Trying to spot a Fairfax bias

Fairfax's sale of profitable Trade Me could've been motivated by opportunism or necessity. Whilst a trading update didn't accompany the announcement, it's not hard to guess what was driving the thinking.

There are two ways in which to view Fairfax Media’s $616 million sale of its 51 per cent residual interest in its best asset, New Zealand’s Trade Me. One is to see it as an opportunistic decision to cash out of a maturing business to wipe out most of the group’s debt and create capacity to pursue less mature digital acquisitions. The other is to see it as driven by necessity.

Maybe there’s a bit of both. Trade Me has been a terrific investment for Fairfax, and indeed has arguably kept the group alive until now, but its growth rate had tapered somewhat, there were no synergies between it and Fairfax’s other businesses and getting rid of all but $100 million or so of its $800 million of non-Trade Me debt means Fairfax can pursue the traumatic restructuring of its metropolitan newspaper business without having to worry about what its bankers think.

It is worth remembering, however, why Fairfax sold its last stake in Trade Me, 16 per cent back in June.

That sale, which raised $160 million, was announced at the same time as Greg Hywood revealed the brutal restructuring of his metro business and the 1900 redundancies, the closure and sale of the Chullora and Tullamarine printing plants, the conversion of The Sydney Morning Herald and The Age to ‘’compact’’ formats and the erection of paywalls for the digital versions of those mastheads.

That "restructuring" is forecast to generate $235 million of annualised cost savings by June 2015 – at a cost of $248 million. That original Trade Me sell down was necessitated by the need to raise the funding for the restructuring.

Fairfax didn’t provide a trading update today, leaving in place its disclosure in October that revenue was down about 7.5 per cent in September and early October. It is no secret within the media sector, however, that advertising revenues for all forms of media, but particularly print media, have deteriorated markedly in the past couple of months.

It wouldn’t be a surprise to anyone if Fairfax were again examining its ‘’Fairfax of the Future" blueprint to see whether it needs to carve further into its cost base.

In June, when that blueprint was unveiled, Hywood made it clear that while Fairfax’s newspapers were still generating positive cash flows the strategy was to milk them for as long as it could while managing down their cost bases in line with their declining revenues.

He also revealed, however, that Fairfax had calculated the costs of simply ceasing to print its metro newspapers and moving to digital-only publishing. It would cost around $200 million.

Given that Fairfax had to sell down its Trade Me shareholding to fund the original restructuring it would appear obvious that it would have to find a way to raise more cash to either expand the existing program or bite the bullet and stop printing and distributing its major mastheads, which would reduce its cost base by another 34 per cent, or about $187 million.

Trade Me, despite being the group’s most attractive asset – or because of it – was the only obvious and readily available source of that cash.

Under the current plan the two major metro mastheads will be converted to compacts, or tabloids, in March next year, with metered versions of a paywall erected in that first quarter. Chullora and Tullamarine are scheduled to be closed and sold by mid-2014, with the papers printed – if they are still being printed – on Fairfax’s regional presses.

Hywood is trying to execute a diabolically difficult transition of those mastheads from their print origins to an eventual digital-only future. While Fairfax has large audiences on its digital platforms the radically different and challenging economics of digital media makes that a near-impossible task, but it does represent Fairfax’s only hope of a viable future for those mastheads.

Fairfax, of course, isn’t unique. Globally traditional media is under dire threat from the growth in online media.

In this market News Ltd (the parent company of Business Spectator) is pursuing similarly radical and painful (albeit less public) surgery to Fairfax, although it is still, until next year’s News Corporation de-merger, part of a group with vast non-newspaper interests and a proprietor who loves newspapers.

It may be that the continuing structural erosion of the sector’s revenue base is being overlaid by a cyclical downturn in a soft economy which has made advertisers extremely defensive, but neither Fairfax nor News can afford to make that distinction.

The changes to their cost structures and models have to be predicated on further revenue declines for print products and conservative assumptions about the growth of digital revenues and yields.

While Hywood did say the sale of Trade Me would provide Fairfax with the financial flexibility to invest, he also cautioned against expectations of major acquisitions and said the sale would allow Fairfax to complete its "structural transformation".

In the current environment, it would appear reasonable to assume that the sale was driven more by the need to finance another bout of "transformation" – or at least have the funding in place in case the deterioration in the environment forced one – than by some new growth agenda.

Indeed, with Trade Me and its $90 million of earnings before interest, tax, depreciation and amortisation gone, Fairfax’s exposure to "old media" will be relatively more concentrated and the need to respond to its deteriorating economics even more pressing.