March 28, 2011

Yellow Media Hopes

President and CEO (Tellier) of Yellow Media Inc. acknowledges that his company has a corporate communications challenge. Too often, people associate his company with its Yellow Pages print directories and that business only.

But Tellier said the $750-million sale of Trader Corp., announced Friday, will allow the company to focus on its core business: growing beyond simply phone books and into digital properties.

"We think we have the product portfolio to re-acquire growth,'' Tellier said in an interview, pointing to Yellow Media's efforts in print, online, mobile, websites, and search-engine marketing and optimization. He did note that the print side still makes up roughly 75 per cent of revenues going forward.

With the deal, Canada's largest phone directory operator will continue to own and operate Yellow Pages, as well as such properties as and The transaction does not includes its real-estate and employment businesses. Income hungry investors, meanwhile, appear more concerned about the company's payout, which currently produce a dividend yield of about 11.7 per cent.

While the stock had lost 20 per cent of its value since mid-December, investors responded positively to the news on Friday. They sent Yellow Media's shares up four per cent to $5.50 as the company said it plans to use most of the proceeds to reduce debt.

Despite the gains, the market appears to have a big bet on against the stock. While the short interest on Yellow Media's TSX listed shares stands at just 2. 9 million, that number is nearly 45 million for its U.S. over the counter securities. That puts the total short interest at 9.4 per cent of Yellow's 509- million share float, according to Bloomberg data.

Analysts said the asset sale does a number of things. It removes some of the risk on the Montreal based company's balance sheet, thereby reducing the chance of a rating downgrade and dividend cut. But it also lowers Yellow Media's growth profile, raising questions about where the company goes from here.

While the price tag may have been substantially lower than the $1.4 billion initially paid for these assets, the amount coming from London based private equity firm Apax Partners is also higher than analysts expected.

The deal includes Auto Trader magazine and, Canada's biggest online automotive classifieds site. Apax further consolidates is presence in the sector with Yellow Media's 30 per cent stake in, the leading U.S. digital solutions provider to the auto dealer segment. The divested assets generated about 15 per cent of Yellow Media's 2010 revenue and roughly 8.4 per cent of 2010 adjusted EBITDA.

In addition to lowering the chances of a dividend cut, BMO Capital Markets analyst Tim Casey believes the transaction will be accretive to Yellow Media's net asset value.

In December, Standard & Poor's said its ratings for the company were based on an expected debt reduction of more than $450 million in 2011. S&P confirmed its BBB credit rating on Friday as the cash boost will allow the company to trim its $3.3 billion debt by about $500 million.

As TD Securities analyst Scott Cuthbertson pointed out, having an investment grade rating is a key part of Yellow Media's agreement with its lenders since it allows the company to make investments and distribute cash as it sees fit. If it loses this rating, that freedom can be curtailed and dividends would be capped at 50% of distributable cash.

Yellow Pages Income Fund cut its annual cash distribution to 80 cents from $1.17 in May 2009 in an effort to reduce some leverage concerns. It trimmed it again to 65 cents earlier this year as part of its conversion from an income trust.

Assuming no mergers or acquisitions, Yellow Media's 2011 year-end leverage ratio is expected fall to below the 3.0 times threshold indicated by credit rating agencies. The company's debt-to-EBITDA stood at 3.8 times in 2010.

"There is no doubt that everyone starting with the credit rating agencies will be happy with regards to us strengthening our capital structure,'' Tellier said. But I don't think there was a sense of urgency. Credit ratings have never been an issue for us or the ratings agencies.''

RBC Capital Markets analyst Drew McReynolds said the sale of the higher- growth Trader business lowers Yellow Media's growth profile, which should offset some of the risk-reduction and visibility benefits the deal brings.

Calling this a sentiment "tug of war,'' he anticipates investors will focus on the rate of decline in print directories and the extent of re-acceleration in online growth over the next two to three quarters.

Desjardins Securities analyst Maher Yaghi agrees that the sale will increase the concentration of earnings generated from the declining Yellow Pages directories business. However, he is pleased by the multiple received for the assets, noting that it is at the high end of recent transactions in the sector. Yaghi suggested Yellow Media could execute a share buyback with the remaining proceeds.

Before the sale, we had no issues. We had not forecasted a dividend cut this year or next year,'' Yaghi said. Usually when you're a seller and people know that, they have the upper hand and not you. At this point in time, the company is more interesting in managing the transition of their directories business to online.''

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