USA Today parent Gannett has joined a long line of media companies to spin off a fading business. Should investors stick with the more promising assets or take a fly on the underdog?
Gannett said Tuesday it would divide itself into two companies, with one containing national newspaper USA Today along with dozens of regional publications. The other company will be home to 46 local TV stations and digital assets such as Cars.com, of which Gannett took full ownership on Tuesday.
The logic of such a transaction is straightforward: Many investors would prefer to own the faster-growing assets and may assign a higher valuation to their earnings without print in the picture. Indeed, many investors are likely to consider unloading the publishing stock as soon as they receive it.
Yet stock-price performances after similar deals have had surprising results. When CBS was separated from Viacom in 2005, the owner of the eponymous broadcast network was expected to lag the owner of the faster-growing cable networks. And yet CBS shares have handily outperformed Viacom's as the top-ranked broadcast network began collecting handsome fees from cable companies to carry its content.
Perhaps even closer to home is the example of News Corp. In June 2013, the company separated into a publishing company that kept the News Corp. name and an entertainment company called 21st Century Fox that houses assets such as Fox News channel and the 20th Century Fox movie studio. Since the split, the stocks have been neck and neck: News Corp. has gained 13 percent while Fox has risen 14 percent.
Gannett's underdog publishing stock will have a hard time pulling off a similar move. First, the company is somewhat different from other spinoffs like News Corp. because it essentially is a pure publishing company. From the very beginning, it was clear that News Corp. would continue to own subscription television assets in Australia and New Zealand that had brighter growth prospects. Even before the split happened, analysts estimated that about 40 percent of the company's value would be in television properties.
Gannett, meanwhile, will continue to generate the vast majority of its revenue from the print business, which continues to see steady declines in advertising sales. Over the next five years, the publishing company will see earnings before interest, taxes, depreciation and amortization decline at a mid-single-digit percentage pace, estimates Jefferies analyst John Janedis. Gannett declined to comment to CNBC.
It will be hard to improve Gannett's performance organically. The company offers some digital marketing services to advertisers, which has some potential in local markets. But too much growth in that business could cannibalize the company's print revenue.
And while some deep-value investors will be attracted to Gannett's ability to pay dividends, the attraction could soon fade. It will be risky to borrow too much against a declining earnings base, and rates may soon rise.
The good news is that Gannett will be "virtually debt free" after the spinoff, giving it flexibility to pursue acquisitions. The separation from the TV stations will also help because some geographic overlap would have prevented Gannett from buying local newspapers in the same places.
But it's risky to count too much on acquisitions to turn the business around. The newspapers that would fit best with Gannett are probably other local and regional papers rather than large metropolitan dailies. Other potential buyers such as Warren Buffett have already shown interest in local print assets and might make any auctions crowded.
Indeed, it may be hard for Gannett to move the needle with acquisitions anytime soon. Janedis expects the print business to generate $460 million of Ebitda in 2014. Assuming the company trades near the industry average of about five times Ebitda, it will have a market capitalization of $2.3 billion. Unless Gannett rustles up a large surprise acquisition target, investors will probably wish they had canceled their subscription.
—By CNBC's John Jannarone.