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FXJ – Rocky 16

Yet another near billion dollar write down of impaired assets at Fairfax has the balance sheet on the canvas once more, but like Rocky, it just keeps getting up again. The fight in Fairfax’s corner is now carried these days by Domain Group which finally gets the spotlight in terms of separate reporting metrics.

 

There seems to be two things going on at Fairfax which will determine the direction of its share price. The first is the emergence of Domain Group as the primary engine of growth and valuation for the company. The second is the slow motion demise of the print assets which have incurred yet another huge impairment charge.

 

Fairfax management have been exasperated at the market’s lack of recognition of the value being created at the Domain Group, specifically when compared to its larger rival REA Group. The Fairfax share price is carrying an implied discount relative to REA whichever way analysts dissect and rearrange the pieces of the Fairfax puzzle. To counter that, Fairfax is setting Domain Group further apart from the print assets that are clearly dragging the valuation chain.

 

The segment reporting for Domain Group was actually supplied to the market last year but to date it seems to have gained little traction. Domain is still not the largest single profit centre across Fairfax but there seems little doubt it soon will be as the Australian Metro and Community Media divisions continue to see revenue and earnings erosion despite the best efforts of cost cutting programs.

 

Domain’s revenue and earnings growth path is very encouraging. In the first half of FY16 it produced more operating earnings than it had in the full 2015 financial year. Some care is required in this sort of comparison as Domain continues to invest large amounts of money building the infrastructure of the wider business. But it does demonstrate that REA Group does not have the online real estate advertising market to itself.

 

Domain’s model is not identical to REA so the battle for the real estate advertising dollar is not straightforward. Agents are the key battleground but many seem reluctant to favour Domain over REA or vice versa.

 

Domain has persisted with an editorial and marketing heavy approach while REA has tried to be innovative with a diversified range of auxiliary services and a contentious but highly successful pricing approach based on area code.

 

It’s not yet apparent whether Domain deserves a bigger multiple and hence valuation. Only a separately listed Domain would achieve that end, but therein lies Fairfax’s dilemma. Fairfax ex Domain is a weak investment proposition.

 

Fairfax CEO Greg Hywood will expound long and loud of the digital audience now being reached through the various mastheads and other digital properties. And more, he will preach the virtue of the company’s slimline cost base.

 

But the stark reality is that traditional print media assets are horse and buggy to today’s mobile and online freeway.

 

Reflecting that, Fairfax will include an impairment charge of $989 million pre-tax in its FY16 result to be announced on 10 August.

 

Of that total, the Australian Metro Media business will be impaired by $484.9 million, the Australian Community Media business by $408.8 million and the New Zealand business will record a $95.3 million impairment charge.

 

Such write downs have become a regular feature at Fairfax (and other print media companies). The balance sheet has shrunk from a peak of around $8 billion in 2008 just after the merger with Rural Press to approximately $2 billion today. Most of the decline has been in the value of mastheads and goodwill.

 

Fairfax is pursuing a strategy of merging its New Zealand business with that of the recently listed NZME, itself a demerged entity from APN News and Media. That proposal is reasonably likely to succeed leaving Fairfax with a more concentrated Australian portfolio.

 

It now seems inevitable that Fairfax will push towards weekend-only publishing of its major mastheads – The Sydney Morning Herald, The Age and even the AFR. Mr Hywood said this is being “too honest, rather than too pessimistic”.

 

Employee numbers have declined by about 35% and publishing costs have been reduced by $400 million.

 

The heavy pruning of staff over recent years has significantly reduced the estimated cost of finally switching off all the printing presses and going fully digital. At around $150 million to completely move out of metro publishing, Mr Hywood says this is down from the $450 million it would have cost in 2012.

 

That step isn’t here yet, but as more and more venerable international newspaper titles go fully online, it seems a similar fate awaits Australia’s main titles.

 

Looking more positively at Fairfax’s prospects requires a singular focus on Domain Group. The company has spent $150 million over the last four years investing in various aspects of Domain’s business. The latest $15 million investment in OneFlare (35% stake) is about online services connecting consumers with local tradies.

 

Fairfax believes the total Australian digital real estate market could be up to $775 million of revenue growing at around 20% per annum so that by 2020 it could be a pot of about $1.6 billion.

 

At some point, the Fairfax Board of Directors might just be asking themselves where the most value is being attained for future investment and value. Each dollar retained in the ailing print business is a dollar deprived in Domain Group.

 

For now, while Domain persists in building its business to span Australia and find adjacent businesses to supplement the offer, it cannot justify the same valuation multiple as REA Group.

 

The FY16 result at Fairfax will probably show that Domain Group is quickly approaching half of Fairfax’s total operating earnings as the print assets continue to slide and Domain grows.

 

Most of the current and future value of Fairfax is therefore contingent on the growth in Domain.

 

Investors might also therefore begin to ponder if the point of inflexion has been reached and that Fairfax is finally worth a look.

 

I don’t think that is the case just yet although it may not be too far away. Even without the NZ assets, Fairfax still has an Australian media business besides Domain that doesn’t need to be thrown away. Finding a smart and profitable solution for it is not easy in the face of the Google and Facebook behemoths that have engulfed most of Fairfax’s advertising revenue.

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