http://www.distressed-debt-investing.com/2013/11/emerging-manager-interview-series.html?m=1
Five years ago, digital was a tiny part of the business for most directories, but today it is a real business, and some have very attractive metrics. We think the incumbent Canadian directory company, Yellow Media, is a great example. Nearly one in three Canadians visit the company’s digital properties monthly, and nearly one in three smart phones have downloaded their app. They provide real service to their customers, and their proprietary traffic and huge customer database give them a meaningful completive advantage over many other digital competitors. The digital business is growing at 10% and soon will account for half of the company’s revenues.
Those types of user penetration metrics and growth profiles would garner a huge valuation if the digital business were a pure-play stand alone. Just look at how Yelp, Web.com and other businesses going after the same niche are valued. Now, I don’t know if any company is worth 20x revenue, like Yelp is currently priced, but I know 2.2x EBITDA is cheap for a Canadian business that has very similar characteristics, save for one key difference in that Yellow Media’s digital business is already quite profitable. And that is to say nothing about the real cash flows still being generated by the legacy print business. While the stock has had a great run this year, the surprising fact is that enterprise value is little changed, as the increase in the equity account is offset nearly entirely by the fact that the company has paid down debt early with free cash flow.
The directory sector offers great opportunities for distressed investors right now for several reasons. First, you have to be able to price a series of decreasing cash flows from a legacy print business in secular decline. This should be a core competency of distressed investors. Second, you have to be able to understand the risks and opportunities of the transition the industry is making to digital. Frankly, this type of thing is not a core competency for distressed investors, but the great news is that several of these businesses in Europe have made the transition to majority digital businesses so there is a road map on process and valuation. We are at a disadvantage to the fortune tellers in Silicon Valley when it comes to foreseeing how a division that accounts for 1% of revenue is the key to the business’ future fifteen years hence, but when that same division is 40% of revenue and growing, even distressed guys can begin to understand what 2016 might look like. Third, you have to be able to look across capital structures and geography. These directory businesses are very similar, and while there are nuances to why perhaps Canada and France are more defendable markets than the US or Sweden, they are all going through the same transitions, just at different stages. They also all have different balance sheets. We own a term loan in one directory which we think is a very attractive credit risk. We own another term loan in a different company that we think is equity risk, despite it being senior secured. And we own converts and equity in yet another, which is very likely the best risk/return tradeoff of all three.
But you have to be able to think first what each business is worth, and then feel comfortable buying the right claim on that enterprise value in whatever form it takes: loans, bonds, common, etc. Again, this is a core competency of distressed investors, who don’t suffer from being restricted to a single asset class. We think there are plenty of catalysts still to come in the space: mergers, refinancing, management changes, and, most importantly, the pending transition to majority digital businesses. It’s a great niche in the distressed market right now.