Friday, August 17, 2007

Harlequin is Torstar's Waking Beauty

The McClatchy’s, the Chandler’s, the Bancroft’s: Is the family that owns Canada’s largest newspaper by circulation The Toronto Star the next to evacuate the newspaper business? Cash cows with seeming locked-in revenue growth for decades, these businesses provided expansive income for the growing web of family members over the years, and they also enabled particular social and political agendas to comfort their sense of responsibility.

Revenues have stagnated, and perhaps some bad decisions can’t be so readily ignored nor radical changes in business models experimented with since revenue growth is no longer a luxury they can take for granted. Younger members of the family don’t share a cohesive sense of mission and grow skittish at any suggestion the nest egg some may have yet to get may be waning. Quarter by quarter management runs out of ways to describe their ‘difficult’ business environment as circulation drops, display ads decrease and classified ads migrate to craigslist and

Torstar is controlled by five families who own ‘A’ shares in the Torstar two share structure. 'A' shares hold all voting rights. B shares have none. Only a member of one of the five families can own A shares meaning that if A shares are sold and are purchased by someone other than a family member they become B shares with no voting rights. Torstar owns The Toronto Star, a stable of community newspapers in Ontario, a percentage in a Canadian broadcaster and the publisher Harlequin. The company is not reported to be for sale even though there has been a natural increase in interest in the company given the churn in newspaper properties south of the border.

On their earnings
call last week, the company warned against investors believing the company could sell-up: "I would never counsel someone to acquire Torstar shares on the assumption that there will be a transformational transaction with respect to the ownership of the company," Torstar chief executive officer Rob Prichard said while discussing the second quarter.

Nevertheless, rumors circulate within the company especially as a result of
an investment by Fairfax Financial Holdings Ltd. which bought 5.4 million non-voting shares earlier this year. Fairfax owns over 18% of class B shares but has said this represents a long term investment and they are not looking to influence the board. Torstar shares have traded in the low C$20 range but some analysts have suggested it could be valued at C$30+ per share.

Harlequin was founded in 1949 as a general trade publisher and morphed into the romance publisher we know today by acquiring publishing rights to Mills and Boone titles during the 1950s. As the popularity of these titles grew they began publishing their own romance titles and eventually acquired Mills and Boone. Torstar purchased 52% of the company in 1975 and until recently Harlequin has been a strong financial performer for Torstar.

In my view, Harlequin is a lost jewel of the publishing industry in the sense that no major publisher has set its sights on acquiring the company. Some have attempted it and difficulties exist particularly with the Canadian ownership requirements that preclude a foreign company from buying a Canadian company; however, with the recent acquisition of Thomson Learning which was (is) also a Canadian company a deal could be constructed that satisfies the legal requirements. Unfortunately, from a Torstar perspective selling Harlequin may not be in their interests because as the Harlequin business improves – and recent results indicate they will – then Harlequin may be responsible for a significant amount of the earnings growth the company can be assured of as their core newspaper business continues to falter.

On projected 2007 revenues of CN$475mm and projected operating profit of CN$65mm the company could be worth CN$500mm. They could generate a higher multiple since they have been able to push margins over 18%. The current Torstar market cap is C$1.3billion which might indicate that the current share price does not reflect a realistic valuation for Harlequin (or the valuation on the newspaper is depressing the share price which seems more likely). It remains to be seen if there is any action here, but on a positive note, Harlequin seems to be improving financially and broadening their revenue base to include the Internet and e-book publishing.

Some of the Torstar family members may be casting about for their own ‘Murdoch-like’ acquirer. Coincidentally, Independent News and Media which owns newspapers in the UK, Ireland, New Zealand and elsewhere could be a candidate. The company is controlled by Sir Anthony O’Reilly who could be more than interested in adding The Toronto Star to the portfolio.

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