QUALIPORT
Two Smart Qualiport Buys

By Maynard Paton (TMFMayn)
June 21, 2005

It could have easily been a portfolio disaster. Two Qualiport companies -- Emap (LSE: EMA) and Johnston Press (LSE: JPR) -- today joined forces to spend over £300m buying a media rival. Although chunky acquisitions so often prove disasters for shareholders, this particular deal thankfully has strategic logic and a fair price on its side.

Deal summary

Here are the key features of the transaction:

* The target company is Scottish Radio (LSE: SRH), which operates 22 radio stations, principally in Scotland, and publishes 45 regional and local newspapers throughout Scotland, Northern Ireland and the Republic of Ireland.

* Emap is to pay 1,088p in cash for every Scottish Radio share, valuing Scottish Radio at around £391m.

* Johnston Press will pay Emap £155m for Score Press, Scottish Radio's newspaper publishing subsidiary.

Rationale

Emap gave the following explanation for leading the latest round of media consolidation:

"The Board of Emap believes that commercial radio companies need to invest in strong brands and high quality programming in order to grow audience share and that this share growth will help increase advertising revenues. Consolidation of broadcasters will create the scale to enable this investment to take place...

The Board of Emap believes that advertising agencies (and their customers) want "one stop shops" from which to source national advertising. It believes they will choose their media partners based on ease of purchase which will increasingly be driven by advertising scale, audience reach and strength of brands."

Johnston's involvement in the deal was based on entering new geographical markets and straightforward cost savings:

"Johnston Press believes that Score Press represents an attractive and complementary addition to Johnston Press' existing portfolio. In addition to strengthening Johnston Press' focused regional newspaper franchise in the consolidating UK market, the transaction will establish markets in both Northern Ireland and the Republic of Ireland. The acquisition will also provide opportunities for operational and purchasing synergies."

Overall, the reasons behind the deal appear quite sensible.

Valuation

To get an idea of the valuations associated with takeover, the following table summarises Scottish Radio's most recent twelve-month financial performance:

Year to March 2005	Turnover (£m)	Operating profit (£m)	Operating margin (%)
Radio	62.6	17.2	27.5
Newspapers	36.4	12.0	33.0

(Minor digital and Internet contributions have been ignored)

The effective cost to Emap in buying Scottish Radio's radio operations is a little tricky to calculate. Emap bought a 28% stake in Scottish Radio during January 2004 for £90m and will now pay approximately £286m for the outstanding 72%. Add the £90m, £286m and £5m of restructuring costs together, then subtract the £155m to be received from Johnston, and Emap will ultimately fork out a net £226m.

In terms of profits, Emap believes annualised cost savings of £5m are achievable by the third full year of ownership. Taxed at the standard 30%, Emap's purchase could produce an annual after-tax profit of £15.5m ((£17.2m + £5m)*70%). The price to earnings (P/E) ratio is thus a reasonable 14.6 (£226m/£15.5m).

That said, Emap's restructure target does seem ambitious. Saving £5m per annum would increase Scottish Radio's annual radio profits by 23% and take the division's operating margins to an impressive 35%. For the record, margins at Emap's own radio division were 22% in 2004/5.

Johnston sadly did not put a figure on potential savings or integration costs. Assuming no benefits and tax at 30%, Score Press could be expected to generate earnings of about £8.4m (£12m*70%) for Johnston. The £155m price tag therefore gives a P/E of 18.4.

However, if Johnston can take margins at Score Press from an already impressive 33% to a wonderful 41% (equal to the margin at Johnston's existing stable of Scottish newspapers), then £3m could be added to Score's annual operating profit. Assume restructure costs of £3m and tax at 30%, and the effective P/E for Score Press then reduces to a fair 15.0 (£155m+£3m) / ((£12m+ £3m)*70%).

Extra debt

Both Emap and Johnston will take on extra debt to fund their respective purchases.

In Emap's case, net debt of £268m will increase to approximately £406m and the annual net interest bill should grow to about £36m. With Emap's operating profit perhaps rising to around £244m,  interest payments following the deal look set to be covered a reasonable 6.8 times by operating profits.

Following its purchase, Johnston's net debt of £328m will expand to £483m, which will then incur an annual net interest bill of about £34m. Johnston's 2004 operating profit of £177m will be lifted to £189m, giving net interest cover of 5.6 times -- low-ish, but not too worrying given the group's steady markets (and in line with interest cover seen between 1999 and 2003).

Conclusion

Strategically, today's deal is smart. Emap and Johnston are buying businesses within sectors they already serve (i.e. there's no diworsification and more chance of the anticipated economies of scale appearing) and are obtaining low-risk routes into new geographical markets (Scotland for Emap, Ireland for Johnston). Neither Emap nor Johnston will be stretched financially after their purchases, both of which should produce useful improvements to overall earnings in the next few years.

Although Johnston's current management has a great record of integrating acquisitions and extracting savings(notably Regional Independent Media in 2002), Emap's board has no such history. Indeed, Emap's cost savings target appears aggressive and its finance director for the past five years, Gary Hughes, recently left the company. Interestingly, Gary Hughes was finance director at SMG (LSE: SMG) prior to Emap and helped oversee SMG's somewhat imprudent purchase of Virgin Radio during the market peak of early 2000. Is it a case of once bitten by radio acquisitions, twice shy?

On valuation, Emap and Johnston are both paying a fair price given the potential cost savings, though trading statements out today from GCap Media (LSE: GCAP) and Chrysalis (LSE: CHS) suggest the present advertising market is far from buoyant. Longer term, however, carving up Scottish Radio can only strengthen the competitive positions of Emap and Johnston further.

More: Emap Results 2004/5 | Johnston Press Results 2004

Maynard owns shares in Johnston Press.

Portfolio value

Holding	Number of shares	Closing price 20/06/05 (p)	Value (£)
Associated British Ports	681	491.5	3,347.12
Emap	372	799.5	2,974.14
Halma	1,920	148.25	2,846.40
Johnston Press	1,608	481.5	7,742.52
London Stock Exchange	2,018	491.5	9,918.47
Cash			345.54
Total			27,174.19