Gate Crashing?

By: Mark Fitzgerald This can't be what GateHouse Media Inc. CEO Michael E. Reed had in mind when he took the community newspaper chain public with a triumphant IPO just 24 months ago: a share price that has sunk so far that one analyst famously declared the stock worthless. A scary amount of debt taken on just as the credit market evaporated. Prestigious, but suddenly poorly performing, newspaper acquisitions dragging down the company's 90-plus portfolio of reliable little dailies like the Devils Lake (N.D.) Journal and the Arkadelphia (Ark.) Daily Siftings.

For GateHouse, the news these days is almost always bad. "The Motley Fool," the widely read syndicated financial advice column, this summer listed GateHouse (NYSE: GHS) in its "Five Deathbed Stocks." NYSE Regulation warned the Fairport, N.Y.-based chain that its stock could be de-listed from the Big Board. And for a couple of months this year, GateHouse wasn't even paying its bills, according to publishers who groused to others in the industry ? and sought out E&P reporters to complain about their embarrassment.

Around the chain, there's a sense of foreboding in the executive suites and the newsroom. "It wouldn't surprise me if we were sold off in a deal next week," says the publisher of one GateHouse paper, who insisted on anonymity. (It didn't happen.)

At one of GateHouse's biggest papers, the Journal Star in Peoria, Ill., Newspaper Guild members have not-so-quietly felt out local business people about buying the paper in anticipation that it will go on the market, barely 18 months after GateHouse snapped it up as part of a $380 million deal to acquire seven dailies from Copley Press Inc.

It's a remarkable reversal of fortune for a newspaper company that seemed to be positioned for outsized success in what many have written off as a sunset industry.

GateHouse had a simple but intriguing plan when it went public in late October 2006. It would quickly add more newspapers to its collection of mostly small-time papers, which dominate their markets and generate good cash flow and earnings even in times when their big-city cousins struggle. Acquisitions would grow free cash flow that would in turn be used to pay out rich dividends that, in contrast to its slumping newspaper peers, would keep its stock price high and healthy.

Investors were impressed not only by the strategy but by GateHouse's principal owner, the private equity firm Fortress Investments ? which had launched several highly successful IPOs. The GateHouse plan worked.

For a few months.

The initial public offering went off at the high end of its estimated $16 to $18 a share, and soon shot up to about $22. But Wall Street soured on the company as it failed to report profits, and doubled its debt to fund more than $1 billion in acquisitions during 2007 ? just as the newspaper industry was crashing, along with real estate and automobile sales.

Morningstar stock analyst Tom Corbett is one of the skeptics about GateHouse. "For the full year 2007, just for their dividend, they spent $62.7 million," he says. "And their cash flow from operations, before capital expenses, was $63.7 million. So their entire cash flow barely covered their dividend. And on top of that they went on a billion-dollar buying spree. It was essentially an unsustainable strategy."

GateHouse began to take defensive action this year, first trimming the dividend, and then eliminating it entirely. It sold off real estate, and began to sell newspapers instead of buying them. GateHouse had in the past shed some of the papers it acquired when it bought up entire groups because it believed an individual property was not a "strategic" fit. It's different now, one publisher says: "If there's money on the table, they'll take it. They don't care about being strategic."

By this summer, GateHouse stock had slipped below $1 a share, and Morningstar analyst Corbett, in a scathing report, estimated the "fair value" of the stock at ... zero. GateHouse contends it is getting an unfair rap. During a conference call with analysts in August, CEO Reed argued that Wall Street is unfairly lumping it in with the rest of the newspaper sector, and that the perception that it is overly debt-ridden is inaccurate.

Reed, who did not respond to an interview request for this article, noted that GateHouse had received a cash infusion from a Fortress subsidiary that paid off its revolving credit facility and wiped out the covenants that required the company to keep its debt-to-EBITDA (earnings before interest, taxes, depreciation, and amortization) ratio to 6.5 times. GateHouse has no principal payment due on its long-term debt of roughly $1.2 billion until 2014 ? plenty of time for the company's fortunes to turn around, Reed said in August.

"Our business strategy here at GateHouse, which focuses on operating strong local media franchises in smaller markets, remains sound and continues to yield performance significantly better than the newspaper industry at large," Reed told analysts. "Our same-store revenues in the [2008 second] quarter were down 4.7% versus a public industry peer average decline of over 12%, and our as-adjusted EBITDA was down 16% on a same-store basis versus a public industry peer average decline of more than 30%."

Some observers believe that GateHouse got itself into this fix not only because of the debt it took on to buy papers, but the kind of papers it has been buying. Before Fortress bought and renamed GateHouse, it was known as Liberty Publishing Group and had a hard-and-fast rule: Never buy a daily with a circulation above 20,000.

Reed jettisoned that rule as soon as he became CEO, telling E&P back in 2006 that it would hamstring growth. But the bigger papers have dragged down results. Especially problematic are the papers GateHouse bought in the troubled Massachusetts economy. In 2006, it spent $400 million to buy two chains that included such prestige properties as The Patriot Ledger in Quincy and The Enterprise in Brockton.

George Sample has followed GateHouse closely since the days when now-disgraced newspaper baron Conrad Black was amassing the community papers in a chain known as American Publishing Co. GateHouse, he says, "got large, and as you get large it gets exponentially more difficult to operate." The bigger papers get most of the attention and the smaller papers are lost in the shuffle, he adds.

One newspaper broker says that on several occasions he offered small non-dailies that would be strategic fits to GateHouse clusters. "They passed on every single one of them," the broker says. "And the reason was they wanted to make these bigger deals."

Now GateHouse is on the "sell" side of deal-making. Sample, CEO of Sample News Group, bought three dailies from the chain in September, but it was by no means a fire sale by a chain desperate for cash. "Absolutely not," he says. "In fact, the deal dragged on for months because of the credit market situations. They're not desperate at all. They're probably positioning themselves to do some bigger things ? that's what I sense."

GateHouse, Sample adds, is a well-run company with a sound strategy suffering from the industry-wide recession and Wall Street's tendency to "paint everybody with the same broad brush."

Weathering the storm
While it has abandoned its dividend and its acquisitive ways for now, at least, GateHouse continues to hew to its original business model of decentralized control. From the start, Reed declared he would not tell his community papers how to run their business ? and that remains true, according to publishers willing to speak about it.

That sets GateHouse apart from numerous newspaper companies, from Gannett Co. in Arlington, Va., to The McClatchy Co. in Sacramento, Calif., that this year ordered across-the-board reductions in staffing and expenses.

"There's no mandated cuts, nothing," says the publisher of one GateHouse property. "We're told to keep track of collections, make sure they are done."

While a hands-off approach from GateHouse's Fairport, N.Y., headquarters is something publishers would seem to favor, a few said it went a bit too far this spring and early summer when corporate wasn't paying the bills of individual papers. "Mike [Reed] got on a conference call and apologized," one publisher recalls. "He said some major debts had come due and they'd gotten behind. They did a big blitz in July to get things paid off."

While Fairport is not ordering cuts, GateHouse papers have undergone the same kind of reductions as nearly every other newspaper in America. This summer, for instance, four GateHouse papers in Kansas and two in Illinois dropped their Monday editions to reduce costs. The Rockford (Ill.) Register Star laid off 13 employees and shut down its bureau in the state capital. And for the first time ever, the Journal Star in Peoria, Ill., offered buyouts.

Jennifer Towery, president of the Peoria Newspaper Guild, says GateHouse, which bought the Journal Star from Copley in May, has been fair with the union. Nevertheless, the Guild is trying to line up local business people who would be interested in buying the paper if GateHouse decides to or is forced to sell. "We want to get the paper out of Wall Street and back into the community," she says.

GateHouse may leave Wall Street ? or the Big Board, at least ? but it's not clear if it wants to leave Peoria.

"It is critical that we not panic and lose confidence in our assets," Reed said in the Q2 conference call. "Rather, we need to weather the economic storm and make sure we have dominant, local franchises in our markets positioned to grow when the cycle does turn."

GateHouse "still has a pulse," says skeptical Morningstar analyst Corbett, and has bought itself some time by paying down its revolver.

"Is it as bad as it looks?" he ponders. "I think it's worse than they are making it sound in the conference call, but the company itself is still a going concern as a business. But that doesn't mean the stock is a buy."