Let's continue our discussion about business and a free and open society in Australia. Shall we?
Gina Rinehart has asked for three board seats at Fairfax. Her accumulation of shares in the company has led Fairfax reporters to fret about editorial independence and the integrity of the Fairfax brand. But let's suck the emotion right out of it and boil it down to business.
If the Fairfax brand is worth anything, and Rinehart is any good at business, she won't tamper with the brand. Good business people don't go messing with things that work (create value for shareholders). Of course the trouble is, Fairfax is not a good business. So why not change things up?
It depends on what the assets of the business are. We discussed the issue with Greg Canavan, our value investing analyst, over the last few days. Greg reports that at the end of 2011, Fairfax reported equity of $1.94 per share. Much of that was made up of intangible assets and goodwill associated with its purchase of Rural Press in 2007.
You don't have to be Benjamin Graham to see the problem here. Fairfax shares trade for around 60 cents today. That's a pretty significant discount to book value. Either the market has it wrong, or Fairfax has overvalued its own assets. But that's really the question isn't it? What ARE the assets?
The brand is not the asset. The journalists aren't the asset (entirely). The asset is the relationship the paper has with its customers. That's what gives value to 'the brand'. If there's equity in that relationship, the business has value. Journalists create that equity with consistent, high-quality reporting, or by establishing a relationship with an audience that shares the same biases, prejudices, worldview, and taste in coffee...and then monetising that relationship by selling advertising.
This model is not working. The numbers don't lie. Look at them below. At the end of the last financial year, 78.5% of Fairfax's assets were non-current, intangible assets. Property, plant and equipment - which would presumably include real estate and those huge printing presses - made up 10% of assets. Receivables and trade made up 5%.
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For all we know these figures are typical of a modern media business. But that really just proves the point. In the age of digital publishing, the means of production (the printing press) is not your greatest asset. Your greatest asset is your people and their ideas. That includes the editors and journalists at Fairfax and, of course, the customers.
You can see from the non-consolidated breakout of intangible assets that the company took a big write-down in goodwill last year. Greg reckons another write-down may be coming with the next annual report. Meanwhile, the value of 'Mastheads and Tradenames', at $3.2 billion, is 61% of intangible assets and 48.5% of total assets.
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So here's the question: just how much value is there left in the Fairfax 'brand' for Gina Rinehart to ruin? That's assuming she wants to ruin a business in which she's become a major shareholder. That assumption might make sense to a paranoid politician. It doesn't make much sense to a business person. And in any event, can Rinehart do any worse than Fairfax's current managers?
The trouble is, there may not be enough paying subscribers that like the 'brand' in its current incarnation to support a business with that many fixed overheads. And that's not even mentioning the composition of current revenues. Fairfax generated $2.4 billion in revenues in 2011. Eighty percent of that cash - or $1.975 billion dollars - was classified as 'revenue from other services'. The other 20%, or $497 million was classified as 'sale of goods'.
We're assuming 'goods' are actual newspapers and 'services' are advertising. There's your problem right there. The Old Media cost structure of the business is supported by a revenue model that's overwhelmingly dependent on advertising. That's not news to anybody. But when you see it in black and white, the case for making a fundamental change to the business is pretty strong.
This case would be pretty strong no matter what the business was. Businesses exist to generate cash flow for their owners by providing a good or a service to their customers. If you're not generating cash flows for owners, you're not a going concern. Incidentally, this is exactly why government regulators are firing up about more media regulation and oversight. They want to subsidise failed media models under the guise of protecting the importance of independent journalism to democracy.
That's absolute rubbish. But we won't get into it today. Instead, do yourself a favour and go buy a copy of today's Australian Financial Review. The 'Fin' has a great story on Lang Hancock's two failed efforts to become a newspaper publisher in Western Australia. It began in 1968 with the Sunday Independent and ended with the National Miner in the 1970s.
Maybe Hancock failed because he was ahead of his time. Or maybe he failed because it was simply bad business to mix overt political ideas (as much as we like them) with everyday journalism. He probably had the wrong model.
We can't imagine Gina Rinehart is eager to make the same exact mistakes as her father. It would be bad business to take over a paper and trash the only real asset it has: its relationship with readers. But then, Fairfax is a pretty bad business anyway. Why not give her a shot?
By the way, if anyone at Fairfax is reading this and you're interested in selling us your printing press out near Tullamarine, drop us a line. Someday, when the government shuts down the Internet or censors on-line speech, the printing press may be the only way to get the word out. Plus, the best time to buy is always during the fire sale.
for The Daily Reckoning Australia
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About the Author
Dan Denning is the author of 2005's best-selling The Bull Hunter (John Wiley & Sons). He began his financial publishing career in 1997 and has covered financial markets form Baltimore, Paris, London and, beginning in 2005 Melbourne. He’s the editor of The Daily Reckoning Australia and the Publisher of Port Phillip Publishing.