Reference no: EM131347294

Springfield PuBLISHING

SETTING THE STAGE - BACKGROUND:

The newspaper industry and Springfield Publishing

Newspaper publishing is a classic example of an industry that evolved within a changing set of economic conditions. Many say the demise of the daily paper is just a matter of time - and not much time at that. Circulation is dropping, display and classified ad revenue is drying up, and the industry in recent years has experienced an unprecedented wave of layoffs. The future of journalism is in the digital world of websites and apps, not newsprint, some say.

The financial ratios below paint a bleak picture of Springfield's financial health. It is apparent that Springfield has been facing the same economic pressures as its competitors: declining margins and sales. Sales increased substantially in 2013, but quickly fell below 2012 levels. Assets have been shrinking as Springfield closed down publishing facilities and reduced new investments in order to conserve cash. But the fact that asset turnover has declined, indicates that Springfield has not contracted assets as fast as the decline in sales.

Financial Ratios (2012-2015)

	2012	2013	2014	2015
Sales growth		-6.6%	-20.4%	-19.4%
Gross Profit/sales	57.8%	57.3%	56.6%	56.0%
Selling, gen. & admin. exp./sales	45.9%	46.2%	46.4%	47.0%
Net Oper. Profit After Tax/sales	5.89%	5.34%	5.17%	4.56%
Asset turnover	1.37	1.39	1.28	1.08

Indeed it can be said that newspapers are facing tough times, and yes, the Internet can offer many things that papers cannot. Even so, the death of newspapers has been predicted by many for decades. Radio, TV and now the Internet were all supposed to kill them off, but they are still here. Those who claim that the future of news is online and only online ignore one critical point: online ad revenue alone just is not enough to support most news companies. So for online news sites to survive, they'll need a different business model.

Paywalls, a system that prevents Internet users from accessing webpage content without a paid subscription, is one such model. There are two types of paywalls. Hard" paywalls allow minimal to no access to content without subscription, while "soft" paywalls allow more flexibility in what users can view without subscribing, such as selective free content and/or a limited number of articles per month, or the sampling of several pages of a book or paragraphs of an article.

Newspapers can implement paywalls on their websites to increase their revenue, which has been diminishing due to a decline in print subscriptions and advertising revenue. A recent PewResearchCenter study found that the success of paywalls, combined with print subscription and single-copy price increases, has led to a stabilization or in some cases even an increase in revenues from circulation, which means papers do not have to rely as much as they once did on advertising revenue. In order to make the "paywalls model" successful, however, investment in content creation and commerce development is necessary.

Content creation and commerce development expenses, including but not restricted to advertising, will be the norm for the modern news company. Typical forms of content creation include maintaining and updating one's web site, blogs, photography, videography, online commentary, the maintenance of social media accounts, and editing and distribution of digital media. Commerce development includes ecommerce costs associated with web design and functionality as well as running costs.

The question, then as we look at this case, is whether the added content creation & commerce development expense will be worthwhile. Otherwise said, will it allow for Springfield to produce sufficient cash flows to add value to the company?

rEACHING A DECISION USING CAPITAL BUDGETING:

Create two sets of cash flows: one for the status quo and one for pursuing growth via "the paywalls" model. I have started this for you by identifying all relevant cash flows, setting up the comparative spreadsheets and filling in some of the information. (See Springfield Cash Flow Spreadsheets.xls)

Assume a Cost of Capital of 10% as representative of the weighted average of cost of outstanding debt and common equity that exists within Springfield's capital structure.

Status quo cash flows

See below for the base-case cash flows for the status quo: assuming that Springfield continues to operate "as is". What follows are the explanations of each of the line items:

Net sales: 2015 sales were $26.6 million, down 19.4% from the previous year. Subsequent years' sales forecasts continue to fall at the same rate as 2015.

Gross Profit: Newspaper production costs in 2015 represented 44% of sales. Assumptions include a 100 basis point reduction in margins annually (i.e. Year 1 production costs are 45%).

Selling and general administrative expenses: Estimated to grow 50 basis points annually. SG&A expense stood at 47% of sales in 2015.

Depreciation: Depreciation is computed using the straight-line method for the book value of existing investments and a remaining depreciable life of years. So while the cash flow analysis subtracts depreciation before NOPAT, so as to arrive at taxes, it adds it back after the fact since it's a non-cash item.

Taxes: Assume a tax rate of 36% for your analysis. (Springfield has not been paying taxes, owing to its consistent string of losses. The effective marginal tax rate is difficult to estimate accurately. Carryforward and carryback provisions in the tax code could eliminate any actual cash taxes for Springfield for many years to come. Thus, the true tax rate on a present-value basis lies somewhere between the nominal rate of 36% and zero.)

Paywalls Model

Net sales: Year 1 sales forecasts reflect a gradual stabilization in revenues. Annual decline is scaled back 300 basis points (Year 0 was down 19.4%, but Year 1 assumed only down 16.4%, etc.). Sales growth turns positive in 2022.

Gross Profit: Newspaper production costs in 2015 represented 44% of sales. With online business growth efforts, assumptions include a 125 basis point improvement in margins annually through year 5 (i.e. 2015 GPM of 56% improves to 57.25% in Year 1) AND THEN FURTHER IMPROVEMENT to reflect a 175 basis point rise annually year 6 through 10.

Selling and general administrative expenses: Expenses related to new digital content and running an improved ecommerce site means this expense category will grow. Estimated growth is 150 basis points annually. (2015 SG&A expense at 47% of sales increases to 48.5% in Year 1).

Net initial investment (one-time):

This represents the initial cash outlay resulting from recruiting new talent, training and the upfront costs associated with web design and other content creation. In total, $4 million is projected. A portion of this cost, $1 million, will serve to update existing facilities/infrastructure. Depreciation was computed using the straight-line method. The value is assumed to be depreciable over a life of 10 years, making for an added annual depreciation expense of $100,000.

CASE III QUESTIONS-

Finish the two cash flow analyses through year 2025 on the basis of the Status Quo and from Investing in the Paywalls Model. Use the template provided - fill in all highlighted area & submit via Moodle Dropbox.

In a one page memo answer the following two questions:

Using a 10% weighted average cost of capital and assuming a 36% tax rate, what do you get as the Net Present Value (NPV) for the status quo scenario? NPV for the proposed "Paywalls Model" project? Show or tell me as to how you arrived at your answer.

Stepping away from the numbers, do you believe that Springfield can survive long enough to realize a positive NPV? Provide not only your opinion but also support it with at least two reasons/arguments for or against the company's ability to sustain for this indeterminate period.