WPO reported 4Q09 results this morning. You can read all of the details here.  The company’s revenue and EPS of $1.238 billion and $8.71 beat the lone set of analysts estimates out there of $1.16 billion and $3.21.  In the table below we outline how each of the company’s operating divisions performed relative to our expectations:

Source: Company reports, PAA Research

Better than expected results in the company’s newspaper, broadcasting, and cable divisions enabled WPO to top our EBITDA estimate despite a large sequential margin decline from Kaplan Higher Education.  Here’s a quick overview on the performance of each of WPO’s major operating divisions:

• Kaplan/Education: Kaplan Higher Education continues to generate strong enrollment growth.  According to the company, enrollments increased 31.4% YOY to 104,800 students, while online enrollments increased 47% YOY.  We have discussed our concerns about WPO’s definition of an enrollment and some of the discrepancies in the company’s historical disclosures here and here.  The company’s fourth quarter earnings release has not offered any additional detail.  Operating margin for Kaplan Higher Education declined 3.9% sequentially to 17.8%.  We attribute the weakness in part to WPO’s investment in its national advertising campaign which continued into 1Q10.  Kaplan test prep continued to witness revenue and operating margin weakness due to both cyclical factors (low demand for real estate licensure prep, reduced discretionary spending) and secular factors (increased competition from online providers of test prep in the company’s core offerings).
• Newspaper: WPO’s efforts to right-size its newspaper division in 2008 and 2009 yielded results in the fourth quarter as the division generated positive EBITDA for the first time since 1Q08.  The overall demand environment for advertising remains weak and subscriber attrition remains high. We estimate WPO can generate mid-single digit EBITDA margins from its newspaper division and 5-8% YOY revenue growth in 2H10 as ad spending recovers.
• Broadcasting: EBITDA margins for WPO’s Broadcasting division increased more than 10% sequentially to 39.7%.  This is the highest EBITDA margin the division has generated since 4Q08.  Although we expect the secular shift away from television advertising spend to accelerate over time, next year WPO will benefit from an increase in political ad-spending, which should boost revenues by as much as $10-$15 million in 2009.
• Cable: CableOne generate a 4% YOY revenue increase in 4Q09.  A price increase of 4% implemented in July 2009 accounted for all of the topline growth.  Total RGU’s declined slightly sequentially to 1.390 million.  The company has witnessed three consecutive quarters of sequential declines in RGU’s.  The company continues to make steady progress in upselling basic subscriber to high speed data and telephony plans.  Total high speed data and telephony RGU’s increased 5% and 17% YOY, respectively.  The attrition in RGU’s can be attributed to cyclical factors, but we wonder if CableOne will ever achieve the same level of penetration of homes passed as other cable networks given mounting competition.  The company’s market opportunity window could be closing.
• Magazine: Total revenues declined 29.7% YOY to $52.4 million, the company’s circulation rate base adjustment earlier in 2009 continued to remain a large drag on topline in the fourth quarter.  To management’s credit, they have been able to eek out break-even EBITDA out of the magazine division despite the rapid decline in revenues.  We think the longer term prospects for this division are particularly bleak.  We have yet to receive a good answer to the question: Why does Newsweek exist?

Waiting on Improvements to WPO’s Disclosure on Kaplan Higher Education

By management’s own account, WPO is a company whose revenue, earnings, and free cash flow prospects are increasingly tied to the performance of Kaplan.  WPO is a for-profit education company.  In 2009, WPO’s Education division generated more than 50% of the company’s EBITDA.  As a leading for-profit education company, we think it is appropriate for WPO investors to expect a similar level of disclosure to that offered to shareholders of other publicly traded for-profit education companies.  We find it strange that management continues to offer, at times excruciating detail in its earnings releases on the newspaper, broadcasting, cable, and magazine divisions, yet investors don’t receive basic enrollment information (starts, online, international enrollments) about the Education division.  Does anyone else find it bizarre that RGU level detail has been provided for the Cable division, but WPO refuses to provide investors with new student start data?

WPO’s Education division has been the company’s “shining star” over the past decade and realistically is largely responsible for saving shareholders from a similar fate that investors in other traditional media companies experienced over the past few years.  Given the strong operating results, we’re not sure why the company has yet to provide investors with basic metrics that would enhance shareholder understanding of the divisions growth prospects. Here are the metrics, which we think the company should provide:

• Student starts
• Organic enrollment growth
• International enrollments (we can back into the data historically through 2Q09)
• A reconciliation of historical enrollments.  You can read more about the issues here.
• Online enrollments and starts.  Kaplan University Online is one of the company’s largest divisions, yet shareholders receive very little information about it
• Bad-debt expense.

We think the addition of these disclosures on a quarterly basis would help investors paint a more realistic picture of WPO and the company’s future earnings prospects. For example, we know that Kaplan Higher Education experienced a large sequential margin decline in 4Q09. We think higher marketing expense contributed to that, but it’s also highly possible (if not likely) that increased bad-debt expense played a role.

Finally, we are surprised that WPO did not make any comments on preliminary FY08 cohort default rate data, which will most certainly be material for a few of the company’s schools.  For FY07, Kaplan Higher Education had four schools whose cohort default rate exceeded 25%. One of these schools had a cohort default rate in excess of 25% for both FY06 and FY07.  As a reminder, if a school has a cohort default rate in excess of 25% for three consecutive years, it will lose access to Title IV funding. As we have discussed in the past, from a cohort default rate perspective Kaplan Higher Education has the worst compliance among publicly traded for-profit postsecondary education companies.  Preliminary cohort default data is certainly material to WPO shareholders given the mounting regulatory risks the company’s schools could face.

From a longer term perspective, we think the company will need to dramatically alter its enrollment policies at many of its schools in order to maintain compliance with regulatory standards under a 3-year cohort default rate calculation.  We anticipate this could be a significant headwind for the company over the next several years.  Should the company choose to continue on its current path, it is our opinion that a number of the company’s schools could run the risk of losing access to Title IV funds in the next 3-4 years.  In a scenario in which some of the regulatory issues are not addressed we anticipate the intrinsic of value of Kaplan could be impaired by as much as 30-40%, which would imply WPO shares would be worth as little as $275-$300. Conversely, we anticipate the neccesary remedies we proposed in the pastcould reduce the growth profile of Kaplan for 3-5 years, but perhaps only impair the intrinsic value of the company by 10-20%. Stated another way, should these regulatory issues go unchecked we estimate peak cycle earnings for WPO of $18-20 per share, assuming earnings recover for the company’s newspaper, magazine and broadcasting divisions. The stakes are incredibly high for WPO shareholders.

As always, please act accordingly…