Time to clip dividends?

By: Mark Fitzgerald And Jennifer Saba

Is it time to end the fad for higher dividends on newspaper stocks? Credit rating agencies ? alarmed at increasing newspaper debt loads ? have been arguing that for a while, and now some influential Wall Street analysts are joining them.

Publicly traded newspapers traditionally paid out dividends because they were generating so much free cash, and for a long time did not have substantial debt. The dividend returned cash to the shareholder, and made the stock more attractive.

GateHouse Media Inc. pushed the dividend envelope with its initial public offering in October 2006. Its business model was to continually acquire community papers that were virtual news and information monopolies in their market, operate them more efficiently, and generate free cash flow to pay dividends far higher than their peers.

Wall Street loved the strategy ? at first.

Soon, other publishers such as The New York Times Co. and Gannett Co. were nudging their dividends up too, though not quite to GateHouse’s levels. John Janedis of Wachovia Securities calculates in a note to investors that the dividends have grown at a compound annual growth rate of 8% ? while free cash flow has fallen 1%.

Dividend payout ratios (the dividends percentage of earnings per share) are getting bigger, too. In 2002, Wachovia says, the average newspaper payout ratio was in the low 20% area. By the end of last year, it averaged in the mid-40% range, with GateHouse and The New York Times Co. paying out 58%.

GateHouse was paying out an annualized $1.60 per share in dividends in 2007. All the while, its stock was sinking rapidly ? and dramatically.

Its concentration on small-town papers had not made it immune to the newspaper industry’s ills. Total revenue in 2007 was up 87% as it spent $1 billion buying papers that year, but its same-property revenue actually slipped a modest 2.5%.

But debt was the big story for GateHouse, which in 2007 alone more than doubled its long-term borrowings to $1.2 billion. (Chairman/CEO Michael E. Reed told analysts in May that the company is in compliance with current covenant limits of to 6.1 times debt to EBITDA.)

GateHouse has brought its dividend down, most recently reducing its first-quarter dividend to 20 cents per share, 85% lower than its Q1 2007 payout. Wachovia’s Janedis said in a note to investors that newspaper companies should go even further, and eliminate the dividend altogether.

He acknowledges it won’t make a big short-term dent in debt load, perhaps cutting the debt-to-EBITDA ratio by 0.2 times. And shareholders will surely howl.

But Janedis argues that Wall Street isn’t rewarding the high dividends with higher, or even stable, stock prices. And this would be a proactive step towards drawing down debt, and freeing cash for reinvestment. “We think continued payment of dividends in the current environment, i.e. deteriorating ad revenue, higher newsprint, etc., increases the likelihood of publishers breaking debt covenants long term, having to refinance, and being forced to pay higher interest rates on debt,” Janedis and his colleagues tell investors. Eliminating the dividend, on the other hand, helps reduce debt and interest payments.

Other analysts agree, and say it’s likely that dividend cuts will spread beyond GateHouse. Sun-Times Media Group, for instance, stopped paying a dividend more than a year ago. “Dividends tend to be the first sacrificial lambs,” says Morningstar equity analyst Tom Corbett.

On the creditors’ side, credit ratings agency Fitch Ratings Services also says the dividend has stopped making sense for indebted newspaper chains with flat or decreasing growth. “The dividend is the one place a company can cut and apply that to de-leveraging,” says analyst Mike Simonton.

But shareholders won’t be pleased, he warns: “In a lot of companies, even the ones under [debt] pressure, because they still generate a large free cash flow, there’s that conflict between creditors and stockholders. The stockholders see that free cash flow, and would like to see it returned in a dividend or stock buyback.”

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