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Yellow Pages looks less rosy if advertisers see better value online

Does anyone use the Yellow Pages any more? I just finished driving across Canada with a friend. We hardly ever used the phone book to find what we needed when we stopped. We mainly used the Internet through laptop or BlackBerry.

I grant you that it can be hard to find a peeler joint in Portage La Prairie or a chiropractor in Penticton on Yahoo or Google, so sometimes we did resort to the Yellow Pages, either online or hard copy. But generally, we looked to the Web. It's so much more convenient, even if the information isn't always as reliable. And a laptop is usually lighter than those Yellow Pages bricks, especially in big cities.

So if most people - or more and more people, since the young tend to prefer the Web - are turning away from the Yellow Pages, should investors turn away from the units of the trust that owns the franchise in Canada?

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A lot of analysts think Yellow Pages Income Fund is a screaming buy. Says one: "We continue to be comfortable with the fundamental outlook for this business. This is driven by our core belief that small businesses do not have the same range of marketing options as larger ventures so are likely to continue to do business with YLO as long as it is able to keep increasing their advertising ROI."

ROI means return on investment, a critical number when it comes to where ad dollars go. Here's how it works in a small or medium business: We make x off every y we sell. A Yellow Pages ad costs us z. If x times y is bigger than z, ROI is positive and we keep advertising. If not, we stop. So ROI is a function of the revenue that advertising generates and, importantly, the cost of that revenue (the cost of the ad.)

Here's one problem with Yellow Pages advertising: It's expensive, and getting more so, in some markets, anyway. The fund's revenue has risen in recent years even as it lost customers. How? Partly through acquisitions. At least 70 per cent of last year's increase in sales came from new businesses the fund bought. But stripping that out, it appears that rates went up more than enough to offset customer losses.

Why were customers willing to pay more? Is it because they're getting more? Maybe they think they are. If my experience is any indication, and I think it is, they're not.

And if that's right, and advertisers come to agree eventually, Yellow Pages is only going to accelerate the pace of customer loss by increasing rates, given the myriad of alternatives out there.

Notwithstanding the analysis quoted above, I'm not sure small and medium businesses have limited advertising choices. One of the great things about advertising on a search engine is precisely that it is so flexible. You choose your budget, and you can vary it monthly (or weekly, or daily). And although I think there will eventually be problems for smaller players trying to claw their way into the online advertising landscape, for now it can still be effective.

You can see that investors already have doubts about Yellow Pages' competitive position in the fund's yield, which is about 10 per cent. A company with 50-per-cent margins, a strong brand name, conservative payout ratio and a 100-year history would probably yield closer to, say, 7 per cent if it was expected to grow.

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Yellow Pages' distributions have grown and some think they'll continue to, but the multiple has compressed a lot over the past few months as investors worried about the threat of competition, which comes from the Internet but also from other new publications trying to get a piece of the directory economy. The units once fetched more than $16. Today they change hands for $11.

But their 10-per-cent yield doesn't seem particularly attractive if you suspect that the pace of customer defection and price discounting picks up. It takes time for consumers to move away from deeply entrenched traditions, but when they start to move, don't get in their way.

While Yellow Pages has shown signs of life online even as the print directories shrink, you have to wonder if that migration is just a stepping stone toward other forms of online advertising. That is, as advertisers use Yellow Pages online, do they then ask themselves why they aren't just buying ads from a search engine?

I suspect that if you took a poll of small- to medium-business owners, you'd find a lot of them questioning the value of using Yellow Pages - and not just the chiropractors and strip joint owners.

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About the Author
Investment Columnist

Fabrice Taylor, CFA, publishes the President’s Club investment letter, for which he and The Globe and Mail have a distribution agreement. More


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