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Yellow Media's cheap, but read the fine print

Think Yellow Media Inc. is a screaming buy after the stock's recent plunge? Be careful, or you could be the one screaming if the company's online strategy doesn't pan out.

On the surface, Yellow Media's beaten-down shares would seem to offer compelling value. They trade at a multiple of 5.5 times trailing earnings and sport an outsized yield of 16 per cent, even after the company slashed its dividend by about 75 per cent recently.

What's more, despite declining print revenues, the company is still churning out lots of cash and plans to chop its $2.1-billion debt load using $708-million in net proceeds from the sale of Trader Corp., its online and print vehicle sales division, and savings of about $258-million annually from the dividend cut to 15 cents a year from 65 cents.

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That will put the directories publisher on a more secure financial footing as it makes the transition from print to digital media – a transformation that is well under way, president and chief executive officer Marc Tellier said on the second-quarter conference call in early August.

"We do firmly believe that our market position, as well as our business transformation, is much more advanced than we are given credit for," he told analysts, citing the popularity of its Yellow Pages mobile app and the launch of Yellow Pages 360 Solution, which provides a suite of print, online and mobile advertising products for small- and medium-sized businesses.

The response from analysts? Show me.

Following the company's disappointing second-quarter results – in which revenue fell 4.8 per cent and earnings before interest, taxes, depreciation and amortization dropped 13.5 per cent – analysts slashed their ratings and price targets on the stock, saying the digital transformation is still a work in progress.

It didn't help that the company withdrew its full-year forecast and said it would no longer provide short-term earnings guidance, citing the uncertainty of revenues from its digital operations.

"Until we are convinced that the road to positive organic growth is clearly established, which we are unable to forecast at this time, we view trading in the shares to be a speculative endeavour," Desjardins Securities analyst Maher Yaghi said in a note to clients.

Organic growth is driven by two factors – average revenue per advertiser (ARPA) and the number of advertisers, Mr. Yaghi said. Yellow Media was able to steadily increase ARPA until the third quarter of 2010, when that growth stalled and then declined year-over-year in the subsequent three quarters.

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More worrisome is the advertiser count, which has been falling for more than two years, he said. That includes a 5-per-cent decrease in the second quarter compared with a year earlier, he noted.

"[Yellow Media's]goal with its 360 Solution is to sell the product to both new and existing clients in order to increase ARPA and advertisers. Clearly, the key performance indicators are showing that to date, the company has not been able to achieve this result," Mr. Yaghi said.

Other analysts are also skeptical that the company's online business can grow fast enough to make up for the steady declines in print revenue, despite Yellow Media's goal to derive 50 per cent of its sales from online by 2014, up from about 25 per cent currently.

Drew McReynolds with RBC Dominion Securities Inc. cut the stock to "underperform – speculative risk" from "sector perform – average risk" and dropped his price target to 75 cents from $2.75, saying the lack of earnings visibility "remains the major concern."

Citing an accelerating decline in earnings, he said "we believe the risk profile of the stock will remain elevated and we fail to see an obvious catalyst" until the earnings outlook becomes clearer, possibly in the fourth quarter when Yellow Pages 360 gains more traction.

Whether the stock recovers, or continues its descent toward zero, could well hinge on whether Yellow Media's results start showing signs of a turnaround soon.

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"Is the stock worth anything? Only if these guys do two things: Number one, follow through on the debt reduction plan as outlined on their call last week. Number two, they need to have a very firm [digital transition]plan … and communicate it well and execute on it well. Then that stock could be worth something," said Paul Tepsich, chief executive officer of High Rock Capital Management, who doesn't hold the shares but owns Yellow Media debt through the Advantaged Canadian High Yield Bond Fund that he manages.

"Let's give them a quarter or two and see how they execute."

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About the Author
Investment Reporter and Columnist

John Heinzl has been writing about business and investing since 1990. A native of Hamilton, he earned a master's degree from the University of Western Ontario's Graduate School of Journalism and completed the Canadian Securities Course with honours. More

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