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Financial risk but strong synergies color outlook for newspaper deal

Two of America's largest newspaper publishers are coming together. Though analysts are optimistic about the savings the deal can yield, they note it does carry some financial risk.

New Media Investment Group Inc., best known as the parent of local news giant GateHouse Media LLC, agreed to buy USA TODAY owner Gannett Co Inc. in a cash-and-stock deal with a gross transaction value of $2.29 billion. For the cash portion of the deal, New Media is using a combination of cash on the balance sheet and a new $1.79 billion five-year term loan from funds managed by affiliates of private equity firm Apollo Global Management LLC. New Media CEO and Chairman Michael Reed said during an Aug. 5 conference call that the interest rate on the term loan will be 11.5%, a rate that newspaper industry analysts say is relatively high.

"It's a lot of money for Apollo to commit," said Rick Edmonds, media business analyst at the journalism-focused Poynter Institute. "I think there's a downside risk that the company won't be able to make all of its payment, so it's a high rate."

Michael Kupinski, director of research and senior media and entertainment analyst at Noble Capital Markets, noted the steep decline in advertising revenues newspapers have seen since the mid-2000s. Data from the Pew Research Center shows total newspaper ad revenue dropping to $14.35 billion in 2018 from a peak of $49.44 in 2005.

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"The newspaper industry is facing secular challenges so … it's not surprising that [Apollo] could charge a higher interest rate," Kupinski said.

New Media recorded total revenues of $404.4 million for the quarter, up 4.0% compared to the prior year. But the increase was due to a series of recent acquisitions. On an organic same-store basis, New Media revenues were down 6.9% year over year. Gannett saw its second-quarter revenues fall to $660.3 million from $730.8 million in the year-ago period.

Given the top-line challenges, Kupinski said the merger is important for the combined entity's future as it will help control costs through the consolidation of production and distribution facilities.

"It does give them more of a runway to maintain cash flow," Kupinski said of the deal's anticipated synergies, adding that this cash flow will be important both for debt payments and digital investments.

New Media's Reed estimated cost synergies across the combined company will reach $275 million to $300 million annually, equivalent to 7.5% of total combined expenses. These savings, according to Reed, will allow the merged entity to "rapidly delever the balance sheet" while still maintaining a dividend and growing its digital operations.

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The $300 million figure "may be optimistic," Edmonds said. Regardless, Gannett and New Media together will be "ahead of the game" financially as compared to operating separately.

During the conference call, Kupinski asked whether the deal could give the combined entity more heft as it negotiates news distribution agreements with online tech giants like Facebook Inc. and Alphabet Inc.'s Google LLC. Reed said it "remains to be seen" whether the combined entity will try to get more favorable terms or even new revenue streams from Facebook and Google in exchange for content distribution rights.

"We have a lot of work to do in front of us over the next 4 to 6 months to get this transaction closed and to work on our combined strategy, both on the top line and the bottom line. So I'd say stay tuned on that," Reed said.

The possibility is something the newspaper industry at large seems to be watching.

"Consolidation is a rational response to the current challenges in the digital market for news. Facebook and Google should pay close attention and understand that, one way or another, we need to get to a system of fair compensation for news content," David Chavern, president and CEO of the newspaper industry group News Media Alliance, said in a statement about the Gannett/New Media deal.

All told, New Media has pursued more than a dozen deals in the past five years, though the Gannett purchase is by far the company's largest recent acquisition. The $2.29 billion gross transaction value is about 8x larger than New Media's second-largest purchase, the $285.5 million acquisition of Halifax Media Group in 2014.

Upon the close of the Gannett transaction, the combined company will operate 263 daily local newspapers across 47 states, along with USA TODAY and the U.K. media company Newsquest. The deal is expected to close by the end of 2019.

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