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ERIC REGULY

Saturday, February 04, 2006

Michael Sifton wanted to become a newspaper mogul. Instead, he became a warning to investors who thought a security containing the cheery words "income" and "trust" could do no wrong.

Mr. Sifton, 45, is the founder and CEO of Osprey Media, a substantial collection of small-town Ontario papers, including the Kingston Whig-Standard and the Peterborough Examiner, that were once owned by Conrad Black. He spun the papers into an income trust in the spring of 2004.

Since then, our boy has not had a lot of fun. "It becomes a little frustrating," he says, referring to the eternal grind of pumping out enough earnings to pay the eternal cash distributions.

At least investors hope the distributions are eternal. Many obviously don't. Since Osprey Media Income Fund's $10 IPO, the ink-stained units have gone in one direction -- down -- and traded yesterday at about $6.50. That gives them a 14-per-cent yield, an alarmingly high level compared with the other two newspaper trusts on the market. FP Newspapers, owner of the Winnipeg Free Press, produces a 12-per-cent yield; CanWest MediaWorks, owner of most of the other big-city dailies in the country, gives you 10.3 per cent.

The high yield suggests investors are pricing in a distribution cut, which some analysts believe is unlikely, at least in the near term. What's behind investors' fears? It's simple: Osprey pays out more money than it makes.

In the third quarter, the company's free cash flow per unit, that is, the amount it's capable of paying out to investors after capital expenditures and the like, was 19 cents. The actual cash distribution was 22.5 cents. In other words, there was an 18-per-cent difference between what the business brought in and what it sent out. To make up the shortfall, Osprey has been raiding the working capital account.

Any newspaper company's third quarter is soft, to be sure. But Osprey hasn't earned its distribution all year. In the first three quarters, the total free cash flow per unit was 60 cents; the actual payout was 67.5 cents. This is not a recipe for corporate success.

How did Osprey engineer the squeeze play on itself? It looks like Mr. Sifton, in pursuit of a high valuation and a hot IPO, got a tad too aggressive on Osprey's payout ratio. A company that essentially pays out all of its cash flow has little room for errors and few bullets to fire at competitors. Indeed, Osprey has been getting roughed up by Torstar and Quebecor Media, two monster rivals with a lot of staying power, in certain parts of Ontario, notably the Niagara region.

While there are signs that the worst is over for Osprey in Niagara, the medium- to long-term outlook for the Ontario newspaper market is hardly encouraging. Alberta, not Ontario -- where manufacturing jobs are getting obliterated by the second -- is the growth story. Meanwhile, advertising in every category is migrating to the Internet.

Auto and housing advertising have held up well for Osprey, but how much longer can that last? A few days ago, Tribune Co. of the United States said auto classified revenue among its papers fell 16 per cent in December. The Newspaper Association of America says revenue from auto classifieds has fallen for seven straight quarters.

Osprey is not sitting still, of course. It is trying to keep a tight lid on costs as expenses, such as energy, rise. Some printing presses are being closed and employees are being let go. Still, you've got to imagine that Mr. Sifton and his partners, Ontario Teachers Pension Plan and Scotia Merchant Capital, which together own 53.8 per cent of Osprey, will eventually tire of fighting for pennies and look for a way out.

If the rumours are correct, Osprey is for sale. Mr. Sifton denies that he is running around banging on the doors of potential bidders, which would include Torstar, Quebecor, Glacier Ventures and Transcontinental Media. But he does, say, in effect, that he is open to offers. "Clearly, we have to look at ways to improve value," he said in a phone interview yesterday. "So to preclude any options would be a mistake."

Osprey has received no offers, he added. Will it? There is little doubt a cluster of 21 Ontario dailies, most of them local monopolies, and dozens of weeklies, magazines and specialty printing operations would attract a buyer. The only question is price.

Mr. Sifton should not get his hopes up. Based on estimates for 2006, Osprey trades at about eight times EBITDA -- earnings before interest, taxes, depreciation and amortization. CanWest MediaWorks trades at 10 times EBITDA. Given Osprey's relatively low potential for growth and small geographic spread, it's hard to make the case that it's worth the multiple of its larger competitor.

Let's be generous and suppose Osprey nails a takeover offer that values the business at nine times EBITDA. That would put a price of $7.50 on the units, still well below the $10 IPO price. Even at 10 times EBITDA, an Osprey buyout would fail to get investors their $10 initial investment back.

When Mr. Sifton says he finds running a newspaper trust "frustrating," believe him. The bad news is that he may find selling Osprey even more frustrating.

ereguly@globeandmail.com

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