RCS MEDIAGROUP INVESTMENT THESIS

$RCS.MI $RZSMF

RCS MediaGroup is a leading publisher of newspapers, television, magazines, radio, and books as well as an organizer of various sporting events - most notably the Giro d'Italia bicycle race.
RCS owns both Italy's largest national and sports daily newspapers, Corriere della Serra and La Gazzetta dello Sport. You've likely heard of them both if you live in Europe. If not both, you've certainly heard of the pink paper La Gazzetta, which has long been a credible reference point for sports news all around the world

In addition to the iconic crown jewels of the Italian newspaper industry, they also own some of the top publications in Spain. El Mundo, the second largest daily newspaper, as well as Marca, the sports news leader, and Expansion, the business news leader.

The company is well-diversified across all media segments, yet those five newspapers represent the company's bread and butter, and one could argue that only their intangible value is worth more than the current market cap.

Urbano Cairo, who is currently RCS's Chairman and CEO, acquired 59% ownership stake in the business in 2016 and successfully turned it around. With that acquisition, his company Cairo Communication has become the direct parent of RCS MediaGroup. The company was in financial trouble at the time, had burned through cash, and owed 275 million in long-term debt. But the situation is entirely different now, in 2022. Cairo has paid off all of the company's debt and the RCS has not had an unprofitable year since the acquisition. Yes - even in 2020, despite bar closures, reduced advertising spending, and the cancellation of virtually all sporting events, they managed to generate positive EBIT and 83 million in free cash flow.

Last year's numbers also show a solid balance sheet with a net cash position and an FCF margin of 15%. And, yes- I almost forgot. A 0.06$ dividend on a 0.65$ stock.

1.      Urbano Cairo

Being the majority owner, everything he does has an impact on the company's future. When you bet on the business, you're also betting on the man. So don't blame me if I mention a few more things about Urbano Cairo and his background.

Having started his career more than 40 years ago, Urbano Cairo is a pioneer in the Italian media industry. In all of his professional roles, he climbed rather quickly, and eventually he made the decision to start his own company, Cairo Pubblicità SpA, now known as Cairo Communications. Running the business, he gained a great deal of know-how and experience in both publishing and advertising. Moreover, since media became his circle of competence, he didn't shy away from making industry acquisitions. Usually, he would buy unprofitable and indebted companies and turn them around through cost-cutting initiatives and efforts to create synergies with the rest of Cairo Communication's portfolio. The same thing obviously happened with our own RCS Media.

Although his track record appears to be solid, with his publishing house never losing money in a single year, one thing that does concern me is the performance of his stock, which has yet to break even since its IPO in 2000. On the other hand, he did take an opportunistic listing during the peak of the dot-com bubble, and if you start looking at the stock performances of other news/media businesses, you may discover that their stock performance looks quite similar.

One "shady" piece of his past is his 19-month prison sentence for false accounting and embezzlement. In Cairo’s defense, he did take a step forward and deliberately agreed to go to prison, unlike other offenders. And – yes, it happened 25 years ago, and he has kept his hands clean ever since.

2.      What was his strategy back then, and what is it today?

Cairo's goal was to build a massive multimedia publishing company focused on producing high-quality, trustworthy content. The company's business model would be digital-first and subscription-based.

His efforts since the acquisition have been nothing short of extraordinary. Corriere della Serra, Italy's most popular daily,  is now outperforming the competition on a consistent basis. He completely reversed the trajectory of the Spanish part of the business, which was lagging behind other newspapers in Spain. Furthermore, he cut costs (as he typically does), reduced staff, and strengthened digital commitment via training in digital areas across the organization.

On a different note, the Giro d'Italia is the one thing he committed to but has yet to fulfill. In 2016, he stated that he believes that the Giro d'Italia cycling race is under-monetized in comparison to its counterpart (Tour de France) and that, if improved, it could generate more than 100 million in additional revenue.
One important development last year was the launch of CAIRORCS MEDIA. A new advertising agency formed by the merger of RCS MediaGroup's advertising business unit with CairoCommunication's parent company. The deal was done mainly to maximize synergies, but here's the complete rationale from the annual report;

The business segments of the Advertising division of RCS and Cairo Pubblicità are, in fact, highly complementary and the transfer of advertising sales activities to CAIRORCS will build a broader business proposition, concurrently covering all major areas of communication - from the web to magazines and television - and create a more effective offering as it is jointly promoted and with a greater client penetration. Specifically, the integration of the activities of the advertising activities will allow RCS and Cairo 2 Pubblicità to leverage on each other's strengths on the market, by increasing the market shares of clients currently shared by the two companies, and by partaking both exclusive and loyal clients. Additionally, the Transaction will enable the two companies to pool their wealth of experience and know-how, both in terms of knowledge of client acquisition models, and in identifying new models of market coverage, by implementing processes for sharing industrial and business best practices.

Ultimately, all of these developments contributed to the company becoming what it is today: a good company hidden beneath the perception of a “dead” newspaper publisher. Let me explain.

Although most traditional news and media companies are and should be valued as if they are going out of business soon, and their high single-digit decline is likely to continue throughout the decade, the rest of the RCS's business should more than compensate for the drop in physical newspaper activity. RCS Media's digital revenue is now 25% of total revenue, growing 19% YoY. Moreover, their high-margin online advertising sales accounted for 44% of total advertising revenue and that figure is increasing by 20% in Italy and 29% in Spain.

Besides that, in 2021 (the most recently available annual report): Corriere della Serra had 384 thousand subscriptions, a 24% increase, while Gazzetta had 80 thousand subscriptions, a 46% increase.

Online newspaper subscriptions in Spain are also increasing by more than 40%...all that while lapping elevated at-home covid numbers.

Now- as a result, you have a business that routinely generates over 100 million in free cash flow year in, year out which trades at less than 500 million in enterprise value.

3.      Risks:

Risk of substitutes

Okay, now that I've addressed the pros, it's time to spill the tea.

In my perspective, one inherent risk that is always present is the risk of social media and other substitutes. In today's world, you can get news almost anywhere. Newspapers and magazines are no longer the primary sources for most readers. People want it to be more personalized—via numerous social networks, websites, or blogs. As a result, advertisers have also shifted their attention and are likely to devote more of their available resources on Facebook or Instagram than on newspapers and “old media”. Therefore, If you plan to invest in RCS, the unpredictability of internet development is one risk you must live with.

Fortunately, RCS's portfolio of newspapers is known for being trustworthy and a point of reference in the industry, making it less likely to be replaced as opposed to smaller news organizations that replicate content. In addition, from my own experience, I don't believe I've ever met someone who reads one newspaper on Monday and Tuesday but an entirely different newspaper on Friday. It seems like people tend to stick to the same news source for longer periods of time. And any business would be happy to have loyal customers with sticky habits.

Economic cycle

Due to their reliance on advertising, media companies are affected by macroeconomic changes.

Any business that generates a sizable amount of revenue from advertising should be aware of this risk. However, compared to other companies, RCS's situation doesn't worry me as much because they were able to maintain profitability in 2020, have a debt-free balance sheet now, and are trading at a ridiculously low price, which should more than offset the decline in profitability.

Newspapers were also one of, if not the, best performing sector throughout the 1970s period of high inflation due to their intangible value and capital-light nature. Yes - advertising spending scales with inflation, so a longer period of high inflation would actually benefit RCS.

Bargaining power

One risk I never like to see is a lack of bargaining power.

For other types of supplies, such as paper in particular, the main risk is tied to a gradual intensification of market concentration, with possible ensuing difficulties in procurement and price tensions (for pink newsprint in particular)

Naturally, this comment from the annual report led me to believe that they may lack sufficient negotiating power with suppliers, and as a result, there's a decent possibility they won't be able to pass those costs through to customers. However, in February 2021, they made an acquisition that, in my opinion, doesn't fit with their plan to become a digital-first corporation. RCS bought the entirety of M-DIS Distribuzione Media SpA, the main operator for the national distribution of press to the Italian public.

Now that I've given it some thought, I believe I've found the answer. I believe the acquisition was motivated by the desire to partially mitigate the bargaining power risk and strengthen their position in the supply chain. At least, until they are able to entirely switch to digital and eliminate the physical side of the business. Yes, I may be a bit biased.

Misallocation of capital

One risk that is also always present is that Urbano will do something dumb with his and your money. Overpaying for a large acquisition tops the list.  

In that respect, there is a lot of uncertainty going forward because he has now paid off all the debt and is paying a dividend yielding nearly 10%, but it is only equal to a 25% payout ratio. Yearly CAPEX is also only in the 15-20 million-dollar range. So the question is, what will he do with the remaining 60% of free cash flow that is available for me and you, the shareholders?

A share buyback is one obvious thing to do, but in this case, it is probably impossible. The company has a market cap of only 350 million, with the top three shareholders holding more than 75%. Therefore, the float is almost nonexistent. As a consequence, he can either increase the payout ratio or make an acquisition. Acquisitions are often seen as value destroyers, but I would give Urbano Cairo the benefit of the doubt given his successful track record and the dirt-cheap prices of everything within his circle of competence. This might as well be an ideal environment for a decent capital allocator.

4.      Catalyst

One, perhaps not all that significant, but short-term catalyst that comes to mind is the start of the FIFA World Cup in a few weeks. Spain and Italy are both "football nations," which means that more time will be spent reading RCS's publications (especially Marca and La Gazzetta) and more money will be spent on brand advertising… In fact, in the year of the most recent World cup, 2018, RCS achieved the highest operating margin. Additionally, it has been almost two years since the launch of CAIRORCS, so additional synergies and efficiencies could materialize.

5.      Why does the opportunity exist?

I mentioned the media industry's hatred and the worst sentiment ever for newspaper companies. I also did say that stock is illiquid. However, there was one unique situation with RCS that made investors uncertain about their future.

That incident was a lengthy legal battle between RCS and Blackstone. In summary, Urbano Cairo sued Blackstone in 2014 for taking advantage of their terrible financial conditions and effectively purchasing one of RCS's properties for pennies on the dollar. In 2018, the situation escalated to the point where investors were terrified. Blackstone launched a lawsuit against RCS, seeking 600 million in damages. Fortunately, the claim was denied, and the entire battle ended three months ago, with RCS having to pay 10 million in legal fees and repurchase a part of the property for 60 million.

6.      Valuation and margin of safety

I could merely say that the company's FCF yield on EV is 20-25% and leave it at that, but that would spoil the fun. Additionally, I see multiple margins of safety on this one, so why not write it up?

The first, and most obvious, is the "What would a private buyer pay for this business" margin of safety.

If you read the details of the 2016 acquisition, you'll certainly see it. There were two takeover bids: one for 416 million dollars from IMH and one for 500 million dollars from Urbano Cairo. Both situations provide an upside to the current market cap of 350 million, with the second offering an almost 50% premium. Bear in mind that the company was heavily indebted at the time and was undoubtedly a worse business than it is today. Also, here's a quote from the man himself after the deal was done;

Cairo explained yesterday on the radio the reason for his estimate. "We have valued RCS at 770 million euros, which, if we remove the 90 million from the sale of RCS Libros [to the Mondadori publishing group] , is almost 700 million...

That would represent a 100% upside from the current price while ignoring any advancements on the digital front and a current net-cash (before leases) position versus a net-debt position of 487M back then.

The second, and also obvious, the margin of safety is the dividend yield. The company is yielding 9.5%, which is a market return if not a market-beating return in the long run. If it remains the same neglected, overlooked company and the multiple that investors are paying never re-rates, and if they squander all of the remaining cash flow. At the very least, you will receive a 9.5% income directly in your pocket, which you can reinvest in other attractive opportunities.

For the third and final margin of safety (three is enough), I will use their own estimates from the annual report.

…so as I went to the notes section because I was wondering what was included within their 350 million intangible assets on the balance sheet, I found something really interesting. That section of the report not only gave me a better understanding of their intangible assets but also helped me in forecasting the future and valuing this business.

Because RCS does not hold conference calls and does not provide guidance in its reports, it is impossible to know what management's expectations for the future are. However, if you look at the notes section for intangible assets, the picture becomes clearer.

Essentially, their subsidiary, Unidad Editorial, which operates part of the business in Spain, accounts for 85% of its intangible assets. To determine the value of those assets, RCS performed an impairment test, which had to include some financial projections and management’s expectations for the business going forward. Well, here they are:

Publishing revenue as a percentage of total revenue is expected to fall over the period of the plan, with an increasing proportion of revenue from digital versions and subscriptions. The expected improvement in margins is driven not only by revenue growth (taking account also of the decline in revenue in 2020 and 2021 as a result of the COVID-19 pandemic), but also by a greater weight of digital revenue and a general efficiency in operating costs.

Projections on the 2022-2026 plan see a recovery in revenue and margin in the first three years, thanks to digital developments and the return/development of in-person events

What is great about this is that these are only the assumptions for part of the business in Spain going forward. For the part that was always considered the weaker half and that lags behind its Italian counterpart. So, I think, it wouldn't be a stretch to assume those projections for the entire business going forward and expect cash generation to be in line, if not better. Again, trading at 4-5x normalized EV/FCF

To conclude, I expect a double-digit bear case return and a 3-4 bagger for the base case scenario. Depending on how much and how quickly multiple rerates and how the capital allocation looks in the future. I don’t even want to talk about the bull case because it makes me uncomfortable and even more biased.

Disc: long

This is not investment advice. Do your due diligence.