The Princess and The Frog

Transcription

1 Pan-Europe Media - General (Citi) Industry Focus 204 pages The Princess and The Frog Upgrade Wolters Kluwer & Johnston; Downgrade UBM & Trinity Kiss The Princess, And Only Selectively The Frog The European media sector trades exactly in line with the Pan European Stoxx index at 9.5x 2009E P/E. The Princess professional publishers and consumer subscription trades at 10.6x relatively good value versus 11-12x for Pharmaceuticals, Household Products and Food. Limited organic growth, cost savings and currency should deliver EPS growth for these groups. The frog media owners could turn into a prince but most likely a dog like their EPS, they are generally not to be relied on. Top Picks Pearson, Wolters Kluwer, Vivendi, WPP and BSkyB are our top picks. Our main changes today: upgrade Wolters Kluwer (1H) on earnings resilience, valuation and positive regulation; downgrade UBM (3M) and Trinity Mirror (3M) on the grounds of valuation/earnings risk. We also upgrade Johnston Press to Hold (2H) on valuation. Sector Strategy We see two options: (1) buy decent value, resilient businesses: Pearson, Wolters and Vivendi; (2) buy early- to mid-cycle stocks where risk may be misperceived: we expect BSkyB to remain resilient operationally and see upgrades; we think WPP's leverage is comfortable and value looks compelling on a meet of consensus earnings; ITV has time to restore EPS power on regulation/ improving 2010E as it has long-dated, no covenant debt. Places to Avoid We see no merit in being long later-cycle stocks, so downgrade UBM to Sell (3M). This also informs our cautious position on Euroland media owners and advertising agencies (Mediaset, Telecinco, Publics all rated Sell). We see scope for a double dip for UK ad-funded media on retail ad pressure and downgrade Trinity Mirror to Sell (this factor prevents us being positive on DMGT). Feedback from Arizona The scale of the deterioration in 4Q advertising and the low visibility into 1Q (retailer warnings, rising unemployment, real estate foreclosures and bankruptcies) leaves us wary of being too positive on the European Media sector. Less bad areas are paytv, professional publishing and college, but no area is immune. There are mildly encouraging signs in the debt markets. Everything You Need for Results Season We preview results season for all the companies under our coverage. We see BSkyB and WPP as good performers over results. We see risk for media owners (especially Mediaset and Lagardere) both on 4Q numbers and the 2009 outlook. We acknowledge some risk to the timing of our Wolters upgrade, given euro strength, hedging and project revenues. For details of all rating, target price and EPS changes made in this report, see Figures European Media Team Marc L Sugarman marc.sugarman@citi.com Thomas A Singlehurst, CFA thomas.singlehurst@citi.com Ruchi Malaiya ruchi.malaiya@citi.com Catherine T O'Neill catherine.oneill@citi.com Italian Country Analyst Mauro Baragiola mauro.baragiola@citi.com See Appendix A-1 for Analyst Certification and important disclosures. Citi Investment Research is a division of Inc. (the "Firm"), which does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the Firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. Non-US research analysts who have prepared this report are not registered/qualified as research analysts with the NYSE and/or NASD. Such research analysts may not be associated persons of the member organization and therefore may not be subject to the NYSE Rule 472 and NASD Rule 2711 restrictions on communications with a subject company, public appearances and trading securities held by a research analyst account. Customers of the Firm in the United States can receive independent third-party research on the company or companies covered in this report, at no cost to them, where such research is available. Customers can access this independent research at (for retail clients) or (for institutional clients) or can call (866) to request a copy of this research. 1 Ltd

2 Contents Sector Strategy Into Recommendation Changes & Core Picks 11 Upgrading Wolters Kluwer (To Buy) 13 Upgrading Johnston Press (To Hold) 17 Downgrading UBM and Trinity Mirror (To Sell) 18 Rationale Behind Our Core Longs Pearson 23 Rationale Behind Our Core Longs Vivendi 28 Rationale Behind Our Core Longs BSkyB 32 Rationale Behind Our Core Longs WPP 35 Earnings, Performance & Valuation 39 EPS Changes and vs Consensus 41 Performance Data 43 Top-Down Forecasts & Previous Recessions 44 Valuation Moving Fast 49 Pensions & Debt 50 Monthly Data Points 55 Monthly Data Points 2008 Best Forgotten 57 Advertising Agencies: Agency Provocateur 58 Pan-Euro Free TV: Remote Control 62 UK Newspapers: Read All About It 65 Calendar & Previews 71 Media Reporting Calendar 72 Company Contacts 73 Aegis FY08 Estimated 18 March 74 Antena 3 FY08 19 February 76 BSkyB 1H09 28 January 78 DMGT IMS 11 February 80 Eniro FY08 18 February 82 GfK FY08 26 February 84 Havas FY08 Estimated 09 March 86 INM FY08 Estimated 26 March 88 ITV FY08 4 March 90 Johnston Press FY08 Estimated 4 March 92 2

3 Lagardere FY08 11 March 94 M6 FY08 10 March 96 Mediaset FY08 Estimated 10 March 98 Pearson FY08 2 March 100 Prisa FY08 Estimated 6 February 102 ProSiebenSat.1 Media FY08 4 March 104 Publicis FY08 11 February 106 Reed Elsevier FY08 19 February 108 Schibsted FY08 27 February 110 Seat Pagine Gialle Estimated 17 March 112 Telecinco FY08 Estimated 27 February 114 TF1 FY08 18 February 116 Thomson Reuters 4Q/FY08 24 February 118 Trinity Mirror FY08 26 February 120 UBM FY08-3 March 122 Vivendi FY08 2 March 124 Wolters Kluwer FY08 25 February 126 WPP FY08 Estimated 27 February 128 Yell 3Q09 5 February 130 Changes to Forecasts 132 Profit & Loss Summaries 150 Appendix A

4 Sector Strategy Into 2009 Our January conference in Arizona produced little cheer in the words of one CEO, there is no light at the end of the tunnel, and that is to save money. The overwhelming view was of a tough Q4 that would get tougher in Q1. We heard of a material step down in trend in outdoor, magazine advertising and internet spend (search, display and ecommerce) during Q4. There was also concern that more shoes would drop with rising unemployment, foreclosures and bankruptcies. In terms of EPS, we are now 3-4% below consensus across the sector; in October, we were 20% below, so in relative terms, we feel more comfortable with consensus. Having said this, our forecasts are built around an average recession, typically -4% to -5% real advertising growth, while banking-led recessions can be far worse. The Scandinavian banking recession of the late 1980s, early 1990s saw a 20% real decline over four years in most Scandinavian markets. Despite the bleak mood, we are minded to stay reasonably balanced on the sector given early signs that corporate issuance is a little stronger, and valuation for the sector that looks still quite attractive. Against this backdrop, we are still biased long EPS growth, short leverage. Our core longs are Pearson, Wolters and Vivendi. Pearson and Vivendi should remain beneficiaries of market share, strong balance sheets and yield, and should see EPS resilience from a combination of acquisitions, currency, cost measures and certain areas of counter-cyclicality. Wolters has solid EPS growth on cost savings, some currency benefit, reasonable leverage given its cash generation and is likely to be a beneficiary of US regulatory change. We try to avoid late cycle, and for this reason turn Sellers of UBM, where we see margin pressure across the group. Our media owner longs are: ITV, which we see as early cycle, a regulatory beneficiary and with long-duration, no covenant debt; and Schibsted, which is the only media owner with a genuinely strong internet proposition (c. 60% EBIT online), and may face a slightly more benign set of economies. In the consumer subscription space, we think BSkyB will enjoy the strongest organic growth in the sector and has a number of cost levers. To complete the picture, we are also long WPP and Aegis, both strong currency beneficiaries, and particularly for WPP we think there is less risk to Q4 than is perceived. Shades of grey; watch the credit markets Our strategists at the start of the year upgraded the media sector to overweight with Pearson and Vivendi among their core portfolio. We are still Buyers of Vivendi, but argue that Wolters Kluwer may prove a better performer, as with the de-rating of Maroc and Activision, Vivendi s core has rerated from under 2.9x 2009E EBITDA to 4x on slightly reduced forecasts (subsidy of France TV within SFR). We argue that if the sector is to outperform, leadership will be narrow, and we argue for Pearson and Wolters as our two fundamental Buys. Our strategists mantra remains simple long growth, short leverage. They argue there is no need to double up on risk with valuations where they are. We pay close attention to S&P and Moody s issuance as indicators of the health of credit markets (credit markets drove us into recession and must surely drive us out) enduring stabilisation here might prompt a move to riskier stocks. Until we see the effects of unemployment, bankruptcies and real estate foreclosures on credit markets, we are wary. However, reasonably stable yearon-year issuance currently provides some potential light at the end of the tunnel, and this informs our balanced overall view. We see the sector in three broad parts: first, defensive professional publishers; second, defensive late-cycle business to business, agencies and consumer subscription; and third, highly cyclical media owners. We argue that there is no longer a black and white choice we have Buy recommendations in each of these spheres. The most interesting area may be the middle tier, as this is where the most dispute over EPS lies. 4

5 Among the defensive professional publishers, we are long-term buyers of Pearson, as we like education exposure (for 2009 we expect US schools will be very soft, but college, assessment and international should mitigate this), see the group as a market share gainer, believe EPS risk is balanced (Pearson is the largest currency beneficiary in the sector) and like Pearson s balance sheet strength. We also upgrade Wolters Kluwer to Buy today. We see relative resilience of EPS on cost savings potential (Springboard plan of 120m over the next three to four years should underpin profitability even against tough revenue environment), and marginal potential upside that comes from increased regulation on financial services (positive for tax and financial), and government spend on health & wellness and Healthcare Information Technology in the US (may boost the group s Health division). Finally, Wolters from time to time has been seen as a potential bid target, and with a new CEO at Reed, this may well come back into investors thinking. We think there is too much EPS risk in Reed from greater than perceived cyclicality, and refinancing risk. In the middle tier, among consumer subscription models, we are buyers of BSkyB and Vivendi. Both have strong balance sheets and long-maturity debt. In the UK, BSkyB looks better placed than its competition and has a rich vein of product offerings which are driving subscriber growth. There are risks: fibre deployment (extremely long term), vulnerability of high ARPU revenue streams and the paytv review. We expect a strong Christmas quarter and see costsaving opportunities, so argue investors are compensated for these risks. BSkyB is taking market share in concentrated markets. Vivendi has attractive investment characteristics: a strong balance sheet, cash generation and yield, and low multiples. In this kind of market, these factors more than offset concerns around some of its assets: recorded music (although UK returned to growth Q4 and UMG was standout); rising churn at Canal+; regulatory headwinds at SFR, fourth-entrant risk and slowing enterprise; advertising exposure at NBC; and slower growth at Maroc. Our telecom analysts are slightly less positive on their sector going into Whilst they are concerned the sector is over-owned, they argue that it is relatively EPS and FCF resilient (they see potential for lower subscriber acquisition and retention costs and capex). Within Vivendi s sum of the parts, we value SFR at 4.5x EBITDA, in line with mobile, and arrive at a valuation of per share. WPP looks cheap enough to us, despite some late-cycle qualities (a variable cost base can preserve near-term numbers, but an enduring recession will reveal operational leverage, and high cancellation rates for client campaigns probably defer the pain). WPP is also a strong dollar beneficiary with the strongest new business in 2008 among the European agency groups. Publicis and Havas suffer from euro strength, and downside margin risk for Publicis there is risk of cushion being used in 2007 to drive margins; for Havas, there is the operational leverage risk of a smaller business. 5

6 Historical cycles warn us of the operational leverage at PRNewswire, and we argue that exhibitions (heavy exposure for UBM) are late cycle and operationally levered. DMGT to us has higher-growth assets, but its exposure to regional newspapers and retail advertising within national suggests that it is too early. In the third category, the media owners, we prefer the UK more secularly advanced, more regulatory relief potentially, earlier cycle and our economists forecast inflation in 2010 as well, which may help advertising. We are Buyers of ITV for these reasons, as despite high levels of expensive debt, it has long maturity and no covenants. Trinity Mirror in our view is no longer cheap enough given its leverage, significant exposure to retail advertisers, secular pressures and market share loss. For the media owners, we pay close attention to our retail analyst views, as the cyclical drivers are similar consumer disposable income. They argue that the recent 250bp of interest rate cuts and fall in inflationary expectations sharply increase available household cash, and this typically drives non-food retail sales with a 3-6 month lag. This positive is somewhat mitigated by consumer de-levering In Europe, we argue the economies may be late cycle and policy accommodation has been far weaker. Our retail analysts note a more cautious French demand outlook. The real question for Mediaset is whether DTT develops into an ad-funded platform, as has been the case in Northern European markets; we think it might, hence our Sell. The Spanish, French and German groups suffer either from high ad prices, strengthening DTT and/or high debt levels. Lagardere may not receive the cash the market expects from its Canal+ France stake, and in our view has more cyclical / currency translation risk than is discounted. EPS reflect average recession; risk to downside Between 2007 and 2009E (forecast recession in all major Western markets and Japan), we forecast a 24% decline in sector EPS. We have limited EPS changes in this report. We were 20% below consensus in October 2008 (see our report Pretty Ugly, 27 October 2008) but are now only 3-4% below. This phenomenon of bottom-up and top-down EPS coming more into line, so delivering a tighter consensus EPS range, is common to many sectors (nonfood retail has also seen this). Unsurprisingly, we are marginally above IBES consensus for most of our Buy recommendations: Pearson, Wolters and BSkyB; and materially above for WPP and Aegis. We are below consensus for UBM and most of the media owners. Notwithstanding a tighter consensus range, there is still, in our opinion, significant downside EPS risk from two main factors. First signs are that this may be far worse than an average recession in the aforementioned report, we discussed the Scandinavian banking recession, which in most Scandinavian markets drove advertising down by over 20% in real terms over a three- to fouryear period. This contrasts with the 1991 and 2001 global real advertising decline of 4-5%, on which our current forecasts are modelled. Second, there is still some refinancing risk, and with cash attracting 1% and high-yield debt costing over 10%, EPS risk here is high. 6

7 If there is some respite from EPS downgrades, it is likely to come from cost flexibility and currency benefit (UK phenomenon). The early-cycle, highly operationally leveraged, secularly challenged media owners (often high financial gearing) have arguably been sucking out costs for so long that they have limited flexibility. It is noticeable that newspapers are getting thinner performance and current valuation The European media sector had very strong relative performance in 2H08 (16% relative to Stoxx 500 for 2008, and more than 100% of this in the 2H), the first meaningful period of outperformance since There were three main drivers, in our opinion: first, the media owners have been so bad for so long that multiples were already very low, so stocks did not respond so much to EPS pressure; second, US$ weakness was a big boost to EPS for professional publishers and agencies; third, sector constituents have changed so that the large-cap, relatively defensive, US$ exposed, under-levered stocks make up a disproportionately large part of the sector. We think that to look at valuation in a meaningful way, we need to break the sector and the market into two. While the Pan European Stoxx Index is trading at around 9.5x P/E (the media sector is 100% in line with the market overall), resilient sectors like consumer staples and pharmaceuticals are trading at 11-12x (Healthcare 11.7x; Food & Beverage on 12x; Household & Personal on 11.7x). In this context, we argue that the professional publishers on 11x are still decent relative value. BSkyB is not cheap at 13.1x calendar 2009E, but this falls to 11x 2010E on our estimates. There is less of a relative argument for the media owners and those stocks which we see as truly late cycle. This is either because multiples are so low reflecting solvency risk or so high reflecting trough EPS that they are less relevant. We attempt to evaluate these stocks first and foremost on EPS surprise and second on how enduring the long-term franchise appears. ITV comes out best on the latter and OK on the former. DMGT comes out poorly on the former, and this is what prevents us from taking a more positive view we do see value in the franchises. We see negative surprise on Lagardere despite a strong valuation case (see our report French Media Owners: Lagardere Too Many Pressures; TF1 Dividend Risk, 12 December). We also see severe margin risk at UBM. The other television and newspaper stocks have too much margin risk for the most part to be called cheap in our view. Messages from EMT Arizona conference While there were some silver linings: Affiliate fee inflation for cable networks remains strong (positive for NBC, over half its revenues are from cable networks). National remains better than local, although this is not saying much. Mobile messaging and non-messaging data is exploding in US. In Europe, data messaging is far more mature, but the take-up of 3G and smart phones promises far greater non-messaging data volumes (according to ComScore in the last 6 months in the US over 50% of handsets were 3G or smart phone). The problem is bill fatigue in a tough economy and the lack of strong models to monetization. 7

8 PayTV remains resilient to date, particularly as regards churn and gross additions. Although SAC is rising, customers are coming in on higher boxes, prompting less medium-term swap out costs. Pricing power is mid single digit and this is mitigating spin down at present. Video games remain an area of attraction for corporates. E-commerce was strongest in sports equipment (not particularly relevant) and video games through the holiday season according to ComScore. Although US schools will struggle in 2009, the outlook for 2010/11 looks strong. College, assessment and international should also see positive growth. Most areas of professional publishing are still growing, though less strongly. There are positive regulatory stimuli in medical publishing as patient records are centralized. There is also a fiscal package earmarked for health and wellness Web MD interpreted this as $50bn of marketing spend. Similarly, educational publishing is likely to see an inflow of money. Match.com is doing well (the dating site), IAC s CEO Barry Diller stated that "if consumers cannot have a financial future, they may as well have an emotional one". Deep set concerns dominated the conference: Q4 saw a marked step down in outdoor (CBS), magazine ad pages (Time Warner and Meredith) and pricing, search revenues (Infospace). The scatter market looks weak for the broadcast networks. Visibility into Q1 is at all-time lows (days) and with retail profit warnings and in many cases tough comps, the outlook is worse not better. There is so much demand coming out of the market and so much supply from new media that deflation is likely to be high. This tallies with comments from P&G and Diageo at the end of last year which suggested they anticipate seeing 25% deflation as they exercise their scale. The internet did not hold up. E-commerce was down 3% through the holiday season (partly secular as physical retail cut prices so hard, partly cyclical) versus physical retail down 9%. Historically, e-commerce has outpaced physical by 15ppt. Online travel and advertising also took a strong leg down. Q4 search advertising was negative quarter on quarter, and in UK also year on year. While there was optimism over new technologies: smart phones; fibre; and visibility of integrated PC TV functionality; routes to monetization remain limited and the tough cycle will inevitably delay progress. Refinancing risk remains a concern and source of downgrades, but extreme costs of financing have moderated somewhat (15%+ to lower double digits). We broadly think that these messages support our bias within the professional publishers and consumer subscription. 8

9 Previewing EPS season hard hats on This results season promises little cheer. Q1 last year for the most part was resilient, so the likelihood of a tough Q4 and tougher Q will make for poor trends and tempered outlooks. For a clutch of stocks, this will come as no great surprise, but given the recent rally, this may be enough to prompt a reversal even where bad news was anticipated. Broadly, we would argue for the media owners, with the possible exception of Mediaset and TF1, which had strong Q3s, there is an expectation of bad news. There are also likely to be some genuine negative surprises. We saw Publicis revise its view of a flat/positive organic year for 2009 at the end of We think Mediaset s Q4 comparable will have been too difficult in the context of a weakening global economy for the group to avoid a warning. We also think the decline in US magazine ad page volumes, problems in retail book publishing and the deterioration in Eastern Europe will be more pronounced for Lagardere than the market anticipates. This will be exacerbated by the strengthening of the Euro, which will likely affect consensus forecast changes post results. This may also be an issue for Wolters Kluwer, which may have also suffered from disappearing project revenues and is exposed to currency trading risk. Having said this, we argue that a combination of valuation and long-term fundamentals are positive if the group can get through results relatively unscathed. This risk on project revenues may also prove an issue for Aegis, although a weakening against the US$ and Euro should provide a significant cushion into The same is true for WPP, where we think expectations are particularly low, so we see the risk is of an upside surprise. For the other professional publishers, the 1H outlook is likely to be tougher. Thomson Reuters remained reasonably robust at our conference but CFO Bob Daleo said that Q4 deteriorated on Q3 for the markets division, and 2009 will be worse than We think February guidance for TRIL may surprise positively (not too negative markets growth and resilient professional), but the stock has been strong of late, so arguably it needs this. Pearson faces a tough 1H comparable for 2009, but had a strong 2008 and has a strong enough market share and EPS story (partly currency) to sustain it, in our view. At Reed, there are issues around refinancing and greater cyclicality left in the business with the decision not to dispose of RBI. This will be Crispin Davis last earnings call as CEO, so the real interest for Reed may wait until Ian Smith takes the reins in March and then presents his vision later in the year. At Vivendi, warnings from Electronic Arts and Take Two are likely to weigh on investors minds, but we expect Activision to have had a strong year. Churn levels at Canal+ are concerning and guidance for mobile will have to incorporate both termination rate cuts and the subsidy for France TV (0.9% service revenues). SFR s guidance on SARC and data revenues will be interesting, as the market evaluates whether there is enough to mitigate these pressures. There maybe positive surprise in music, which we think ended the year strongly based on industry data and releases we have seen. Greater focus may be on any update on Digital+. Finally, at BSkyB we expect continued progress in subscriber trends and decent operating profit performance as the Q1 trends continue in a seasonally strong quarter with more marked hardware price reductions. The concern is greater evidence of ARPU degradation, but on balance, we think the quarter will be a positive catalyst. 9

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11 Recommendation Changes & Core Picks 11

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13 Upgrading Wolters Kluwer (To Buy) As a business, Wolters Kluwer is perhaps a little unexciting, but in the current environment we think this should be a virtue. The group is essentially defensive, with 80% of the business from classic professional publishing activities serving stable legal, tax, accounting and healthcare industries. While there is pressure on the group s cyclical revenue streams (transaction revenue streams in Corporate & Financial Services as well as pharma-related advertising revenues in Health), the group s Springboard cost-saving programme should safeguard margins into the medium term. We also note that longer term there are potential structural trends that significantly benefit Wolters business. Tax & Accounting should continue to benefit from ongoing changes in tax and accounting regimes the introduction of IFRS in the US in the next five years could be a significant potential benefit to this business. Within Health, while Pharma-related marketing activity is facing pressure near term, increased spending on health/wellness by the incoming Obama administration as highlighted by WebMD at our Arizona conference could be a major boost (said to be as much as $50bn albeit over an unspecified timeframe), as could increased spend on Healthcare Information Technology (HIT). Finally, while Thomson Reuters has said that it is not interested in Wolters Kluwer as a potential acquisition target, an incoming CEO at Reed Elsevier with a track record of strategic u-turns may take a different view (based on prior experience at Taylor Woodrow). Bears will argue that the group requires investment to bring its electronic distribution platforms up to scratch with peers, has slightly more cyclical exposure than one would like (although at 20% of revenues this is less than Reed Elsevier) and could come a cropper with its financial leverage and FX. These are valid points and we highlight the importance of the latter in our preview of the FY results and for this Wolters deserves a discount to peers. Our argument, however, is that it is not deserving of the c.20% 2009E P/E discount that it trades at (8.9x vs.10.6x for the sector). We see scope for a relative and absolute re-rating and upgrade our recommendation from Hold/Medium Risk (2M) to Buy/High Risk (1H). The High Risk code reflects our near-term concerns, especially over the group s FX hedging policies and the impact on cash flow. Our new price target is 18 (from 13.5). Wolters Kluwer The Push and The Pull The bull arguments on Wolters Kluwer are as follows: Defensive business Wolters Kluwer is essentially a defensive business. c.80% of revenues are non-cyclical in nature, of which 67% is subscriptionbased. While we anticipate pressure on Wolters Kluwer s cyclical revenue stream, we expect organic revenue growth to remain positive in the medium term. 13

14 Figure 1. Cyclical vs Non-Cyclical Revenues 1H08 Figure 2. Subscription Revenues 1H08 Other Cyclical 13% Training 2% Advertising 4% Non-Subscription 33% Subscription 67% Non-Cyclical 81% Source: Wolters Kluwer Figure 3. Electronic Revenues 1H08 Source: Wolters Kluwer Figure 4. Geographic Split of Revenues Services 16% Asia Pacific 3% Electronic 50% Europe 47% North America 50% Print 34% Source: Wolters Kluwer Source: Wolters Kluwer Cost Cushion The Springboard efficiencies plan initially targeted 50-75m of savings per annum from 2010E. This was subsequently deepened and accelerated. The group now expects 120m of annual savings by 2011E. This, on our numbers, should mean that margins stick at around 20% despite limited or no organic revenue growth across the period. Figure 5. Wolters Kluwer Anticipated Cost Savings, 2008E-2011E (Year-end December, m) 2008E 2009E 2010E 2011E 08-'11E Springboard Excellence Plan Run rate savings Group Restructuring charge Net Impact on Group Source: Company Reports Regulatory Benefits As outlined above, there are a number of areas where increased regulation or changes in regulation, an/or government policy may positively affect Wolters Kluwer s businesses. In particular we note the potential positive impact of migration from US GAAP to IFRS on the Tax & Accounting business. We also as per WebMD highlight the potential benefit of the incoming Obama administration s plan to invest heavily in health/wellness communication programmes (said to be worth up to $50bn over an unspecified timeframe). 14

15 Corporate Action While not a cornerstone of our view, discussion of corporate action could come back on to the agenda once near-term refinancing pressures at Reed Elsevier are resolved, especially with an incoming CEO revisiting strategy. (Note that Reed has previously been mentioned in press reports as a potential acquirer of Wolters.) Thomson Reuters, meanwhile, has been more specific on its lack of interest in Wolters Kluwer. We see the following bear arguments on Wolters: Cyclical Risk Wolters generates around 20% of revenues from cyclical activities, including advertising (c.4% of group revenue) which declined 7% in 1H08. The balance is the transaction-driven revenues within C&FS, which makes up c.13% of group revenues (40% of C&FS) and 2% of trainingrelated revenues. While these revenue streams could contract meaningfully in 2009E/2010E (10%+), the proportion of the business from these activities is sufficiently small as to mitigate the risk to the whole group. Pointedly, we note that less defensive revenue streams for Reed Elsevier makes up 40% of revenues (RBI, Exhibitions and the non-legal/non- Insurance components of LexisNexis), for Thomson Reuters 60% of revenues (the Markets division), for Pearson upwards of 25% of revenues (FT newspaper plus US Schools). In this context, Wolters doesn t look that bad. Investment Risk A legacy concern of ours and the market is that Wolters faces a significant investment hump as it catches up with Reed and Thomson with regard to its electronic distribution platforms. There is no escaping the fact that investment is required; however, while the group has started late vs. peers like Reed Elsevier and Thomson Reuters, at least the transition now should be more efficient (less trial and error) and lest costly (reflecting significant technology cost deflation in the decade since Reed/ Thomson started the transition). In is worth noting that investment so far is no less effective: Wolters reports significant improvements in retention rates on electronic services/solutions. Leverage & FX Hedging Something we raise as a concern is the group s leverage and the impact of FX hedging on cash flows. 2008E debt is expected to be at, or mildly above the 2.5x net debt/ebitda level as per company s guidance, even if the maturity profile is eminently comfortable. Some of this is a function of acquisition spend in 2008E but we fear some may also be driven by the reversal of cash inflows from FX hedging (as per the 1H). Having been a positive factor driving cash inflows, the group s proactive hedging policy could be a risk factor if and when the devalues, especially vs. the $. 15

16 Valuation and View We believe Wolters Kluwer will struggle to keep pace with its peer group in terms of underlying growth through the cycle. To address this it will need to invest perhaps not as much as the market fears but enough to act as a drag on returns. The group s leverage and hedging policies are also a mild cause for concern. Nevertheless, the group should post comfortable mid-single digit earnings growth (constant FX) even during a downturn given the business mix and cost savings programme. Even if Wolters Kluwer deserves a discount to the peer group, when we look at relative valuation we discover that this is already the case. Indeed at 8.9x 2009E P/E, vs. peers on 10.6x, the discount is approaching 20% which is too extreme in our view. It is a combination of the relative security of earnings and valuation that underpins our upgrade to Buy from Hold, while the uncertainty relating to trend growth and FX hedging going into FY results drives our move to a High Risk code (from Medium). In absolute terms, we can justify a price target of 18 based on a 10% discount rate and a 1% long-term growth in perpetuity, which doesn t seem unreasonable given the group s capital structure and growth profile. 16

17 Upgrading Johnston Press (To Hold) Our key views on Johnston Press and the regional newspapers business model are unchanged. Advertising trends are deteriorating fast and leading to accelerated structural shifts. However, with the recent share price underperformance, Johnston now trades 15% below our new price target of 18p. At 5.5x 2009E EV/EBITDA and 3.0x 2009 PE, it trades at what we believe to be a justified discount to its consumer publishing peers (6.5x 2009E EV/EBITDA, 9.0x 2009E PE). We therefore upgrade to Hold (from Sell) At the same time we move our risk code to High (from Medium). We see a number of risks as outlined below. Key risks: We still see substantial pressure on regional advertising and forecast significant declines in 2008/09 (see Figure 6 for recent ad trends and forecasts). Furthermore, slowing digital growth means there is less of an offset. Given the high operational gearing of the business, top-line declines can have a significant impact on the bottom line (we already forecast a 1260bps margin decline between E). On digital, the risk is that the group may hold back investment during the tough environment which may hurt longer-term prospects for the regional media business model. To date, investment in online has been insufficient to build a presence to compete effectively with national players. On our current forecasts, we see net debt/ebitda reaching >4x (current banking covenants) by year-end In reality, we expect the group to refinance or renegotiate covenants before breaching them; however, the uncertainty over debt refinancing (the group is currently in negotiations to refinance September 2010 debt) makes us cautious. At current valuation (as discussed above), we feel risk-reward is balanced. Figure 6. Johnston Press Advertising Growth (%), E % 2007 Jan-Feb 08 Mar-Apr 08 Jan-Apr May-June 1H08 Jul-08 Early Year to July-Oct FY08E FY09E August Nov 1st 08 Total UK (print + online) By Category: Recruitment Property Motor Display "deteriorated" NA NA Print only growth Online only growth Republic of Ireland 4.5 worse than UK Source: Citi Investment Research, Company reports deteriorated NA

18 Downgrading UBM and Trinity Mirror (To Sell) We downgrade UBM to Sell/Medium Risk (3M) from Hold/High Risk (2H) and Trinity Mirror to Sell/Medium Risk (3M) from Hold/Medium Risk (2M). We argue that both stocks have performed extremely well, tilting risk-reward for each of them: Trinity Mirror because it still shoulders a significant debt burden and is likely to see negative earnings for the next two years; UBM because each of its businesses are vulnerable to slowing or negative revenue growth, and most of its divisions are heavily operationally levered and in some cases late cycle. We make the overall point that if one were to compare DMGT to a combination of UBM and Trinity Mirror (similar mix and EV, though DMGT has more debt), DMGT now looks the cheaper, and in our view has a far superior collection of assets. Our sense on DMGT is that its debt levels and exposure to retail advertising may lead to continued subdued performance over the reporting season; however, over the longer term, we think DMGT looks more attractive relative to UBM and Trinity Mirror. Relative views If we are correct to argue that a combination of UBM and Trinity Mirror is a good proxy for DMGT, then the divergence in performance over the last quarter or so has been notable. Figure 7. DMGT, UBM, Trinity Mirror Price Performance Since 27 Oct Trinity Mirror +63% Price Index (Rebased to 100 at 27 Oct 08) UBM +21% DMGT-12% Oct Nov Nov Nov Nov Dec Dec Dec Dec Dec Jan-09 DMGT Trinity Mirror UBM Source: Datastream, Citi Investment Research Priced rebased to 100 at 27 Oct 08 (date of previous Media sector report) As Figure 7 shows, the divergence in performance over the last two and a half months has been pronounced, and now valuation metrics of the entities are similar, and actually if anything DMGT is now the cheaper stock. 18

19 Figure 8. Valuation and Leverage UBM-Trinity combination vs DMGT UBM-Trinity Mirror DMGT UBM market cap 160 Market cap 935 Trinity Mirror market cap Net debt Total EV Combined net debt YE EV Pension deficit (Trinity + UBM) As At As At Trinity Jun-08 Pension deficit 41.2 Sep-08 UBM 19.3 Jun-08 As At Gross Pension liabilities (Trinity + UBM) As At Pension liability 1621 Sep-08 Trinity Jun-08 UBM Jun-08 EV adjusted for pension deficit ( 1 ) EV adjusted for pension deficit ( 1 ) EV adjusted for deficit and liability ( 2 ) EV adjusted for deficit and liability ( 2 ) E UBM - TNI DMGT EV/EBITDA Adjusted EV/EBITDA (1) Adjusted EV/EBITDA (2) Leverage ex the buyout consideration Source: Citi Investment Research 1 EV plus pension deficit 2 EV plus pension deficit, plus 10% gross liabilities, reflecting assumption of funding on the event of a buyout We considered upgrading DMGT in this report, particularly as we believe DMGT s business divisions have faster organic growth (see next table), but given the leverage level and the exposure to retail, we think it is more sensible to wait until after the 1q results to see if significant downgrades mean that debt does indeed become an issue. Figure 9. Organic Revenue Growth DMGT and UBM DMGT - B2B Year to UBM Year To September DMGi Exhibitions Euromoney Total DMGT B2B Dec Total UBM (c.80% is B2B) 2008A 5% 2% 3% 4% 2008E 0% - 5% 2007A 17% -5% to -10% 14% 10% 2007A 5.0% 2006A 17% 1.5% >10% 12% 2006A 4.3% 2005A 11% 11% 5% to 10% 10% 2005A 4.1% Source: Company reports and Citi Investment Research estimates UBM issues and valuation For more of an in-depth view on UBM, please see two reports we published at the end of last year. Disclosure Disappointing, Mix Encouraging, 5 August 2008 and One Risk Too Many Downgrade To Hold, 11 September UBM is a broad mix of business-to-business assets and PRNewswire, and by discipline, it is a fairly even mix of print, events and online / data. 19

20 Figure 10. UBM Group Revenue Split FY08E Online and Online Data 33% Events 31% Print 36% Source: UBM presentation Further, in its largest division, CMPI, the group is heavily exposed to construction. Figure 11. CMPi Exposure By Sector as at Dec 2006 Other 10% Licensed Trade 5% Healthcare 6% Music & Entertainment Technology 4% Travel 5% Consumer 5% Agriculture 5% International Exhibitions (incl Pharma and Chemicals) Property / Construction / Interior Design 42% Source: Citi Investment Research, Company reports 20

21 In Tech, the outlook is negative, with ongoing warnings / cautionary comments from Technology companies. Our US software analyst Brent Thill recently carried out a proprietary quarterly survey of Chief Information Officers. He wrote, "with CIOs expecting their 09 IT budgets to be down ~2%... the first time in 5 years of polling that CIOs expect their budgets to be down for the next year budget contraction that may get worse: 40% of US CIOs, or nearly 4x the previous 4 quarters average, expect their company to be worse off in the next 12 months; also notable was the meaningful uptick in the number of CIOs reporting they under-spent their 08 budgets... and, seems to fly in the face of those expecting an economic, or IT spending, rebound in 2H09". See the full report at As the global downturn starts to bite, we take the view that each of UBM s Business assets is vulnerable to negative organic growth, certainly in its print and on a late-cycle basis, its exhibition assets as well. The chart below shows that total spend by UK exhibitors on Trade and Consumer Exhibitions saw three years of contraction from 1990, with spend decreasing 7.7% CAGR between before returning to growth in The UK was in recession (defined as two consecutive quarters of negative growth) from 3Q 1990 to 3Q Figure 12. UK Exhibitor Expenditure, (Pounds in Millions) million Source: Marketline/ EIF. Figure 13. PRN Revenue Growth and Margin, E Revenue Growth (%) 35.0% 30.0% 25.0% 20.0% 15.0% 10.0% 5.0% 0.0% 20.0% E 2009E 2010E -5.0% -10.0% -15.0% -20.0% Revenue growth % Operating margin % 40.0% 35.0% 30.0% 25.0% 15.0% 10.0% Margin (%) In addition, although we model some contraction in margins at PRNewswire, we model nothing like the contraction we saw in the early part of this decade, and this is a further risk (Figure 13). Therefore, the main issue for us is the vulnerability of numbers set against this backdrop of strong share price performance. On valuation, a straightforward DCF with a 10% WACC and 0% long-term growth arrives at a valuation of 425p. Note that we assume a tax rate of 30% (long-term standard rate), rather than the 17% we expect the group to achieve this year. We argue that because there is a contingent liability of 80m in respect of disputed CGT (2007 accounts, note 33), this may mitigate some of the net operating losses / tax planning the group is set to enjoy. Source: Company Reports, Citi Investment Research 21

22 Figure 14. UBM Sum-of-the-Parts Analysis Revs EBITDA EBIT Margin % Tax rate PAT EBITDA P/e Revenue Valuation Valuation 2009 m m m 30% m x x x m P PR Newswire % Technology % CMP Asia % CMPi % CMP Medica % Commonwealth % RISI % Corporate costs Sub Total % Minorities EV Net debt Market cap target Holding company discount 5% Source: Citi Investment Research Trinity Mirror valuation and debt tilt risk reward negatively Our call on Trinity Mirror is really about valuation and debt levels. With the stock having almost doubled from its lows, the risk-reward, given the issues facing the group and the poor economic backdrop, looks poor in our view. Figure 15. Trinity Mirror Valuation Metrics 2008E 2009E 2010E Trinity share price (p) 61 Market capitalization Enterprise Value Adjusted EV (pension adjustment) EV/ Sales 0.7x 0.8x 0.8x Adjusted EV/Sales 0.8x 0.9x 0.9x EV/ EBITDA 3.2x 5.2x 5.9x Adjusted EV/EBITDA 4.0x 6.5x 7.3x P/E (basic, normalised) 1.9x 3.9x 4.5x P/FCF 5.7x 14.6x 26.1x Free cash flow yield 17.5% 6.8% 3.8% Dividend yield 5.2% 0.0% 0.0% Net Debt/ EBITDA 2.31x 3.77x 4.24x (Net debt + pension deficit) / EBITDA 3.1x 5.1x 5.7x EV/ Net Debt 1.4x 1.4x 1.4x Interest cover (EBITDA/ net interest) 8.4x 3.7x 3.5x Interest cover (EBITA/ net interest) 6.6x 2.9x 2.8x Source: Citi Investment Research For more in-depth analysis of the drivers of both regional and national newspapers, please see the section within this report on Read All About It. 22

23 Rationale Behind Our Core Longs Pearson We like Pearson s assets. We think education, in the US and internationally, should sustain solid growth, and Pearson should outpace its markets. The issue is that its businesses have both a negative phasing cycle in US schools and a negative economic cycle to deal with in 2009E. As a result, we model double-digit organic declines for US schools, Penguin and FT, and severe margin contraction for these businesses in 2009E. The weak $, however, results in reported EBIT and EPS growth of close to 10%. 2010E and 2011E promise very strong adoption cycles in US schools and the possibility of economic recovery. We feel valuation at 11.6x P/E is not a barrier given a E CAGR of 10% and low leverage. Our DCF, on a 9.0% WACC and 2% growth, gets to 800p. Pearson the push and the pull On the positive side We point to two reasonably recent factors which continue to persuade us of the priority in the US of funding education. First, in President-elect Barack Obama s book The Audacity of Hope, education is one of the policy priorities he writes about. In general, he argues that investing more money and investing better is vital for schools he talks about the global economy posing huge issues for the US economy (a digital world and a smaller world means more outsourcing of jobs to cheaper labour markets or mechanisation leading to unemployment) the remedy must be in training more engineers and others who can benefit from the knowledge-based global economy. He also talks about paying teachers more to improve standards but holding them accountable, which may be a boost for Pearson s Student Education Systems and testing businesses over time. Of more importance for Pearson, we think, Mr Obama also talks directly about poor educational text books and materials as a cause of poor educational achievement. With regards college, while he talks about the high cost of education particularly tuition fees (he makes no mention of text book pricing) one of his policy priorities is higher enrollments. He also talks about efficiencies from more investment in non-traditional colleges (Pearson is strong in community colleges), which require more emphasis on materials due to the lower ratio of teachers to students. We note the table below, which also demonstrates the counter-cyclicality of college enrollments. Figure 16. Absolute Level Of US College Enrollments, Figure 17. Year on Year Growth of US College Enrollments, Absolut level of post secondary education enrollments (thousands) 20,000 18,000 16,000 14,000 12,000 10,000 8,000 6,000 4,000 2, yoy growth in post secondary education enrollments 10.0% 8.0% 6.0% 4.0% 2.0% 0.0% -2.0% -4.0% Source: NCES Source: NCES 23

24 Above all, Mr Obama sees the US at a massive crossroads as a struggling economy in a global trade world and makes the link between global trade and global standards of education. This feeds into the second factor, which is that the recent Timms (Trends in International Mathematics and Science Study) study, which looks at educational standards across the globe, shows that the US is still lagging. The 2008 study showed (relative to the previous 2003 study) marginal progress for US in Maths, but none in Science. The study found that 1 : In the fourth-grade math survey, Hong Kong, Singapore, Taiwan, Japan, Kazakhstan, Russia, England and Latvia were higher than in the United States. Nearly half of eighth graders scored at the advanced level in math in Taiwan, Korea and Singapore. This compares to 6% of American students. Singapore dominated in science at both fourth and eighth grade. Scores for a few US states were analysed individually. For eighth grade science, students in Massachusetts scored higher than or equal to students in all countries except Singapore and Taiwan. We think Pearson looks well placed to take share in college and schools, in what have become concentrated (three-player) markets. We have discussed in previous research the high levels of leverage that Riverdeep in schools and Cengage in college are having to sustain, and the implications for investment. Further, McGraw Hill has lost significant share this year in both markets. McGraw is more exposed to Supplemental, which finished down around 12% in 2008, partly because in a digital world more supplemental help can be given to children within the core curriculum, and since Pearson is picking up share as a result of its digital programs, this trend looks positive. For McGraw, this issue is particularly important, as Supplemental is a high-margin business. By contrast, Pearson s exposure is more to growth areas. Custom products and MyLabs (remedial) have been strong in College. Pearson also owns strong digital products: 1) Envision Maths has massive market share in California / Florida; 2) Student Information Systems (SIS); 3) Edustructure connects school and state information systems; 4) Fronter (just acquired) enhances the learning experience. For Mr. Obama s education policies to work, and for funds to become available to invest in teachers and materials, there is a need to make savings in the business of education. Pearson is very strong in this area and facilitates a lot of those savings with some of the points made in the previous bullet assets like Edustructure and SIS are there to enhance productivity. Phasing for school adoptions in 2010E and 2011E looks very strong, and if this accompanies a recovery in FT advertising and some of the other economically cyclical areas of the business, EPS growth could prove strong in these years as well. 1 Summary of survey results sourced from the New York Times, 09 December