Just a quarter ago, Yellow Pages Ltd. was quick to emphasize its "Return To Growth" business plan, citing it in the second paragraph of its earnings release, about 40 words in. This week, as the company reported its disappointing year-end results, "return to growth" didn't appear until about 1,700 words in to the news announcement.
Appropriate, as Yellow Pages closed the books on 2016 with lower levels of revenue, compared to the prior year, in three of the four quarters. But the company's problems transcend just these top-line problems; indeed, investors, who whacked the shares down to a 52-week low Wednesday, are concerned, with good reason, that we are seeing a Return to Decline at the company.
The story with Yellow Pages, as with all legacy print-based media companies (hello, newspapers), is familiar: The shift is on from the high-margin paper business to the fast-growing digital future. But can the company grow that digital revenue fast enough to replace its dead-tree products?
The answer for Yellow Pages is, now, likely not. Here are the stats from the fourth quarter: Print revenue declined 24.8 per cent year-over-year, while digital revenue increased 3 per cent (on a "pro forma" basis, adjusted to include an acquisition). While Yellow Pages has sped its transformation to the new age better than other North American phone-directory companies – digital was more than 70 per cent of company revenue in the quarter – the top line shrank 2.8 per cent in total.
There were things more troubling than that in the report, however, namely what Yellow Pages called "an unfavourable change in the product mix" in the fourth quarter. As noted by analyst Vahan Ajamian of Beacon Securities Ltd., revenue from Yellow Pages' own high-margin properties, such as the YP website and app, declined in the fourth quarter, while the source of digital growth was lower-margin search-engine marketing services, such as helping a customer get better Google results for its website. This, Mr. Ajamian says, "was previously believed to be a longer-term trend which could be partially offset," but with this change in product mix already surfacing, "the company has in effect locked in lower margins."
This is not just his opinion: Yellow Pages took this mix shift to heart as it did its annual impairment testing at the conclusion of 2016, and it took a $600-million charge on its intangible assets, namely trademarks and non-competition agreements. Now, the company notes this charge is "non-cash," which it certainly is. However, when a company takes an impairment charge, it's acknowledging its estimated future cash flows simply cannot support the valuation of the related asset on the balance sheet. It's a serious admission, and it bodes poorly for the future.
This week's misadventure would not be complete, of course, without the Street's least-favourite kind of announcement: a failure to provide earnings guidance, coupled with negative comments about what it will look like when it arrives later this year, likely in May. Citing the adverse mix of revenue, Yellow Pages said it "anticipates additional pressure on Adjusted EBITDA in 2017 … [and] expects stabilization in Adjusted EBITDA in the short to mid-term, post-2017. However, not at the levels previously anticipated."
(Not to pile on or be excessively churlish, but the company's "Adjusted EBITDA," or earnings before interest, taxes, depreciation and amortization, excludes the impairment of intangible assets, and restructuring and special charges. Those are a frequent and normal cost of doing business in a company that's going through this kind of repositioning, and shouldn't be excluded as if they are unusual items. The company also fails to provide its net income, as calculated by International Financial Reporting Standards, until deep into its earnings release, which runs contrary to guidance by the Ontario Securities Commission that companies should not give more prominence to non-GAAP measures.)
Anyway, the company's guidance, or lack of it, seemed to be the largest driver of the stock's collapse this week, as it fell 25 per cent Tuesday and dropped another 4.1 per cent Wednesday to close at $12.10. Combined with the drop after the third-quarter earnings, the shares are now about half their 52-week high. "We believe visibility on the company's return-to-growth plan has materially deteriorated following management's cautionary tone," RBC Dominion Securities analyst Drew McReynolds wrote, as he cut his price target from $21 to $16 and held his "sector perform" rating.
Mr. Ajamian of Beacon cut his target from $26 to $16, but kept a "buy" rating on the shares. At Tuesday's close, he says, the stock was trading at just 4.1 times this year's EBITDA, which he feels "represents good value … We suspect 12 months from now current levels will have proven to be a good entry point."
That advice, I think, is for the deepest of deep-value investors. Because there's a good chance that 12 months from now, the phrase "return to growth" won't find its way into a Yellow Pages earnings release again.