Digital Media Investment Thesis — The New York Times Company (NYSE:NYT)

For decades, print newspapers tended to be an excellent industry to invest in. Given the local nature of the industry, the town or the city’s subscriber base could only support 1–2 newspapers economically and these newspapers became natural monopolies / duopolies enjoying good ROEs compounding over many years. However, the advent of internet changed the landscape dramatically. News moved online and advertising dollars shifted to Google and Facebook. Newspapers have had to change their business model fast or face existential threat.

The New York Times Company (“NYT” or the “Company”) has arguably seen the most successful transition in the industry. Instead of a business model driven entirely by ad revenues, the newspaper’s business model has shifted to primarily digital subscriptions by consumers. NYT made a bet that readers would be willing to pay for quality journalism when it put up the paywall in early-2010s and the bet has been successful — NYT has 6.9m subscribers today (Sep-20), >4x their print-era peak of 1.6m subscribers. Of the 6.9m subscribers, c. 6.1m are digital subscribers comprising of 4.7m news product subscribers and 1.4m other digital product subscribers (primarily Crossword and Cooking). The 4.7m digital news product subscribers is >2x of the closest competitor, the Wall Street Journal and subscriber base has grown at a CAGR of 30%+ over the last 3 years. The future growth in subscribers could be material, as NYT has more than 120m MAUs in the U.S. / 150m MAUs globally, suggesting a paid subscriber penetration of just 5–10% (Company estimates addressable market of 100m).

The Company’s new CEO articulated the business model’s strengths in the remarks below in the 3Q FY20 investor call:

“We’re confident that the market is there and also in our ability to penetrate a large portion of it. Our model creates a virtuous cycle: A large newsroom, made up of the world’s best journalists; a widely recognized and trusted brand; and a differentiated digital product enables us to attract and retain more subscribers. The larger our subscriber base becomes, the more we can invest in our journalism and standalone products, and the more we can spread our fixed costs across a wider base of users. That means strong unit economics that improve as we scale, with further contributions from advertising, licensing and affiliate fees”

Each of the digital subscribers pays an ARPU of c. $9 / month, lower than the full rate of $17 / month due to introductory pricing of $4 or $8 / month (for 1 year) and intermediate step-up rates (for further 1 year) being availed by a substantial fraction (est. at 50%) of digital subscribers. While the run-rate ARPU is a matter of debate, the Company has been able to successfully transition subscribers from introductory pricing to full pricing historically. While the churn is not disclosed, the CFO has described the retention as ‘strong’.

As such, current digital subscription revenues are c. $650m with considerable upside once ARPUs reset to higher levels (offset by some churn). Digital advertising, which consists of ads on NYT website, apps, emails, podcast (“The Daily” — #1 podcast in the U.S. by audience reach), classifieds, etc. was c. $260m in 2018 and 2019 (before falling by c. 20% in FY20 on account of COVID-induced economic impact). As such, NYT’s digital revenues stream is about c. $900m currently (accounting for c. 50% of total revenues), with substantial upside from subscriber growth and ARPU uptick over time.

NYT’s legacy print business contributes another $750m of revenues (40% of total revenues). While print subscribers have been declining (currently at 0.8m), the ARPU has increased to c. $60 / month, c. 7x more than digital ARPU, resulting in largely flat print subscription revenues. This is likely NYT’s most profitable segment but has a challenging future and will eventually become a much smaller segment as a % of total revenues.

The last 10% of revenues (c. $200m) comes from a content licensing deal with Facebook, original video programming (e.g. The Weekly on FX / Hulu), WireCutter referrals, etc. This segment grew 34% in FY19 and 4% in 9M FY20. A discussion of the relative balance-of-power between search / social media companies and news publishers is warranted here. While initially the balance-of-power was overwhelming tilted towards the tech platforms which were the primary digital distribution channel for news publishers, today the pendulum has swung in favor of trusted news publishers like NYT given the misinformation rampant on these platforms and the news publishers ability to monetize their content directly. The Facebook licensing deal is one such instance of major tech companies investing in paid partnerships to aggregate premium news content across their platforms and there might be more to come in the future. Nonetheless, these platforms are still important sales channels and also represent risk of cannibalization for publishers, and NYT management is monitoring the risk / opportunity.

NYT does not breakout the operating profits for each of its segments, but its consolidated EBITDA margin is c. 12.5%, producing $220m of EBITDA from c. $1,750m of revenues. In the long-run, one can expect the digital business to have margins in excess of c. 30%, in line with expectations for other direct-to-consumer digital subscription businesses (journalism costs = 25% of revenue, digital direct costs = 15% of revenue, S&M / G&A / product development = 30% of revenue).

A sum-of-the-parts valuation can be derived as below:

· Digital subscription + advertising = 10x revenues = c. $9bn

· Print subscription + advertising = 3x EBITDA (segment EBITDA margin assumed to be 15–20%) = c. $400–500m

· Others = 10x EBITDA (segment EBITDA margin assumed to be 25–30%) = $500–600m

As such, cash-free debt-free valuation of NYT can be estimated to be c. $10bn. Adding balance sheet cash less pension obligations (no third-party debt), fair value of equity is estimated to be 10.5bn or $72 per share, an 80%+ upside from current valuation of $40 per share.

The key risk here is that the digital business is not worth as much as estimated above due to lower growth and / or lower future margin potential. However, given the strong brand / customer engagement, secular tailwinds in terms of consumer willingness to pay for online news, early-stage successful transition to an attractive business model and increasingly scaling economics, strong new product development, and bundling opportunity, I feel confident in the prospects of the Company for it to command such a valuation multiple.

Catalysts:

1. Continued increasing # of subscribers

2. Increasing digital ARPU

3. Improving operating margins