Torstar's ongoing value trap

According to my weekend newspaper, “Fairfax’s Torstar investment scores points for value“.

Here’s the investment thesis from Norman Rothery’s piece:

“The past few years have been particularly hard on the industry, and the financial crisis was the last straw for many newspapers…. Those that survived are but shadows of their former selves. As a result, the idea of buying newspaper stock seems preposterous. But Fairfax Financial’s Prem Watsa thinks otherwise. His firm recently snapped up another 3.4% of Torstar’s Class B shares [at $5.35] and it now owns roughly 22.7% of them.”

Apparently, buying stock at “0.54x book value” (0.68x by my math) and “5.4x forward earnings” is the way to go, and Mr. Rothery’s bought some Torstar stock himself. “Those are attractive metrics for many value investors.”

Mr. Rothery highlighted some of Torstar’s current financial woes: a money losing year thanks to a $77 million writedown of intangibles; declining revenue over the past five years, which has led to weaker gross profits and free cash flow. Thus the low book value multiple and equally low forward earnings multiple, one would think. If the horizon is murky, particularly with the backdrop of a declining business, it is tough to value stocks.

In Torstar’s case, perhaps it’s not so difficult: the company had $534 million of goodwill on its balance sheet as of December, and another $51 million in the form of a deferred income tax asset. As such, 43% of Torstar’s assets are up-for-dispute. Add to that the fact that another 10% of Torstar’s assets that are in PP&E (Capex consumed $23 million last year), which are likely most useful if you want to publish newspapers and the like. No wonder its shares are trading at “0.54x” book value.

Just the same, Mr. Rothery believes the “market has over-reacted to the situation. If it has, Mr. Watsa stands to make a tidy profit on the stock.”

I suppose that’s entirely possible, if Fairfax hadn’t paid around $20/share for its original 18.2% non-voting Torstar stake seven years ago. TS.b needs to rise about 200% before Fairfax earns a profit on the entire position. Fairfax shares have risen almost 80% over the same time period, which speaks to the benefit of not exposing yourself too much to any single “value” investment; but that’s why you buy the “parent company’s” shares, not the individual punts.

In 2009, the very same Globe and Mail reported that Mr. Watsa “regrets his investments” in the media business:

The chief executive officer of Fairfax Financial Holdings Ltd. (FFH:TSX) told investors yesterday that his financial bets on two of Canada’s biggest media companies were predicated on the value of the operations being much higher than their share prices.

“Industry conditions [were] perhaps worse than expected, and management’s ability to navigate them. It’s very difficult, but perhaps they might have been able to do a little better,” Mr. Watsa said after the company’s annual meeting.

Fairfax has been basking in profits from credit default swaps that it began buying in 2003. The swaps largely amounted to bets that a number of major international financial institutions would tumble, and Mr. Watsa noted yesterday that Fairfax was losing money on them until 2007.

But he did not sound optimistic that the company’s media industry bets will ultimately fare as well. With hindsight, he said, they were mistakes.

“If you take the parts of either of the newspaper organizations and you add them, the stock price was much less than that,” Mr. Watsa said. “We should have been a lot more careful, both about the newspaper business as well as the ability of management to navigate” the situation.

I hope Mr. Rothery searched the Globe archives before putting pen to paper. If he had, he’d have found that Mr. Watsa had already outlined that the original premise for buying Torstar shares, back in 2007, was that they were trading below book value. Same as today. The only difference now is that you can buy-in at much lower share prices. And, when valued on a tangible book value basis, Torstar isn’t so cheap.

If you are going to give advice to retail investors about following smart investors into a particular stock issue, make sure you point out when that very same smart investor is down so far on his/her investment.

That Warren Buffet recently ended his 40 year relationship with The Washington Post in a $1 billion transaction gives you a sense of how others see the long term future of the newspaper business. That, too, would have been relevant information to anyone being advised to invest alongside a big name like Mr. Watsa.

When you are down more than 70% on a position, and you buy a little bit more, it’s called averaging down. Not value investing. Particularly when a very high profile value investor is exiting one of his most beloved positions in the same sector.

MRM
(disclosure: this post, like all blogs, is an Opinion Piece)