Reinvesting in media companies is the ante for staying in business.
Sometimes it can be useful to look back to help understand what current events are telling us.
About 7-1/2 years ago, the New York Times published “Private equity firms attracted to traditional media companies“. At the time, Clear Channel Communications, Reader’s Digest and Univision had all been purchased by private-equity firms, and the Tribune Company was contemplating a sale.
Robert Berner, managing director of Ripplewood, the firm that bought control of Reader’s Digest in a highly leveraged transaction, told the New York Times:
The more people disparage ‘old media,’ the happier I am. These companies don’t require a lot of capital investment. They sell subscriptions, so you get the money up front and deliver the product over time. They generate a lot of cash, so they make great buyout candidates, and you can get them at reasonable prices, because everyone else is focused on buying shares of Google.
You’ll note that Mr. Berner did not say anything about the nature of the business, the markets it serves or how it adds value. Three years after Ripplewood took control of Reader’s Digest, it wrote off $462 million in a single quarter. A post I wrote at the time offered my assessment:
These disastrous declines will persist until owners and operators come to grips with three inter-related problems: they rely too much on advertising; they charge too little for subscriptions, so that they can push up rate bases to get as much ad revenue as possible; and they deploy content far too narrowly.
Reader’s Digest declared bankruptcy later that year, in the process making its creditor, JP Morgan Chase, the largest publisher in the United States.
It’s fashionable to look at acquisition targets as financial machines, but businesses have to do more than throw off cash to prosper. Reinvesting in media companies is the ante for staying in business for more than a few years. In any rational market, the disastrous results of the Reader’s Digest and Tribune Company buyouts would offer ample warning.
On that note, we come to the announcement made last week that Time Inc. would spin out of its parent, Time Warner, with $1.4 billion in debt that it will use to purchase IPC Media, a company that Time Warner already owns. Why not just divest the combined entity?
Well, debt is one of those things that sucks up cash. If an acquiring entity wanted to buy Time Inc., the money spent on IPC would not be available to pay down any acquisition debt. In effect, this increases the amount of cash an investor would have to risk to buy Time Inc. In turn, that reduces the risk of a hostile takeover.
Starting new businesses also sucks up cash, a reality that might explain why private-equity transactions are not known for innovation. Unfortunately, private-equity reality means that companies like Time Inc. have to plan for the worst, at a time when they’d be better served using that $1.4 billion to create something of value to readers.