Connect Group – Smiths News business

PUBLISHED: Dec 12 2018 @ 09:35 | Comments (0) |

Connect Group (LSE:CNCT) has two businesses that produce profits and lots of cash flow year after year. Smiths News has a collection of local monopolies delivering newspapers and magazines to newsagents. It has a rival at a national level, John Menzies, but these duopolists 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 JM will take that contract.

The other business, Dawson Media Direct, DMD, 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.

Thus, both businesses have a barrier to entry. A potential new entrant to the newspaper distribution business would have to contemplate winning five-year contracts from the major publishers on operating margins of 2.7% and then organise a fleet of vans, with drivers and sorting depots. All the while, SN and JM, with their efficiencies and experience will be breathing down their necks and constantly undercutting on price.

DMD has the barrier of strong relations with airlines and airports as a trusted partner. I’ll look at this division tomorrow and concentrate on SN today.

Smiths News

Smiths News has a declining turnover, because the volume of newspapers and magazines bought in the UK 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 from 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 the operating profit stabilising around £40m.

It’s not as exciting for the managers to simply look after the nuts and bolts of a steady-as-she-goes, low-cost producer business as it would be to build through acquisitions a fast- growing company, but for shareholders it is great – a nice stream of free cash flow to pay dividends.

The recently appointed new team of managers immediately recognised the importance of aiming for excellence in the existing business and going for continuous improvement and constantly bearing down on cost as the best strategy – do the ordinary extraordinarily well, as Buffett says.

Figures for Smiths News

£m, Year to Aug	2018	2017	2016	2015	2014	2013	2012
Connect News Revenue	1,335	1,384	1,444	1,479	1,525	1,529	1,571
Connect News. Adjusted operating profit (excluding PMP losses)	41.3	40.4	40.0	41.4	42.9	40.0	39
Connect News Statutory operating profit	25.0	36.1	34.1	23.2	40.8	n/a	n/a
Connect News Depreciation and amortisation	7.9	7.2	6.8	6.0	5.4	5.6	5.7
Connect News Additions to non-current assets	3.8	6.8	5.2	8.0	7.7	6.7	6.7
John Menzies Revenue from distribution	1,216	1,215	1,210	1,171	1,184	1,203	1,224
John Menzies operating profit from distribution	25	25	25	25	24	24	28

Notice the stable operating income of the duopolists, SN at around £40m and JM at £25m. Neither wants to rock the boat. (The large difference between SN’s “adjusted” and “statutory” 2018 numbers is mostly due to a write-off of a bold but costly experiment in using its distribution network to deliver parcels to newsagents and other shops for the likes of Amazon and ASOS. This business, Pass My Parcel, was never allowed to generate a profit by the giant retailers and so is

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