Time Inc. Is on My Side

 | Jun 10, 2014 | 10:00 AM EDT  | Comments
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Monday on "Fast Money Halftime" Joe Terranova and I debated Time Inc. (TIME), the publisher recently spun-out from its parent Time Warner (TWX). Twitter folks sided with Joe and I lost the debate. But I think I'll be right on the stock pick over the long term and I thought I'd lay out my case in more detail for you.

Time Inc. was founded in 1922 and is the largest magazine publisher in the U.S. in terms of readership and print advertising revenues. It has more than 90 magazines across a multitude of topics in its collection. The names are well known -- People Magazine, Time, Sports Illustrated, Southern Living and more. Suffice it to say, you probably know at least one of these publications and the new management team's goal is for that to only increase. It also operates 45 websites that share the same brands as its magazines, like People.com, SI.com and Time.com. Half of the company's revenues come from advertising sales and the remainder is from circulation.

After several years of management turnover, the company now has in place a new team that is committed to turning things around. By now you know I like turnaround stories, especially ones that have very low expectations. CEO Joe Ripp has been at the company since September 2013 and was given the chairman title in April 2014. He's had a pretty long tenure in publishing as well as online business information services and has notable turnaround experience when he was chairman of Journal Register Co. and COO of Dendrite International. He worked at Time Warner for 20 years prior to these other positions.

CFO Jeff Bairstow also had stints at Journal Register and Dendrite and most recently worked at Digital First Media. Chief Content Officer Norman Pearlstine ran all of content at Bloomberg News for the last six years and also served as chairman of Bloomberg BusinessWeek. He also was editor in chief at Time Warner and spent 23 years at The Wall Street Journal. I won't go through others on the team but, to me, it's impressive that this management team has not only experience in the publishing business but also has a strong background in content and turnaround stories. This group has a new strategy to focus on cost-cutting, profitability and to make each line manager accountable for sound business decisions. They've centralized the organization with one goal in mind: to make money while growing digital content.

Some of the heavy lifting has already been done, but the management believes there is more in consolidating offices, renegotiating content contracts, streamlining editing, and outsourcing several back-office functions. Just moving its corporate headquarters from midtown (the Time-Life Building) to downtown Manhattan will yield $50 million in savings per year, while renegotiating print contracts in the U.S. and U.K. will yield another $10 million in annual savings. Another area of potential savings will be from the October 2013 acquisition of American Express Publishing Group. The two entities worked together before the merger, so Time Inc. certainly is familiar with their operations and where there are opportunities for further synergies, which management has said will be in the "multi-million dollar" range. In addition to cost take outs from AEP the company acquired five upscale magazines that cater to the affluent customer -- a stickier customer. The name brands are Travel + Leisure, Food & Wine, Departures, Executive Travel and Black Inc.

Adding this up, after the initial one-time related expenses incurred (new company costs, share based comp expenses) margins will stabilize and have a good shot at moving higher over time. I believe at the current valuation, all the company needs to show is an incremental improvement in operating margins where the rate of declines become less each year. There is no doubt management has its work cut out, but there are definable areas where this can be done. Analyst models have operating margins down 100 basis points year over year in 2014 but will show improvement from the 120 bps decline seen in 2013. A 75 bps decline is expected in 2015, and then just 20 bps by 2017. Keep in mind that management is guiding for 50-125 bps declines this year, so my assumptions could be beaten.

Beyond operating margins' rate of improvement, I like the story for its untapped content potential. For years, Time Warner management basically underinvested in the publishing business, opting to focus more on the TV and film assets -- understandably so given the higher returns in these other businesses. But now that it's separated, the new management team will concentrate on rebuilding, investing and improving these strong brands. The key going forward will be to focus on its digital strategy, which should drive top-line growth stabilization and offset the secular declines in print advertising and newsstand sales. Digital only accounts for 15% of total advertising currently, but its growing mid-teens, plus the margins are higher than traditional print, so profitability should improve over time. Over the next few years, I believe they can easily get to 25% of total digital ad revenues and, if successful, that could be another area where margins show upside.

On digital, there is good and bad news. The bad news is they've been slow to adapt to the digital world of tablets, laptops and desktops, so they have their work cut out for them. The good news is the company has a vast array of content/product, size and scale along with a huge installed base. Management will invest in brands, people and technology over the next several years, and that should lead to better top-line results over time. The company has 1.1 billion monthly page views and 74 million monthly unique visitors across 45 websites. It will focus on brand extension on SI.com initially, 120 sports in video streaming video (two-minute intervals of analysis, game footage, and original programming), and it will expand its 6,000 short-form videos to drive more Web traffic. Beyond digital, the company will look for adjacent revenue drivers like licensing and bolt-on acquisitions. There is speculation that the company would sell out after the two-year time requirement expires, but for now, management will focus on the fundamentals and creating a stronger company.

The company is generating $250 million to $300 million in free cash flow annually for the next several years. Again, they'll use this to invest and also implement a dividend (by the third quarter), which is expected to yield a competitive 3.4% -- management's stated goals are to payout 30% of its FCF annually. Shares trade at a 14% FCF yield and 7.3x 2015 EBITDA -- better than its peers at 7.9x. Its margins are 17.5%, which also compares favorably to some industry players like News Corp. (NWSA) at 11.8% and The New York Times Co. (NYT) at 15.4%.

With strong brands, vast size and scale and at the beginning of technology change, I believe the story is interesting. Maybe it takes a few days to settle following the spin, but I believe it will stabilize. I'd buy shares ahead of the 3.4% dividend and the exciting digital transformation yet to come.

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