In this paper, stock analyst Doug Arthur makes a detailed case that Knight Ridder is an attractive acquisition target under “numerous scenarios.”  For Arthur there is a here’s-where-I’m-coming-from flavor since he is one of very few who has a buy recommendation on Knight Ridder shares, even now after their 20 percent rise on takeover speculation.

RESOURCES

Morgan Stanley Knight Ridder: A Scenario Analysis Ten-page excerpt attached here with permission of author.

Arthur is a veteran and highly respected newspaper industry analyst.  Nonetheless, as he acknowledges, the bulk of the attached excerpt from his analysis, including most of the numbers, represents informed speculation rather than fact.  Also, as he discloses, his firm, Morgan Stanley, is an investment banking advisor to Knight Ridder, though Arthur’s unit operates independently.

Here are five areas of particular interest in his analysis:

(1) Labor costs.  In a comparison to Gannett (page 3 and Exhibit 1), he suggests that the two companies have a similar cost structure  -- except for labor, which runs 30 percent higher at Knight Ridder.  That is the product of having more jobs and higher pay scales, perhaps influenced by union contracts.  If Arthur is right, that suggests that further job cuts – maybe deep cuts – would be in the offing if Knight Ridder is sold.  Another candidate for cutting, Arthur suggests, is “corporate,” which includes Knight Ridder’s Washington bureau, a leader on Iraq War reporting.

Screengrab from Knightridder.com

2) Individual papers.  Arthur thinks that most Knight Ridder newspapers have typical industry operating profit margins in the low to mid-20 percent range (Exhibit 7, page 8).  The two exceptions are the Philadelphia Inquirer and Daily News and the San Jose Mercury News, both of which he estimates will earn less than a 10 percent return on revenues in 2005.  The implication is that these would be problem children for a buyer of the whole company or difficult to sell individually until financial performance improves.

(3) The value of “other.”  One of the headlines in Arthur’s report is his look at the company’s non-newspaper holdings.  The most important are Knight Ridder’s successful and fast-growing digital operations, its one-third share in the Career Builder electronic recruitment franchise, and a 49 percent stake in the Seattle Times. Together these and smaller holdings are worth between $1.5 and $ 2 billion, Arthur argues (page 9). That’s a nice chunk of value embedded in a company whose market capitalization is just $4 billion.

(4) Assuming an upswing.  Cutting costs may be the heart of the matter for many buyers, but Arthur also thinks there will be some revenue growth for the newspapers and modest margin improvement in Philadelphia and San Jose (page 10).  Not everyone agrees.  Paul Ginocchio of Deutsche Bank published a detailed report December 1 predicting flat revenue at printed newspapers in 2006 and suggesting the sector, even after this year’s stock tumbles, may still be overvalued.  Looking at it another way, Gannett, the one buyer clearly large enough to absorb Knight Ridder, has shown much more interest the last few years in spending its acquisition kitty to acquire non-newspaper ventures.

(5) McClatchy as a buyer?  Unlikely but not totally out of the question, says Arthur (page 10).  McClatchy is smaller than Knight Ridder and might need the help of a financial buyer.  But management is respected on Wall Street and this represents a rare opportunity to jump from a mid-sized company to a top-tier player.  Such an option could be particularly attractive in a package in which McClatchy would pay a premium for the healthiest properties and offload those that don’t fit the companies “strong growth market” tradition.  This would be the happiest of endings for many Knight Ridder reporters and editors since McClatchy is a strong proponent of the value of quality journalism. (Here's a round-up of McClatchy possibilities from Romenesko.)

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Knight Ridder will be absent during the Media Week conferences for investors and analysts that begin Monday, December 5 in New York. Gone but not forgotten.  Management teams will be quizzed about their current acquisition strategies, as a proxy for outright statements of interest in Knight Ridder.  In the halls, the talk will pick up the thread of Arthur’s and other analysts’ speculation.  However Knight Ridder’s exploration of “strategic alternatives” turns out, it shapes up as the financial event of the decade for the newspaper industry.  Who will buy the company? Will anyone?