions. My referencing suggested that the primary driver of the heritage title underperformance was the lack of regional autonomy which led to unoriginal and low value content, thus a clear positive that this has been addressed. Management are focused on upskilling existing talent and hiring new talent which can produce content across written, audio and video mediums in order to maximise the value of the inventory. This has been proven to be extremely valuable with other national publishers (UK and international) who are further progressed on this transition.

Digital strategy pointers

                     i.            Revenues currently generated through a mix of programmatic (the ‘World’ sites) and direct sold channels (mostly heritage titles). With a refreshed sales team, we hope to see greater direct sold in the revenue mix which will drive improved yields. The business is currently dependent on ad revenues, but with a focus on concurrently growing a subscription business.

                   ii.            Subscriptions is a nascent revenue line but has been growing quickly – H121 same as entire FY20. While subscriptions are low, registrations have already grown to 1m and we expect that registered users are significantly more valuable (Reach report 3x content consumption for registered users). The aim is to convert registrants to subscribers in due course through access to exclusive content and ad light/ free user experience.

                 iii.            This hybrid model (ad revenue alongside subscription revenue) will reduce the risk of a wholesale switch and generate meaningful digital ad revenues and profits for reinvestment into content and technology. Ultimately, subscription is the optimal outcome for user experience and quality content, but I like the de-risked route to achieving this since some titles ultimately may not work with subscription model, and the technology will take time to ‘get right’.

                 iv.            Other initiatives, such as newsletters, are intended to drive improved engagement and higher yields. Reach is also focusing on delivering relevant newsletters and report 30% more traffic and 3-6x more content consumption from these users. In due course, we expect that NWOR will build out an e-commerce offering as well as packaging content into different formats to improve yield and generate additional revenue streams

                   v.            Digital requires the right technological infrastructure and this is still early days. However, there are now several successful playbooks to follow which should reduce execution risk.

Print strategy pointers

                     i.            Print strategy is largely around keeping the cost base right-sized and variable to cope with the long-term circulation declines whilst maximising cash generation from these assets

                   ii.            Post-COVID, declines should moderate to low-to-mid-single digits (Reach quote “low single digits”). As per NYT and other print publishers, COVID has likely shaken out weaker print advertisers and physical buyers with those remaining being more sticky which should generate slower declines from here.

A key attraction for me is that print is very cash generative. NWOR lacks all the legacy liabilities and cost structures which consume cash in other print publishers – debt, pensions, printing assets, phone hacking liabilities, outsize properties/ offices etc. This provides greater cash for reinvestment into content and technology.

The final piece of the strategic jigsaw is the buy and build. NWOR has £22m of net cash (>30% of its market cap) and will be rolling up legacy print assets and (/or) digital assets. (More on this below).

3.   MARKET OPPORTUNITY: scarce unencumbered asset in print media creates consolidation opportunities

There are five types of local publishers in the UK market:

i.                     PLCs: Reach (25% market share by circulation, 112 titles) + Newsquest (sub of Gannett listed in the US, 32% market share by circulation, 129 titles) + NWOR (17% market share by circulation, 104 titles)

ii.                   ii. Mid-size, regional: includes Archant and Tindle (16% market share by circulation, 38 titles)

iii.                 iii. Family owned, regional: includes the MNA, Iliffe, Bullivant Media (10% market share by circulation, 10 titles)

iv.                 iv. Small independents: remaining publishers of local and regional papers. Nominal market share.

v.                   v. Trusts: includes Maidenhead Advertiser. Used historically to protect titles. Very few examples remaining.

Given the historic decline in print revenues, the market has been through significant change and consolidation with many publishers fighting to survive in an increasingly digital word without cash to invest in the transition.

I think that NWOR is at an interesting juncture here with its balance sheet and a relatively lower market share which would avoid potential takeover concentration issues. Newsquest and Reach are the most obvious competitors in the regional news market, the former are likely extending their reach with the acquisition of Archant assets from Rcapital which is rumored to be near completion. NWOR were also competing for this asset but lost out on price. Reach is not going down the subscription/ quality content route.

4.   MODEL: restructured cost base to generate operating leverage in growing digital and ‘variablise’ declining print

NWOR is correctly structured to generate operating leverage in the right places. Much of the legacy, high fixed cost base has been jettisoned (with more to come) and management have worked hard to variablise as much cost as possible tied to declining print. With a print associated cost base which is variable and reducing on an absolute basis alongside a digital business which is growing with, naturally a greater proportion of fixed costs, I now think that NWOR is generating operating leverage in the right places, and this will be strongly accretive to margins.

This creates an operating structure where I estimate a c10% margin from print. As digital grows, the incremental cost to serve is not really changing, but on a potential revenue base which considerably exceeds that of print, there is a pathway to 20-30% (higher at scale) margin from digital. These margins are in line with print/ digital peer metrics and like the incrementals implied by Local World before it was sold. Digital has the potential to be much larger than the print business ever was. NYT reports over 6x the digital subscribers than peak print circulation achieved and NWOR is gaining traction on some titles in regions which the print version could never with the US contributing c20% of its traffic.

There remains substantial opportunity for further cost savings which I discuss below.

5.   FINANCIALS: clean and with respectable and growing margins with minimal working capital or capex cash leakage on an exceptionally capital light balance sheet

Revenue: I expect print declines around 5%, in line with Reach and others. This masks circulation declines >5% offset by mitigating factors such as cover price increases. Digital growth is a key driver and while my revenue mix assumptions here are broadly (60/ 25/ 15% ad/ subscription/ other) I think there is significant scope for upside particularly in subscription if the business can demonstrate audience conversion KPIs like other operators (discussed below).

Costs: as highlighted below, there are some significant upcoming drivers which could generate further savings, namely: office and printing costs.

Interest: after the LN conversion there is a single £1m LN paying cash interest at 15%. The LN along with all accrued interest was converted into shares.

Tax: there is potential for the company to do better here in near term years with potential offsets available through the SPA. Won’t be zero but could be a significant reduction

Working capital: should be broadly neutral over the medium term. Print is typically very clean. Digital can be c45 days cash collection. In FY21 there will be a reasonable w/c inflow (c£2m) beyond which the cycle normalises out.

Exceptionals: I make a conservative assumption here to accommodate restructuring and potentially to absorb other unforeseen cash costs (implementation/ capex could be higher, w/c could be larger drag as digital scales)

Capex: I assume £1m pa which feels reasonable, this is predominately IT based and for central functions and kitting out serviced office space. Capex in publishers is typically much higher because they own the printers, which is not the case here.

Dividend: I assume £1.5m from next year and keep it flat. We don’t think that, in the short term, there will be much impetus to grow the yield given the re-investment opportunities.

6.   RETURNS: 20-25% IRR on FY23 base case which excludes any acquisitions (net cash build to £27m)

Potential to achieve a higher rating if digital really accelerates as it looks like it is doing (see below) and earnings should also be ahead of my numbers which would suggest 45p+.

The closest listed peer, Reach, is now trading at a discount to NWOR (albeit I’m unsure if Reach will actually generate cash this year..), so you must take a view on the type of business you’d prefer to own. Reach are having their own problems with cost inflation, pension, restructuring costs etc. The content is lower quality and the culture does not sound great (https://pressgazette.co.uk/reach-newsquest-page-view-targets/). I prefer to pay a bit more for a much cleaner set up with more visibility over the drivers and catalysts and digital growth from a lower base.

Catalyst

Catalysts

Are mostly earnings and rating based

Read across: National World is not Reach

Reach recently disappointed the market flagging higher than expected costs, particularly newsprint, among other things (issues with pension negotiations, restructuring, phone hacking liabilities etc) and I think some of that read across to NWOR.

The businesses are structurally very different, and I do not think that NWOR will face cost pressures to the same extent. For a starter, this is a cleaner and simpler business and Vijay manages it with lots of headroom in the numbers. Reach has several quite large daily publications, whereas NWOR have only 7 – Reach probably have over 2.5x the daily circulation. NWOR is predominately weekly titles and absolute numbers are much smaller. Reach’s newsprint also includes lots of third party whereas NWOR has none of this. All of this adds up to Reach’s £52m of newsprint (ex-production) costs last year, and this may well have inflation of 10+%. NWOR’s newsprint is just a fraction of the £12m “newsprint and production” line, it will also be subject to similar inflationary pressures, but the absolute number will be easier to offset through pagination and cover price changes. Elsewhere, the Reach estate of offices and printers will be battling much higher energy costs, whereas NWOR has much less exposure to this.

I expect that these differences will become apparent around the results in March and NWOR should begin to re-rate.

Better print revenue decline – I think consensus is too bearish

Consensus has print declines of 7%. As in my numbers, I think that they can do better than this, based on management comments and how others are reporting.

Stronger digital – traffic monitoring suggests that the sites are trading very strongly

I use SimilarWeb to monitor traffic and quality of the traffic and ezoic for the health of the ad market generally.

All these metrics are suggesting that the heritage sites and the digital-only sites are performing very strongly.

There has been significant traffic growth c45% since the December close update and quality of visits (duration, page/ visit, bounce) is constant over the periods I have looked at.

Ezoic suggests that the digital ad market is strong and c20% ahead of where it was last year.

Higher margins – consensus understates the mix effect of digital

Consensus assumes only 10.8% EBITDA margin in FY21, growing to 12.9% in FY25. This is against print revenues declining 23% and digital revenues growing almost 3x. I think this is too conservative.

Management don’t split out margins across print and digital, but we can look at Reach – a more mature business operating at scale – to see that group EBITDA margins are c30% and operating margins >20% with management targeting 25% over the medium term. Similarly, Reach don’t split out print and digital explicitly (too difficult to separate journalistic headcount across the functions), but it is generally accepted that print “must be around 10%, and digital 20-30%” which is in-line with other print-only and digital-only businesses I have looked at.

Another cross check, Local World (pre-sale to Reach) reported 20% EBITDA margins with only c10% digital mix. NWOR’s digital revenue mix is already higher than this and will continue to grow so it’s not unreasonable to assume that there could be considerable margin upside with more scale.

Higher margins – contracts running down could present re-negotiation opportunity

There may also be upside to print margins through increasing scale (via acquisition) and renegotiation of the DC Thomson and dmg printing contracts which end in 2022 and 2023, respectively. Other contracts up for renegotiation are with wholesalers Menzies (Dec 2021 and 2022) and Smiths News (Dec 2022).

Higher margins – ‘other costs’ mask potential for operating leverage and further cost reductions

25% of the cost base ‘other’ includes property, IT, digital product and engineering, administration and other operating costs which is more fixed in nature. These are unlikely to grow with revenues, and should be reducing since management have hinted at further cost savings here but no quantum yet provided (I think £1-2m potentially).

Should be some property cost savings to come as the business moves to adopt more flexible working through hot desking and serviced office space rather than a fixed commercial space. The Scotsman is moving from 200 desks to a 40-desk serviced office. There remain two large commercial leases left in Sheffield and Leeds which end in 2022.

IT cost savings coming through primarily because of re-platforming the business which is moving to Google Cloud to complete in 2022, and also specialised pagination software costs which I expect to  reduce with print revenues reducing.

Accretive M&A – NWOR will end FY21 with £22 million net cash and £9 million EBITDA. @ 1 turn = c£30m of firepower for consolidation

Management are looking at both heritage media assets and digital only assets. Heritage deals will likely have some hair, similar to JPI, but will be significantly cheaper with cost synergies. E.g. I think that Archant could potentially have been 50-100% earnings accretive after synergies, since most of the operating platform is now established thus very similar in scale and valuation to the original JPI assets at c1x.

Regardless, we should be more conservative than this and let’s assume that £30m could buy just £7.5m EBITDA + synergies of £2.5m. This would get us to £19m of pro-forma EBITDA. Assume that delivering the strategy is worth a turn on the multiple and I get an implied share price of 50p+.

Digital only may well be preferred as is likely to bring in an experienced digital team as well as niche content and a functioning platform. However, this will be more expensive – probably around 10x depending on scale. The return for shareholders will really depend on how the market decides to capitalise the earnings. The break even multiple versus the heritage case I presented is >12x which is a stretch.

But in any case, a transaction is going to be earnings accretive and will demonstrating strategic progress which should generate some multiple expansion from here. I don’t think it’s unreasonable to assume 45-50p from my base case, and if assume that the underlying business is performing better (which it is) then there is upside again from there.

On a 5y view I arrive at a pathway to 80p assuming further organically funded roll up and no disasters in the underlying business, the risk being availability of suitable targets.

Exit – ultimately, I think this gets sold

I think that there is a high likelihood that NWOR is exited to a financial or strategic buyer who will use the digital platform coupled with cash generative print to scale more aggressively than the business could do on public markets.