BREAKINGVIEWS-Still too early to call McClatchy's recovery

-- The author is a Reuters Breakingviews columnist. The opinions expressed are her own --

By Lauren Silva Laughlin

DALLAS Feb 1 (Reuters Breakingviews) - McClatchy's prospects are looking up -- just a year after investors seemed to expect the U.S. newspaper publisher to go bust.

McClatchy is marketing $875 million of bonds this week. But bond investors should be wary. McClatchy's performance will be tough to maintain.

The company has taken steps in the right direction. Early last year it cut its workforce and reduced pension costs. In the fourth quarter of 2009, operating expenses fell a third from the previous year. And digital advertising revenue rose 15 percent compared to 2008, offsetting some declines in print advertising.

The stock recovered from levels that reflected bankruptcy expectations -- 40 cents a share -- to $5.35 today. But caution is deserved. Online ads only make up 16 percent of total ad revenue. So advertising from its newspapers, including the Miami Herald, Sacramento Bee and Fort Worth Star-Telegram, was still a fifth lower in the quarter.

The worry is that McClatchy can't cut costs fast enough to bridge the time it will take to transform print revenue to digital. Without ending the print declines, lost revenue could easily consume the benefits of cost savings.

Indeed, assume that digital ad revenue continues its trajectory and an economic rebound helps print advertising pick up a bit, so the decline in total advertising revenue slows to 10 percent annually. Even with expenses remaining at current levels, McClatchy's EBITDA could still fall by more than 30 percent at the end of 2011. In such a scenario, its debt-to-EBITDA ratio would jump to more than eight times from five times now, with interest expenses eating up over 40 percent of operating income.

True, buyers of the new debt are slotting into the top of the capital structure. And McClatchy's $452 million of equity value should give them some comfort that they're not on the front lines of bankruptcy. But their cash will be used to pay out previous senior creditors -- not cushion the balance sheet.

The newspaper business is making headway in cutting costs and moving to new online subscription models. But metropolitan print newspapers are still in decline. Bondholders should make sure McClatchy pays up to reflect this not so long-term risk.

CONTEXT NEWS

-- McClatchy Co (MNI.N) is selling $875 million of senior secured notes due in 2017 in a deal that is expected to price on Feb. 4.

-- McClatchy intends to use the net proceeds of the offering to repay approximately $614 million under its credit agreement and to fund its cash tender offer for approximately $166 million aggregate principal of notes due June 1, 2011 and approximately $24 million of senior notes due 2014.

-- The company recently said that fourth-quarter earnings improved significantly from the same period last year. Revenue in the fourth quarter was $393.2 million, down 16.5 percent from the previous year. Advertising revenue was down 20.5 percent, though online advertising grew 15 percent in the fourth quarter and was 16 percent of total advertising revenue compared to just 11 percent in the fourth quarter of 2008.

-- The company cut compensation costs by 26 percent and cut newsprint costs in half. Operating cash flow was up about 20 percent in the quarter compared to the year before.

-- For previous columns by the author, Reuters customers can click on [SILVA/]

(Editing by Rob Cox and Martin Langfield)