Why The Economist is Valued at $1.5 billion while The Washington Post was sold for $250 million

The Economist Thrives While Established Rival News and Magazine Publishers are Losing Money

By Ignatius Chithelen. November 2015

(This is an extract from “Six Degrees of Education: From Teaching in Mumbai to Investment Research in New York” Bryant Park Publishers, New York, 2016.)

The Economist - and The Financial Times – have continued to prosper amid fierce competition from free online news and opinion sources over the past two decades, especially in the United States.

In contrast The New York Times, The Wall Street Journal, The Washington Post, Time and Newsweek, all legacy publishers with affluent readers, have seen sharp declines in circulation and advertising revenues and sharply reduced profits and, in some cases, losses.  

The decline began in the mid 1990’s when these and other legacy print publishers in the U.S. allowed free online access to their stories and photographs via AOL, Yahoo and Google. They also allowed their content, created through costly reporting and editorial work, to be re-packaged and distributed for free by new online competitors known as aggregators.  

Many print readers cancelled their subscriptions of the legacy publications since the stories were available free online. These publications, seeking to stem revenue declines, began restricting access to their online content and charging a subscription fee. The New York Times began charging for online content in March 2011.

But many traditional print readers, having gotten used to free access to news and opinions online, do not want to pay subscription fees. The potential younger audience for legacy print publications grew up reading stories on Business Insider, BuzzFeed, The Huffington Post, Vice and other free online sites.

The free online publishers carry brief stories, often based on content from other sources, top ten lists, celebrity gossip, quizzes and lots of photos and cat videos. Their goal is to grow their audience to try and raise advertising revenues. One of their recent revenue strategies, which some legacy publishers have also adopted, is native advertising. This is content created by a publisher’s staff for advertisers and placed amid editorial content, blurring the line between editorial and advertising.

Free online publishers are attracting hundreds of millions of dollars from eager investors, including major venture capital firms as well as legacy media business like Rupert Murdoch’s 21^st Century Fox and Hearst. The German media company Axel Springer bought 97% of Business Insider in 2015 for about $450 million, while Amazon founder Jeff Bezos owns the rest. Such funding is enabling the free online publishers to hire more journalists to rewrite stories from other sources and to create original content.      

One of the few legacy print publishers to grow circulation and revenue is The Economist, which followed a different strategy from that of its legacy print rivals. It did not give free online access to its content and its website offers non-subscribers only brief teasers and that too for some older stories. The content, largely analysis based on facts and data, is also difficult for the online aggregators to convert into popular stories on their free websites.

The magazine continues to be a weekly must read for a growing English educated global audience ranging from academics to professionals on Wall Street. Its circulation has grown consistently reaching 1.6 million in 2015, up from one million in 2006. Three quarters of new and renewing subscribers pay for digital and print subscriptions and it has over 100,000 digital only subscribers.

The Economist also does not offer steeply discounted subscriptions. During the November 2015 Black Friday sales on Amazon in the U.S., for instance, annual subscriptions were slashed 90% for Bloomberg Businessweek, from $300 to $25, and the bi-weekly Fortune, from $116 to $12. The Economist was sold at its full price, $127 for annual digital access and $160 for digital and print formats in the U.S.

The subscription fees provide The Economist with a stable, recurring source of revenue. And its affluent audience, reached via high priced, undiscounted digital and print subscriptions, is very attractive to advertisers selling global brands like watches, alcohol and luxury cars.

Several publications, ranging from The New York Times to new digital ones like the Quartz, are trying to replicate the editorial and business strategy of The Economist. In 2014 Michael Bloomberg hired The Economist’s editor John Micklethwait as editor in chief of Bloomberg News, which owns several media platforms including Bloomberg Businessweek.   

The strength of The Economist’s strategy became evident in August 2015 when the London based Pearson PLC sold its 50% non-controlling stake in The Economist Group to other shareholders, including magazine employees. This cash transaction valued the business at about $1.5 billion. For the year ended March 31, 2016 The Economist Group had $96 million in operating profit on $530 million in revenues. (61 million and 331 m British Pounds respectively.)

In July 2015 Pearson also sold The Financial Times Group to Japan’s leading business media group Nikkei Inc. for $1.3 billion. In contrast Amazon founder Jeff Bezos paid only $250 million to buy The Washington Post in August 2013.

Like The Economist, The Financial Times does not provide free access to its online content. Three quarters of its 720,000 daily global circulation comes from digital subscribers and a year’s subscription is about $700, accounting for much of its revenues. Nikkei’s purchase, following an intense bidding war, was at a steep price of about $1,800 per subscriber. The Financial Times Group’s 2015 revenues were $512 million and profit $37 million.

Exor, the investment arm of Italy’s Agnelli family, increased its stake in The Economist Group to 43% in the 2015 transaction. John Elkann, 39 year old chairman of Exor and a regular reader of the weekly magazine since a teenager, justified the high purchase price telling The New York Times November 23, 2015 “If you have a distinct journalistic offer, which is independent; if you have a readership, which is growing in the world…. and if you have the technology that can help you reach them…. the combination of that, if well executed, is pretty powerful.”

The unique value of The Economist, which numerous web based rivals are yet to disrupt, is summed up in a quote from Eric Schmidt, Executive Chairman of Google, on the magazine’s website: "Life without The Economist would be life without a global perspective." 

(Ignatius Chithelen is manager of Banyan Tree Capital, New York.) 

Why Valeant Pharmaceuticals Was a Momentum and not a Value Stock

Valeant Pharmaceuticals: a Momentum not Value Company

by Ignatius Chithelen*. December 4, 2015.

Investors in Valeant Pharmaceuticals accepted characteristics remote from value investing: rapid revenue and margin growth driven by costly acquisitions which ballooned debt, massive price increases which risked payer backlash and new competitors and a high technology business with low R&D spend. And now, after its stock price collapse, its future is largely dependent on legal and legislative battles.   

(Since 12.4.2015 the stock fell from $96 to a low of $13.)

(*Ignatius is managing partner of Banyan Tree Capital Management, New York. He has no position in any Valeant securities.)

Valeant Pharmaceuticals was indeed a very hot company and stock. Its revenues grew over ten-fold to $8.3 billion, in the six years to 2014, while operating income soared 17 fold to $2 billion. An investment of $100 in the stock in December 2009 was worth $1083 in December 2014, over five times greater than an investment in the S&P 500 Index. The stock gained an additional 126% when it reached an all-time peak price of $264 in August 2015.

A company based in Quebec, Canada, Valeant develops, manufactures and markets drugs in areas of dermatology, gastrointestinal disorder, eye health, neurology and branded generics. Earlier, from 2006 to 2008, increased competition and reduced payments from third party payers had halved its operating income. It then shifted from oral drug delivery technologies to developing drugs for central nervous system disorders such as epilepsy, Parkinson's disease and multiple sclerosis.

Valeant’s strategy shifted again in 2010 when J. Michael Pearson became CEO following an acquisition. Pearson had been CEO of the acquired company since 2008. Earlier he was at McKinsey, which he joined in 1984, heading its global pharmaceutical practice and serving on the board of directors.

The strategy under Pearson, the company’s 2014 10K SEC filing states is rapid acquisitions of companies with drugs which ”.. are largely cash pay, or are reimbursed through private insurance, and, as a result, are less dependent on increasing government reimbursement pressures...” It bought over 50 companies, using cash and debt and paying steep prices. They include dermatological drugs provider Medicis Pharmaceuticals, bought in 2012 for $2.7 billion, nearly four times its 2011 revenues, eyecare company Bausch & Lomb in 2013 for $8.7 billion, roughly three times 2012 revenues and in April 2015 gastroenterology drugs maker Salix Pharmaceuticals for $15.8 billion, fourteen times Salix’ 2014 sales.   

Typically companies list risks in their annual 10K filings more for legal protection than to state likely risks. But in Valeant’s case its mention of “Debt-related Risks”, in its 2014 filing, is a real one: “We have incurred significant indebtedness, which may restrict the manner in which we conduct business and limit our ability to implement elements of our growth strategy.” At year end 2008 Valeant had a good balance sheet with no long term debt, cash of $340 million and equity of $1.2 billion. But at September end 2015 it’s debt was $30.2 billion, nearly five times its equity.  

A drug company with patents and other intellectual property typically has a fair amount of intangible assets. But Valeant’s intangibles at September 2015 were $22.5 billion, over three times its equity. It also had $17.4 billion in goodwill, resulting from acquisitions. Overall it thus had a negative tangible equity of $33.4 billion.  

Salix, before its purchase by Valeant, spent 15 % of its $1,133 revenue in 2014 on research & development. Drug major Merck too spent 15% of its $42.2 billion 2014 revenue on R&D, excluding restructuring and merger related expenses. In contrast, Valeant slashes R&D costs at companies it acquires enabling it to grow operating margins. In 2014, for instance, it spent only 3% of its revenue on R&D. While this low spend helped increase profits short term, strong R&D expense is key to future revenue and profit growth for drug and other companies with patents, intellectual property and competitors.

Under Ethics, in its 2014 10K filing, Valeant states that its “.. most important objective is to serve our stakeholders, including the patients and consumers who use our products, the physicians who prescribe/recommend them, and the customers who provide retail outlets for these products.”  

Yet Valeant’s drugs had the highest price increases amongst the 19 commonly prescribed dermatologic drugs tracked in a research study published in the Journal of the American Medical Association in November 2015. The study was conducted by Miranda Rosenberg and Steven Rosenberg, a daughter and father team with the daughter a student at The Perelman Medical School at the University of Pennsylvania. Valeant raised the price for 30 grams of its Carac cream, for treating pre-cancerous skin lesions, from $159 in 2009 to $2865 in 2015. The price for its Targretin gel 60 g tube to treat skin cancer was raised from $1687 to $30,320 over the same period - both about a 1700% increase.

The mean price increase, by Valeant and other drug companies, for the 19 drugs was 401% over the six year period, while the consumer price index rose 11%, the study found. “We’re not talking about new drugs,” Steven Rosenberg, a dermatologist in West Palm Beach, Fla., who led the research told The New York Times, November 26, 2015 “We’re not talking about exotic drugs. We’re not talking about drugs that are listed as being in shortage.”

In October 2015, Valeant’s stock price was cut in half to $94, after news reports that it instructed workers of Philidor, a pharmacy with ties to Valeant, to use a variety of questionable methods to try to get insurance companies to pay for its drugs. Also that month a company news release said it received subpoenas from U.S. Attorneys in Massachusetts and New York seeking documents “..relating to financial support provided by the company for patients, distribution of the company's products, information provided to the Centers for Medicare and Medicaid Services, and pricing decisions.” A couple of weeks later Valeant appointed Mark Filip, a former Deputy Attorney General of the United States of the law firm Kirkland & Ellis, as an adviser.  

Charles Munger, partner of Warren Buffett in running Berkshire Hathaway and a very successful value investor, told Bloomberg November 1, 2015 that in his role as chairman of the Good Samaritan Hospital in Los Angeles, he "could see the price gouging.” Valeant’s practice of acquiring rights to treatments and boosting prices, Munger added, was legal but “deeply immoral”, deeply wrong and unsustainable.  

In early December 2015 Valeant’s stock traded at $96, down from $117 at year end 2014. Its strategy of buying companies to get more products requires increasingly bigger purchases to boost profit margin growth, since the denominator gets larger with each purchase. Also its huge debt load, higher interest costs due to a cut in its debt ratings and a fallen stock price will make large future acquisitions difficult. Valeant’s survival hence depends, not on its business economics, but on whether Pearson and major investors can save it from punitive actions from politicians and regulators and if it can manage its huge debt load.