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Connect Group (LSE:CNCT) has a business which produces profits and lots of cash flow year after year called Smiths News. SN is a duopolist alongside Menzies delivering newspapers and magazines to shops. They tend to stick to their own territories in allocating their vans – it is pointless having two rivals sets of vans passing each other in rural Norfolk for example, so either SN or M will take that contract.
These two players have a barrier deterring entry to the newspaper distribution business. A potential new entrant would have to contemplate winning five-year contracts from the major publishers on operating margins of around 3% and then organise a fleet of vans, with drivers and sorting depots. All the while, SN and M, with their efficiencies and experience will be breathing down their necks and constantly undercutting on price.
Connect has another profitable business, Dawson Media Direct, DMD, which supplies printed and digital media to airlines and travel points in the UK and worldwide. It delivers to strict time windows, and most importantly has security accreditation for the airports.
But, in the last few months, DMD has suffered after losing contracts due to airlines switching to electronic newspapers. In the year to the end of August DMD’s revenue and income, for the first time, are subsumed within Smiths News numbers. This is to be expected given that DMD is now quite small and engaged in media distribution.
Smiths News
Smiths News has a declining turnover because the volume of newspapers and magazines bought in the UK has fallen and is expected to continue to fall. Offsetting this are cover price rises, but nonetheless SN’s revenue has dropped by 3% – 5% per year – see table. This pattern has severely disturbed Mr Market – why buy into a business with falling sales?
The pattern of sales also bothered Connect’s leadership team over the past decade. It bothered them so much they thought it a good idea to go out and spend vast amounts of shareholders’ money generated by the cash cow that is SN on a series of expensive acquisitions. Most of these failed, usually because too much was paid and then the businesses were not run well.
Clearly, the old team should not have worried so much about the declining revenue numbers. The operating managers, who concentrated on getting the basics right, were able to offset the falling revenue by finding around £5m of cost savings each year. This resulted in annual operating profit stabilising around £30m – £40m. The MCap of Connect is £0.29p x 246m shares = £71m.
The team of managers appointed last year immediately recognised the importance of aiming for excellence in the existing business, going for continuous improvement and constantly bearing down on cost as the best strategy – do the ordinary extraordinarily well, as Buffett says. While that worked well for Smiths News, which seems to be growing in strength, Tuffnells deteriorated badly (see tomorrow’s newsletter).
Figures for Smiths News
In the year which ended 31st August, under the leadership of Jonathan Bunting, a SN lifer, adjusted operating profit was up 12.1% despite revenue falling by 4.3%. Jonathan’s team squeezed
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