Torstar Valuation (Part II)

There are many ways to value a business but one way is to lump all the techniques into two methods. One focuses on earnings, while the other concentrates on asset values. Typically each method suits a particular type of business, although you can apply both when looking at a business. Martin Whitman would consider the first method (earnings-oriented) when looking at "earnings common stocks"; while the asset value method is more useful for "wealth creation common stocks."

The earnings method is what is most common on the Street. It basically involves trying to determine the value of a going concern based on future earnings.

The wealth creation method is more rare, but Martin Whitman's Third Avenue Value Fund generally specializes in these. This method involves unlocking value through corporate restructurings, share buybacks, spin-offs, asset sales, and so on. Looking at earnings will not capture the possibility of wealth creation potential for these firms.

Check out Jeff's analysis of Sears Holding to see how you can look at company using the two different approaches. In the Sears case, the earnings method is when you look at it as a retailer; while the wealth creation method is if you look at the value of Sears' assets.

Whitman seems to like buying earnings stocks at peak-P/E ratios below 10, while he seems to like buying wealth creation stocks at a 25% discount to readily ascertainable net asset value. If you are a contrarian type and looking at beaten down stocks or distressed industries, I personally think that you should not buy anything if the asset value discount is smaller than 40% or if the peak-P/E is above 7 or thereabouts. There are so many things that can go wrong with distressed companies that your margin of safety needs to be really large.

Let me take a stab at evaluating Torstar. If anyone has any input or corrections, feel free to leave a message or e-mail me.



Earnings Method

Torstar's net income in 2007 was $101.4 million (I'm rounding all the numbers). Looking at the stock price may not show it but 2007 was actually a very good year for Torstar. It's likely to be a peak and earnings will be far lower in the near future due to slowing economy (decline in advertising revenue), potentially declining subscriptions, restructuring charges for shutdowns/layoffs/etc (although I ignore these one-time charges,) and expiry of US$ currency hedges for Harlequin. In 2006, a weaker period, its net income was $79.1 million. Operating margin was 10.5% in 2007 and 8.1% in 2006.

The difficulty is in trying to figure out reasonable income in the future. Since we are looking at a declining industry (at least the paper side, particularly the big-city dailies,) income looks to be lower in the future. However, counterbalancing that is the fact that the book division is fairly stable and Torstar's investments in CTVglobemedia (particularly TV and cable channels) is more stable as well.

Given a market cap of around $749m right now, you are looking at a P/E of 7.4 if you use 2007 earnings, and a P/E of 9.5 if you use 2006 earnings.

If you use the Benjamin Graham formula for implied P/E, well, a company with zero growth should have a P/E of 8.5 or lower (this is just a rough formula that Graham provided but I like it better than trying to rely on a DCF.) I think the 2007 earnings are too bullish but think the $70m in 2006 is more conservative and reasonable. I think Torstar may post a loss or very low earnings this year due to economic slowdown but $70m seems reasonable as a long-term earnings estimate.

Torstar isn't quite at 8.5 P/E level based on 2006 earnings but if its stock price drops 10% more (quite likely given how the stock is being sold off,) it is attractive. So one should consider buying when the price hits around $9.5, according to this evaluation.

One might ask how I can go with a 0% growth rate, rather than a negative growth rate. After all, isn't the newspaper industry declining and going to end up with zero profits soon? Well, the answer is not obvious. Although the industry is struggling, revenue is holding up for many of the companies. It's not growing much, if at all, but if non-paper sources (websites, books (for some), content licensing, etc) can grow, I think a zero growth rate seems achievable. Ideally I would want a positive growth rate but we are looking at conservative evaluation here.


Asset Value

(source: The danger zones of 2008 by ROB CARRICK. The Globe & Mail. Friday, July 04, 2008 )

Why mark time with Torstar when you can buy fast-rising oil and mining shares that deliver instant results? "Torstar sells for 50 cents on the dollar right now," said Wade Burton, manager of the Mackenzie Cundill Canadian Security Fund. "If you sold [Torstar] piece by piece, you would get $25 to $30 per share."


I'm just a newbie and I'm not sure if the quoted analyst is looking at Torstar the same way I will be but let's see how the market is valuing the company.

Torstar's current market cap is $749 million. Its book value (1Q2008) is $897.8 million, to yield a price-to-book-value ratio of 0.8. So the company is trading below book value but there are a couple of caveats. On the downside, around 60% of book value is goodwill, which cannot be converted into hard cash. If you prefer to look at companies using enterprise value, it happens to be $1.4 billion ($749 market cap + $671 long-term debt.)

According to the June presentation to shareholders, Torstar's initial investment in CTVglobemedia was $378m (original cost) and Black Press stake is $80m. This sums to $458 million. All of these companies are privately held so we don't know what their current price is. In the long run, these assets are likely to be worth much more than Torstar's original investment value. Black Press will likely do OK given that its papers are in the booming west, and CTVglobemedia may face near-term headwinds but its dominant TV and cable holdings should do well in the long run. Torstar is carrying these investments (along with Q-ponz) on its book at a value of $432.8 million.

So a full 50% of its book value happens to be its strategic investments. So Torstar, excluding these investments, has a book value of around $291m.

The presentation also implies that its workopolis investment is likely worth $150m. Although workopolis doesn't make much money now (this is my impression; Torstar doesn't break it out,) it is becoming more and more valuable by the day. Workopolis is well on its way to dominating the online job search market, a crown that used to belong to Monster I believe. If you take out this workpolis value, along with the strategic investments, you end up with a book value of around $141 million.

So, Torstar, including 100+ rural papers, The Toronto Star (highest circulation paper in Canada,) goldbook directory publishing, Harlequin, and several online properties (these are all money-losing or insignifcant right now) is being given a book value of around $141m. To me, that seems like an attractive bet if you think the company can survive. I don't think one needs to do any hard calculations to determine that this is at least 50% undervalued (Harlequin alone is probably worth $150m).

Now, I should note that one can never be sure what any of these properties are worth. Is workopolis really $150m? It could be lower; but it could be higher too. I'm just basing my opinion on what can be considered as close to a hard fact as possible. Furthermore, the company is not going to be broken up just because it is undervalued. The company is controlled via a dual-class share structure with voting power left to some family members of the original founder. So there will be no rush to break up the company or unlock shareholder value any time soon. But, having said that, what the asset value indicates is that even if things totally fall apart, the company has enough assets and is in a position to sell them off if needed.

The next thing to determine is how long it will take for the discount to be made up--assuming the market will close the gap. Given that Torstar voting shares are not held by the public, the discount may persist for a long time. In fact, I do expect the company to trade at a slight discount. Although one can never be sure what the families with voting shares will do, I feel that they will undertake restructuring of the company if this gap stays as large as the present. Even if they don't want to do anything drastic to change the business, they can sell off their strategic investments in CTVglobemedia and Black Press.

The timing is uncertain but even if it takes 5 years, I think the current prices are attractive (assuming there aren't permanent material losses.) For exampl,e if we assume the stock will always trade at a discount of 20% and assume that the company is trading 50% below fair value (meaning 100% upside from current price), then there is an 80% upside over 5 years. That works out to 12% annualized, which is good enough for me (note that this is with zero earnings growth).

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1 Response to Torstar Valuation (Part II)

July 21, 2008 at 2:06 PM

Ram,

Good looking analysis here.

I'd make two points that you may or may not have considered.

1. Is there a catalyst that will allow Torstar to reach value? If not, and it seems the answer to this question is yes by your above statement, are you satisfied if it takes 5 years to hit that value?

2. Are you sure that the asset value will not erode in that timeframe (5 years)? If you're waiting for the gap to close, and it takes 5 years, you better be very, very sure that base is either stable or growing.

I have no idea the answers to those questions, I'm just making sure you raise them in your mind and think hard. If (1) is yes, then (2) is a little less important. If (1) is no, then (2) is very, very important.

Good job.

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