GoldenTree Asset Management has multiple reasons for doubling down on dead trees. The New York-based hedge fund is putting up as much as $186-million to back consolidation in the Canadian newspaper business, a brave move at a time of newspaper doom-and-gloom.
GoldenTree is the major shareholder in Postmedia Network Inc. and may end up putting up more than half of the purchase price for the company's acquisiton of 175 papers from Quebecor.
So what is GoldenTree thinking?
For starters, the fund has a long history with Postmedia and is said to have a high degree of trust in Paul Godfrey and the management team at Postmedia. Beyond that, the thesis appears to be that the Canadian newspaper business is following the same track as the U.S., but with a lag.
And U.S. newspaper revenue shows signs of stabilizing after a long decline.
If it follows the same pattern in Canada, a bigger but leaner Postmedia can start to throw off solid cash flow. The projected earnings before interest, taxes, depreciation and amortization (Ebitda) for the combined company would be $204-million. Add the projected synergies, and that approaches $214-million at the high end. If there are any revenue synergies from being able to sell a wider selection of readers to advertisers, that will help even more.
Add to that the fact that Postmedia has about $250-million in tax loss carry-forwards, and a lot of that cash drops to the bottom line pretty quickly – especially considering the fact that cash flow is going up much faster than debt. Most of the transaction is funded by equity. Debt to Ebitda is expected to drop to 2.9 times from 3.8 times, so interest coverage gets a lot easier. Adjusted Ebitda will now be about three times cash interest, instead of two times. That's a lot more breathing room. And leaves a lot more cash left over.
In other words, suddenly you have a company that is producing a fair bit of cash that can be used to de-lever, or return cash to shareholders if things turn out as the investors hope.
Oh, and it's not like GoldenTree necessarily has to put up the whole $186-million. It has agreed to do so if necessary, but not until January. In the interim, Postmedia is trying to sell $50-million of real estate. Every dollar that comes in from real estate sales reduces the equity component.
And there's a bet that other investors will step up to buy more equity. The rights offering will triple the market capitalization of Postmedia, potentially offsetting one of its major issues: a lack of liquidity because GoldenTree controls so much. (Though this is a bit of a circular argument to be sure. Liquidity only increases if other shareholders step up because they believe liquidity will increase.)
And the improved capital structure might draw a bit more interest in Postmedia from investors with a strong constitution.
It's not a bet for everybody, but for GoldenTree, it's not as out there as it might seem.