In a I described how you can find attractive deep value investment opportunities by looking for profitable everyday companies with ‘Rembrandts in the Attic’, i.e. sizable hidden assets which the market has yet to price in.
Today, I would like to share with you a write up I did for the Pynk Investment Committee a few months ago on one example that fits within this ‘Rembrandts in the Attic’ Theme: Reach (Ticker: RCH, Price 233p, Market Cap: £727.20m as at 26th February), which is a London listed midcap newspaper group. While the market has been focused on the obvious decline in their core newspaper printing business, the potential growth and inherent value of their incredibly sizable online presence has been overlooked. This is a new holding for me.
You may have seen in the news recently that Reach, the owner of the UK based Daily Mirror and Daily Express newspapers, said it expects profits to beat market expectation after a surge in online revenue. The company said it expects underlying operating profit for 2020 to be ahead of market expectations, [in the range of £130 to £135 million], following a record digital revenue performance. Online revenue grew by 24.9% in the fourth quarter, up from 13.4% in the third. Print circulation sales were down 11.7% in the fourth quarter, an improvement on the 12.6% decline in the third. These trends contributed to an improved total revenue decline in the fourth quarter of 10.2%, compared with the 14.8% decline in third. Reach said it achieved the milestone of five million online customer registrations and completed the development of Reach ID, its proprietary customer insight platform which provides a combined view of a user’s activity across its sites. Chief executive officer, Jim Mullen, said: ‘It is a testament to our people that Reach has not only dealt with the unique challenges 2020 has presented, but we have accelerated our strategy and we are ahead of where we expected to be. The new Covid-19 restrictions bring macroeconomic uncertainty, but the changes made in the business during 2020 to develop a new, more efficient operating model put us in a strong competitive position.’
All this means that the group’s online presence is growing as rapidly as we had hoped and the recent share price rise means the market is starting to price in this fantastic asset. Even after the recent share price surge, the shares trade on just 7.1x PE and enjoy a 2.82% yield so in my opinion, there is still significant upside potential. Read my original note below for a full description of the business and investment case below.
This article is for illustrative purposes and is not intended as investment advice.
“Rembrandts in the Attic” Thesis:
Reach is one of the most compelling valuation anomalies I have found in a long time: it is in fact the fifth biggest online property in the UK, behind Google, Facebook, Microsoft and Amazon. It is in exalted company indeed for a £727m stock market minnow. Yes, the group is saddled with a declining newspaper print business and a £2bn+ pension liability but the core business is still a cash machine (even in lockdown) and means the cash-adjusted PE is now just 7x. If the online digital side continues to grow, not only will profits explode but the multiple has plenty of room to expand as this new growth avenue is reflected in the valuation.
Past performance is not an indication of future results.
Reach is actually a newspaper group. It owns a range of national papers (eg. Mirror, Express, Star) as well as regionals (eg. Manchester Evening News, Birmingham Live, Belfast Live, Liverpool Echo).
Reach is moving from just selling newspapers to targeting advertising income from data and analytics. What is exciting here is that it has its own audience of 42.9m unique users across a network of 50 media assets so it doesn’t need to go and buy an audience at cost like others would have to. Reach has a huge chunk of the 51m UK population on the internet; put into context, the audience makes it a top six digital asset (behind only Facebook, Google, Amazon, Microsoft and the BBC).
The really incredible thing is that the shares can be bought on a PE of 7x current year earnings. Even better, unlike most data sellers, the growth is self-funded so there is no risk of a dilutive equity raise.
Under new chief executive Jim Mullen and finance director Simon Fuller, it’s only just getting started in the process of collating data on its customers and as more companies build their direct-to-consumer strategies with it, I think its advertising rate card and advertising yield could grow like topsy.
Consider Facebook (44m users) and Google (57m), who allow marketeers to take such a precision targeting approach; they generate sales of £3.7bn and £5.6bn, respectively, from similar sized audiences. Although Reach may never get to these exalted levels, the prospects for its £110m sales from digital side have actually been given even more of a boost as people have begun online shopping more than ever due to covid, ordering groceries, pet food, exercise gear, electronics and even new cars.
In my opinion, Reach is catching up with the big shift from print to online advertising and hopes to realise a substantial data opportunity. Increased digital advertising would lead to a higher margin revenue mix. It’s a vast market and Reach has plenty of low-hanging fruit to aim for. The big 4 have an estimated average customer consent or addressable sign-up ratio of over 90%. Reach had less than 2% of its audience signed up and giving consent as of FY19. It’s a significant commercial opportunity and one that the refreshed board is keen to attack.
What else has changed?
A new management team is in and there’s a renewed strategic focus on capturing the data of its millions of engaged customers. Reach has nine national newspaper print brands, 110+ regional print brands, 40m online monthly unique users, and it continues to expand its web presence. It’s not just the national newspapers that are important here - it’s the regional ones which are probably more important strategically - and their pivot to online.
Revamped, Heavyweight Board
Jim Mullen - CEO, appointed August 2019. Ex-CEO of Ladbrokes from 2013-2018. Mullen has spearheaded the Ladbrokes digital evolution and helped drive the expansion of its consumer database.
Simon Fuller - CFO, appointed March 2019. Previously CFO of McColl’s, having joined in 2015 after seven years at Tesco in a variety of divisional finance director roles.
Nick Prettejohn - Chairman, appointed in May 2018. Former CEO of Lloyd’s of London and Prudential UK & Europe.
Cash generation - Free cash flow generative - over the past five years, the group has frequently generated more than 20p per share in annual free cash flow against today’s share price of around 120p. Stripping out the cash means the valuation is at extremely low levels.
Recent Results Demonstrated Resilience
H1 2020 results were ‘materially ahead of expectations’:
- Revenue down from £352.6m to £290.8m
- Adjusted operating profit down from £71.3m to £54.9m
- Adjusted profit before tax down from £69.9m to £53.5m
- Adjusted earnings per share down from 19.1p to 14.6p
Although the direction of travel continues to be downwards, these results were way better than expectations … and the ex-growth core business is reflected in the dirt cheap valuation.
Commenting on the interim results for 2020, Jim Mullen, Chief Executive Officer, Reach plc, said:
“We have seen a strong recovery in the digital advertising market since the worst impacts of COVID-19 in April which has driven a return to healthy digital revenue growth since July, assisted by increased customer engagement and loyalty. This illustrates the significant potential of the customer value strategy as our websites, apps and newsletters attract increased page views from our scale audience, helping to drive forward digital revenues.”
In Q2, when lockdown happened, Reach obviously saw significant challenges to its print circulation and print advertising income as most of its audience was isolating and therefore not going out to buy papers. But because Reach was seeing ‘dead tree’ publishing decline even before the pandemic, it was well versed in managing its cost base down and so when the lockdown happened, it accelerated a transformation program. Changes were made in just three months, which in normal times might have taken years to put through. The cash cost is £20m but Fuller says it recoups this within just six months. Overall £9m of the cost benefit will be felt this year and the full £35m will come through next year, leaving a leaner business.
Rembrandt in the Attic? Digital Side is Sizable & Growing
At the same time as that transformation program, lockdown accelerated digital uptake as demand for trusted news and content soared. Fuller notes that January and February saw digital yields grow 20% year-on-year. Although the March lockdown saw a decline, it went on to hit a record in August and it now generates £300,000 income a day from digital advertising (£400,000 some days, says Fuller). This all means that digital income has climbed to one sixth of overall income, up from one twentieth of a similar revenue back in 2015.
Much of this is going to stick. I think if you look at Reach in two years’ time, chances are that digital income will exceed 33% of sales (currently 15%). That’s their strategic goal. And remember the logic of a higher margin digital business is that there is no physical cost of production and distribution, so profitability could go through the roof.
More detail on strategy here:
Digital investment steps up
The digital side is where it all gets eye-poppingly exciting. Cost savings from the restructuring is helping to accelerate its investment. It already has a team of 100 people building its App Reach presently has 50 sites, which are being turned into must-visit destinations by engaging the audience, increasing dwell time and encouraging return visits with new features and regularly updated information. During lockdown, audience numbers and monthly page views began to balloon. For instance, Reach has continued the roll out of its Live city websites around a common platform. There are 30 significant Live sites already. It has also launched a local area COVID-19 widget, which carries up to date information on infections in your local area.
Another new site that encapsulates perfectly what is happening is In Your Area. This is a hyper-local news offering, which uses lots of existing content from within the Reach group and has now passed 650,000 registered users. Reach recently added a nostalgia photographs feature so that when you put in your postcode, you can search all the 200m photographs from the entire Reach archive of between 1 and 100 miles from where you live (some of which were stored in glass plates, says Fuller!). This was developed at little capital outlay and is a major source of new registrations.
Emphasis on data and analytics
Reach expected that by December it would have[ 2m registrations across the network but it has already exceeded this with 3.5m in just nine months. The exciting thing is that 100m page views are already being consumed by registered customers, which is worth £100ks of revenue per month. Fuller expects Reach to have 10m registrations by 2022. The benefits of having a registered user are compelling. First, Fuller says return visits of a registered user are 4x higher and they consume 5x more web pages. Knowing their interests also drives more engagement as when they are on one Reach site, they can often be redirected to other sites on the network.
A second aspect is targeting. As Fuller notes, the audience at scale means it is able to provide advertisers and agencies with a large number of high quality leads. Display ads are typically served to audiences on a CPM or cost-per-thousand-impression basis but Reach also uses Programmatic advertising (based on contextual keywords or your cookie history and are sold on an auction basis). Those interested in sports can be shown relevant sports betting ads, those interested in pets can be sold pet insurance and so on. He says selling leads into a general auction compared to being directly sold to an advertiser gives a yield 5-7x higher - precisely why Facebook commands sales of c.£4bn.
Building profile of its customer base
In a hugely exciting extension of this, late last year the company launched "Reach ID", which gives it a single view of a customer’s activity across not just one visit but all visits across all the Reach products. Reach ID will allow Reach to track ad yields associated with the entire portfolio and to fine tune its own content as it will know what is the most effective. With advertisers able to monitor their return on a per-ReachID basis, Reach will be able to target high value campaigns and is already in talks with several big spend FTSE-100 customers and Fuller will be putting colour on the full uplift potential in income towards the end of the year.
Extremely low valuation because the attractive asset of the digital side is hidden behind the ex-growth core business. As the relative share of these two sides continues to shift, there is meaningful valuation upside. The regional content and assets is also underappreciated and strategically important.
There’s potential to build a higher margin digital advertising business here, with low capital investment requirements. At the same time, the group is cutting millions of pounds in costs. So those two forces working in tandem could prove to be significant.
Barclays estimates that if digital were to be 5% better than it has modelled, it adds 18% in its forecasts, which already has Reach as a very cheap share. Their eps is presently 30.6p this year to end December and 32.1p next year.
In my view, RCH is at an exciting point of moving away from its ex-growth core business but faces above average risks of executing its new digital growth strategy. This risk is in my opinion more than mitigated by the ultra-low valuation and the cash in the business.
I see key risks as:
There’s an ongoing triennial pension review and that pension liability is significant. The group has a grand total of six pension schemes… It all adds up to a big £2.4bn pension liability with a £250m deficit and committed cash contributions of around £50m per year. That’s material but is easily covered by Reach’s considerable cash flow from operations (which totalled £147.4m in FY19).
In FY19 the pension deficit was reduced by £52.7m to £295.9m before deferred tax. We should have more information on contributions going forward later this year. Certainly a risk but it’s important to note that the group has remained resiliently cash generative despite the structurally challenged print business.
Businesses that have been around since the year dot often have pension liabilities to contend with and in Reach’s case these are £210m, down 26% on 12 months ago and due to disappear by 2027. The balance sheet is strong with £40m cash (and access to £65m bank facilities) to keep up the investment on the digital side (interestingly, despite COVID-19 impacting, increased internet investment, pension payments and paying £19m of the Northern & Shell deferred consideration, £22m cash was thrown off in the latest H1).
Dying and Economically Sensitive Core Business:
Lockdown will hit this core business in the short term and there is a limit to how much cost can still be taken out to address future falling demand.
Investors are obviously worried that in the short run there will be persistent negatives as a result of Covid-19. As Fuller notes, non digital income is 85% of sales and presently derives from four areas: print circulation, print advertising, third party printing services of the Guardian, Racing Post, Metro and other periodicals and “other.”
The split shows that 51% of revenue is print circulation and another 6% is from third party printing (exposed to the physical sales of other newspapers), so any permanent changes in newspaper purchasing habits and frequency of purchase would matter. But Fuller says that thanks to the loyalty of readers, sales have recovered strongly after the dip in Q2; sales shifted from supermarkets to local retailers, home deliveries increased and in September, circulations had gone back to 94% of what they had been expecting at the start of the year.
The advertising income on the National titles was similarly impacted during Q2 but there has been recovery in Q3. It has benefited from COVID-19 related advertising from government whilst financial services, sports betting and supermarkets are seeing a recovery in activity levels. Hospitality will obviously take time to recover.
The regional print advertising market has had it tougher but some improvement is also being seen. In particular, what is playing into Reach’s hands is that national advertisers frequently want to use local distribution methods and Reach’s regional titles provide them with good exposure in Glasgow, Manchester, Hull, Liverpool and Newcastle, so it’s SME advertising that is most impacted.
But that said, there are two offsetting coups - (a) the cost savings from the reorganisation are going back into growing the digital side and (b) it’s seeing double digit growth (13% in Q3) in digital advertising as advertisers return to the market.
Fuller says there has been a fundamental reorganisation of its editorial teams (it no longer has separate regional and national editorial teams). As part of this, the 2,300 writing staff now share a common internal wire service of news and pictures. By sharing content and resources between titles, costs have fallen - for instance, you reduce duplication by only needing one reporter to attend a particular event or to take royal photos.
A turnaround play not devoid of strategic risk:
According to the CEO, Reach is doubling down on local, rather than national news. I think this is a much more interesting battleground for them. The Aggregators are great at bringing friend groups together, but they are rubbish at local news.
Perhaps Reach (with the power of a better data platform and unified customer tracking model) can make this work - but only if they can find a good way of monetising. I found Mullen’s presentation at the last results interesting as they are clearly going to be trying different monetisation routes and trying to register a lot of users.
“A sustainable local news publication will be fundamentally different: a minimal rundown of the news of the day, with a small number of in-depth articles a week featuring real in-depth reporting, with the occasional feature or investigative report. After all, it’s not like it is hard to find content to read on the Internet: what people will pay for is quality content about things they care about (and the fact that people care about their cities will be these publications’ greatest advantage).”
In conclusion, I see Reach as a medium risk investment with a truly compelling valuation proposition. Not only are we buying a cash generative core business (albeit a dying and low quality one) on a single digit PE, we are getting a sizable and growing online presence (which is highly valued by the markets) in the price. Although risks associated with further declines in the core business, funding the pension deficit as well as executing this strategic transformation of the online business remain, the valuation proposition is extremely attractive.
Disclaimer: This information does not constitute any form of advice or recommendation by Pynk One Ltd. and is not intended to be relied upon by users in making (or refraining from making) any investment decisions. Appropriate independent advice should be obtained before making any such decision. When investing, your capital is at risk and you may recover less than the initial investment. Past performance is not an indication of future results.