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The new rivers of gold

The three internet stocks that stole Fairfax’s classifieds business are now bigger than Fairfax itself.
By · 20 Nov 2009
By ·
20 Nov 2009
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PORTFOLIO POINT: Fairfax is in a death spiral while its online competitors continue to grow and seek new categories.

The market passed another milestone last week and nobody noticed. The three internet stocks that stole Fairfax’s classifieds business now have a combined market capitalisation greater than Fairfax itself.

And not just a by a little bit. The combined market capitalisation of Seek, REA Group and Carsales.com is now about 10% higher than Fairfax: $4.2 billion versus $3.9 billion. It’s quite an amazing turnaround. In less than a decade, Fairfax has gone from looking ready to dominate the online classifieds industry to an also-ran in the market.

Just on some rough numbers these three companies – who provide employment, real estate and automotive classifieds respectively – appear to have done about $420 million in classified revenue in Australia.

Fairfax does not itemise online classified revenue numbers in its accounts – web-based businesses from online dating to NZ auction websites are lumped together – but my best estimate is that its Australian online classifieds earned $70–75 million last year.

So Fairfax’s three main competitors combined are doing about six times as much business in the same online classifieds categories: employment, real estate and automobiles.

There has been a view among investors that Fairfax’s problems have been largely cyclical, that the company has been suffering because of the economic downturn and that there would be this big bounce coming out.

So people have been buying Fairfax on the recovery turnaround story; the recovery in advertising spending is indeed happening – it’s just happening to other companies.

nFairfax (red line) REA Group (green) and Seek (blue)

At its recent annual general meeting, Fairfax said its first quarter was tracking about 15% behind the same time last year. At SEEK, REA Group and Carsales, they all opened the year with rising order books and the prospect of double-digit revenue growth.

It’s probably the first time in Australia we’ve ever seen a company of the size of Fairfax in a classic death spiral. There are an awful lot of investors who still believe in this company; an awful lot of institutional investors who are all working on the assumption that it still has a future and that one day they will get their online strategy right. Right now I cannot see a shred of evidence for how these hopes can be met.

The irony is that the only thing that can save Fairfax now is Rupert Murdoch.

Fairfax’s biggest structural weakness is that it invest heavily in editorial content – about $150 million a year – and gives it all away for free on its website. Readers have noticed this and are cancelling subscriptions to the main metropolitan newspapers in droves. Revenue from online advertising is OK, but not enough to cover the cost of investing in quality journalism.

Fairfax would love to charge readers for its online content but it has a problem shared by most of the world’s newspaper publishers: its competitors give away their content as well.

In Australia, Fairfax’s arch-rival News Limited gives away its content. And while News Corp keeps providing free content, Fairfax won’t be able to charge for it either.

Of course, Murdoch has been talking a lot about charging for content lately. But if he were to erect the pay walls everywhere but in Australia ... well, you get the idea. Fairfax’s fate is quite literally in Rupert’s hands.

On our internal estimates, Fairfax’s share of the classifieds market has been in steep decline for some time. The company’s only real chance of survival depends on being able to monetise its editorial resources, and clearly classifieds aren’t supporting that. Their online display ads aren’t coming even vaguely close to being able to cover that cost.

Instead, what we’ve seen is just this continuous cycle of cost-cutting. The company is now into about its 20th round of cuts and it will just keep trimming and trimming until it finally disappears.

I don’t know whether this is true or not but the other day someone told me that the planned total trainee journalist intake at Fairfax’s metropolitan papers this year is two. Back in the 1970s, when I joined Fairfax, it would have been something like 30 of the best and brightest.

Thousands and thousands of people would apply for jobs at the Age and the Sydney Morning Herald. It was seen as the place to be and the competition to get those jobs was extraordinary.

Now the company isn’t replenishing its intellectual capital because it just can’t afford to. Unless Murdoch starts charging for content its problems will just get worse and worse.

Fairfax’s problems are made worse because there is not a single person on the Fairfax board who has even been involved with running an internet business or even someone who has the foggiest idea of how hard it is to make an online business work. If they were really serious about preserving the value of the company, the entire Fairfax board would resign and hire some head-hunters to populate the board with people with real hands-on online experience, at whatever the cost.

nHow they compare
Company
Seek
REA
CarSales
Fairfax
ASX Code
SEK
REA
CRZ
FXJ
Share price ($)
6.19
8.25
4.52
1.695
Market Cap ($m)
2082
1060
1049
3987
Yield
1.49%
1.21%
-
1.18%
EPS (cents)
18.8
0.74
-
-21.6
52-wk high ($)
6.81
8.73
4.56
1.805
52-wk low ($)
2.02
2.95
3.56
0.795
Close of trade November 19, 2009

All of these internet classified companies, such as Seek, REA Group, Carsales.com and the others, they have all worked on the theory that you must dominate your category. They’re category killers.

They knew that to be a success in this sector they had to dominate traffic and advertising, and they’ve all done that very well.

The online classifieds market in Australia is worth about $500 million today. It will probably max out at about $750–800 million in four or five years, but it’s never going to get any bigger than that.

Even though most of those companies are less than a decade old, they’re already facing the issue of how to handle maturity. So in contrast to what’s happening at Fairfax, they are developing growth strategies that will be able to take them forward once they reach saturation point.

The guys at Seek have grappled with this question and their answer is the education business. They have a traditional TAFE classroom-style business called Think Education Group, the online Seek Learning business and a half-interest in IDP, which, among other things, recruits students from Asia for Australian universities.

Within a couple of years, their education business will eclipse the employment business. They’ve addressed what will happen when they reach capacity a found another suit they be equally strong in.

REA Group, on the other hand, is expanding internationally. It has had some problems with its expansion into the UK and the Middle East and is now concentrating on Italy and Hong Kong. It’s too early to tell if this is going to be a success or not but at least they are thinking over the next hill.

Carsales.com has only just listed, so time will tell how its growth plans pan out.

What’s fascinating is that all of these online companies are already investing 10–15% of their revenue from each year in the next growth initiative. Meanwhile, the traditional media companies such as Fairfax are lucky to invest 1% of their revenue in future growth opportunities.

Although all of these online companies are fairly expensive, I would say to any investor who has time horizon longer than two or three years that they are a much better option than the traditional media companies. Because unlike traditional media companies they recognise that you’re never going to grow unless you invest, and you invest serious money.

Ivor Ries is head of research at EL&C Baillieu Stockbroking. He may have interests in any of the stocks mentioned.

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