The Stock Market's Easiest One-Way Bet

Newspapers have been among the most highly prized assets in America for hundreds of years.

They are trophies in part because the First Amendment protects them. And for generations they've been a primary source of news and information for most people. Powerful businessmen like the idea of controlling what gets printed and about whom.

Newspapers are also trophy properties because historically almost nothing has been as safe or as profitable as the local paper.

As Warren Buffett has explained over many years in his letters to Berkshire Hathaway shareholders, owners of even the worst newspapers in America couldn't help but reap huge profits, thanks to the monopoly position most newspapers enjoy.

"When Charlie and I were young," Buffett wrote, "the newspaper business was as easy a way to make huge returns as existed in America. As one not-too-bright publisher famously said, 'I owe my fortune to two great American institutions: monopoly and nepotism.' No paper in a one-paper city, however bad the product or however inept the management, could avoid gushing profits."

It's a far different story today. Newspapers are now under attack from the Internet, satellite communications, and wireless networks. Their revenues have been in decline since 1987. And most Americans under the age of 30 wouldn't consider subscribing to a newspaper, for any reason. When they want news, they get it from a webpage, a blog, an e-mail, a cell phone, or through their digital social networks.

Worse, when they want to sell something through a classified ad or when they're looking for a job, they're using free or cheap services like eBay or Craigslist.

This onslaught of new competition has been brutal for the owners of America's local newspapers. Three of the largest publicly owned newspaper companies – McClatchy, Lee Enterprises, and Journal Register – are on the verge of bankruptcy. McClatchy's stock price has fallen 94% in the last five years. Lee is down 93%. Journal Register shares are trading over the counter for about 1.5 cents apiece.

As a publisher myself, I have some insight into what's happening to newspapers. New distribution technologies (mostly the Internet) make content you'd typically look to find in a newspaper – stuff like a local weather forecast, movie listings, sports scores, etc. – available free.

And with free wireless networks (WiFi) becoming almost ubiquitous in most cities, most people can either get this information sent to their computers or even to their cell phones automatically. You have no reason to buy a newspaper for your commute when you can see the latest headlines on your cell phone, listen to news over satellite radio, or download your favorite columns to your iPod.

Meanwhile, newspapers make the majority of their revenue selling space ads, not subscriptions. Moving their content to online formats (which are smaller) destroys their business model because web pages don't offer nearly enough ad space. The Internet also makes it easy for advertisers to judge whether buying space ads in newspapers is worth the expense – and most of the time it's not. Online advertising can be accurately tracked, which makes life hell for ad salesmen. There's no longer any question about how many people looked at a specific ad – and how many bought because of it.

If newspapers didn't already exist and an entrepreneur came to you and said he was going to start a newspaper business, you'd think he was insane...

Look, here's what I'm going to do: First, I'm going to cut down a ton of pine trees. Then I'm going to grind them into a pulp and make cheap paper out of them. I'll establish offices all across the country and hire thousands and thousands of highly skilled, expensive employees. We'll get these folks to write and edit small, easy to read stories about what's happening in their communities and around the world. We won't take any sides – we'll have journalist integrity – a milquetoast countenance – so that we don't alienate any of our real supporters, our advertisers. Yes, advertisers. That's why we need all of the paper. The more space, the better, because the bigger the paper the more ads we can sell.

Why would you bother with the trees and the paper when you can send e-mails to millions of people directly, for almost no marginal cost? Or simply put up a webpage that's easy to update and can serve millions of people at the same time. Why would you bother with advertisers if you don't need to pay for printing? And why would you publish copy that no one is passionate about – not even your journalists – when by taking a position you'll attract a dedicated audience?

The fact is, most newspaper companies can't adopt the more direct (and honest) business model of selling directly to subscribers because their cost structure, their asset base, and their culture are all built around selling ads, not selling content.

Compare your average large newspaper company with the Drudge Report, the leading news and political opinion website on the Internet. Drudge has two employees – himself and one other guy. He has one webpage. And he serves millions of readers per day, all around the world. Even if he's not making all that much money selling the limited amount of ad space on his page, it doesn't matter because his overhead is almost nothing. But that's not true for big newspaper publishers.

Newspaper publishers can't compete with the new generation of web publishers in any case, because most don't know much about great writing or selling subscriptions. They've never had to know these things because they're actually in business to sell advertising.

Furthermore, the consumer is now far more empowered to ignore advertising. Technologies like TiVo make it possible to remove almost all of the advertising from your television. And various software packages can make it nearly impossible to advertise to people viewing web pages.

These technologies make it easy for buyers of advertising to know what it is really worth (not much) while at the same time enabling readers to avoid the ads. Add it all up, and you have shares of newspaper companies going much lower in the next few years.

Good investing,