Can a manager’s reputation withstand that of his business?

Can a manager’s reputation withstand that of his business?

The announcement that Roger Corbett will become the coxswain of Fairfax, the esteemed publisher of titles such as The Age, The Sydney Morning Herald and The Australian Financial Review, had me wondering; when a manager with a reputation for brilliance gets involved with a business with a reputation for poor economics, is it the business whose reputation remains intact?

Your performance in the share market is more a function of the business boat you get into than who is rowing it.  Even the ‘oarsome’ foursome will sink if their boat has a leak.

Newspapers have had to change dramatically as readership and classified revenues decline. Other major advertising revenue is also under pressure as the vast tracts of broad-acre advertising real estate is replaced by the cheaply created, high density and high-rise internet.  Even Warren Buffett, once the most vocal exponent of the toll bridge like virtues of owning the only newspaper in town, has more recently declared that he now would not buy newspapers at any price.

The Rocky Mountain News, founded in 1859, printed its final edition on Feb. 27 this year. Its former editor, John Temple, now writes a disarmingly frank blog in which he first observes; “we didn’t fully believe in the value of the web” and “Denver.com was available but the $50,000 price tag was considered too steep.”

As a fund manager I cannot comment about the execution of Fairfax’s online media strategy, however I can comment on the performance of the business, the irrational book value of its intangible assets and its intrinsic value.  For me, these are the things that are relevant in determining whether it is worth buying.

Fairfax’s reported profit before abnormals of $217 million for 2009 is less than the profit reported 5 years ago and has grown by less than 3% over the last nine years.  This latter statistic suggests, even without looking at the share price, that after inflation Fairfax owners have gone backwards.

Even more concerning however is the decline in return on equity from 15.5% in 2000 to 4.6% this year. If 4.6% seems exciting for you, there are plenty of bank deposits on offer through which such salubrious returns are available at much less risk.

Such a low rate of return on equity indicates that the assets, and in particular the $3.6 billion of intangibles and $2.3 billion of accounting goodwill, are unsustainably overvalued on the balance sheet.  If return on equity does not improve substantially, the auditors must surely ask how they can justify such high valuations.

Finally, it is worth noting that investors have injected $4 billion into the business, on top of the $600 million the company had a decade or so ago. In total, investors have put in and left in $3.8 billion over the last decade and yet the total market value of the company is only $200 million more. And so I repeat my initial question… when a manager with a reputation for brilliance gets involved with a business with a reputation for poor economics, is it the business whose reputation remains intact?

By Roger Montgomery, 15 October 2009