With so much hype around the iPad, many investors are wondering how this, and other tablet devices, may affect earnings and the outlook for traditional newspaper and publishing businesses.

Fraser McLeish and Ashley Wallace of RBS Equities just published the note below discussing the potential impact and benefits for Fairfax Media, and concluded that the iPad could be the real deal for newspapers.

The iPad gives newspapers a way to monetise readers that would otherwise belost to the web. We expect application revenue yields to be below print, but above online.

Below are some of the key points of their findings.

Fairfax to bundle iPad application (app) with weekend print subscription

Details have emerged of Fairfax’s likely pricing strategy for its first release apps for the iPad. The Sydney Morning Herald (SMH) app is expected to cost $4.50 per week when bundled with a subscription to the print version of the weekend newspapers. This compares with the $6.85 discounted rate that subscribers currently pay for seven-day paper delivery ($3.30 for weekend only). We expect the first apps to be basic ‘PDF’ versions of the newspaper, with more advanced and higher priced versions later in the year.

Provides new way to monetise readers migrating from print

The iPad and other tablet devices provide newspapers a way to monetise readers that would otherwise be lost to the web, as well as an opportunity to convert low yielding web users into higher-yielding app subscribers. We expect newspapers to increasingly reduce the amount of free online content to try to drive users towards paid apps. Tablet devices may also open up a new base of potential subscribers outside print distribution areas (e.g. Australians overseas).

Advertising yields key to monetisation

Advertising yields are the key to monetisation of app subscribers. Early feedback from the US is that yields on the iPad are approximately half the level of print and five times those online. App subscribers are already being included in circulation and readership figures in the US and publishers are pushing for the same treatment in Australia. We see this as important to achieving advertising yields closer to print than online.

Model app revenue scenarios – 140,000 app subscribers required by financial year 2015 to offset print declines

We have modelled a central scenario of a subscription price for the SMH app of $8 per month and an advertising yield 50 per cent of print. On this basis, we estimate SMH needs to sign up 140,000 app subscribers by financial year 2015 (eight per cent of existing user base) to offset revenue lost from a two per cent annual decline in print circulation. Broadly, for app revenue to offset print decline, we estimate Fairfax needs to upsell one website user for every print reader that shifts down.

iPad offers way to monetise lost print readers

We believe that new tablet devices (including the iPad) offer publishers a way to monetise print readers who would otherwise be lost to the web. Whilst we expect revenue per app subscriber to be well below revenue per print reader, we do expect app yields to be above those currently being achieved on the web. This reflects the fact that users are already conditioned to paying for apps over mobile devices, whereas they still expect the internet to be free. We also see potential for higher advertising yields than are currently achieved over the web given the ability to better target the advertising and the possibility for bundling app advertising with print.

In this report, we conduct some sensitivities around potential newspaper app revenues and how many app subscribers Fairfax needs to sign up for the SMH, in order to replace revenues expected to be lost as a result of ongoing declines in print circulation.

Newspaper apps on the iPad – early pricing and sales results

We expect the initial app to be a relatively basic PDF version of the newspaper in iPad format with the functionality to flip pages etc. We expect the advertising on the electronic version to be the same as in the newspaper. We believe that Fairfax is working on a more advanced app that with enhanced interactivity and video, which will be released later in the year.

Initial reports in the SMH suggest that Fairfax will launch with a bundled pricing strategy. It will charge $4.50 per week for an iPad edition of the weekday newspaper plus delivery of the print versions of the SMH and Sun Herald on weekends. This compares with the $6.85 per week that subscribers currently pay for seven-day paper delivery ($356 per annum) and $12 at full cover price – SMH weekday $1.50, Saturday $2.50 and Sun Herald $2. An existing weekend-only newspaper subscriber currently pays $3.30 per week at discounted rates and will therefore pay an additional $1.20 per week ($4.80 per month) if they upgrade to an app subscription. Overseas readers will be charged $1 per week provided they are accessing from an overseas IP address and using an overseas credit card.

This pricing strategy differs from News Ltd’s The Australian, which costs $4.99 per month for an iPad-only subscription, although we understand that this is only an introductory offer. Fairfax is charging $2.49 for its monthly Sport & Style magazine (which is normally free with the newspaper).

In the US, pricing strategies also vary significantly. At one end of the spectrum, apps for The New York Times and USA Today (Gannett) are free. At the other end, The Wall Street Journal is charging US$17.99 per month (A$20) for its iPad app. The Times in the UK charges £9.99 per month (A$17). The New York Times free app has seen the biggest uptake with 300,000 downloads by May, equivalent to one third of US iPad users at that time.

The Australian has signed up 8500 subscribers in its first month, despite the limited availability of iPads in the Australian market.

Early iPad sales success suggests large potential market for apps

Early strong sales of iPads suggests that penetration of tablet devices could ramp up quickly and create a substantial potential subscriber base for newspaper applications.

The iPad went on sale in the United States on 3 April and sold one million devices globally in the first 28 days, two million in two months and three million after 80 days.

SMH reports that industry analysts now forecast iPad sales of 12 million in 2010 and 17 million in 2011. In Australia 30,000 iPads were sold at launch on 27 May and we understand that Apple has allocated 200,000 iPads to Australia this year. We believe expectations are for one million sales by the end of 2011.

We believe that wireless broadband could represent a good proxy for tablet uptake in Australia. We forecast 3.4 million wireless broadband users in Australia by the end of financial year 2010 (15.2 per cent penetration of population) and for this to increase to seven million users by financial year 2015 (27 per cent penetration).

Fairfax has large user base to try to migrate to apps

We expect the vast majority of newspaper app subscribers will come from customers who already use Fairfax content and interact with the brand in some form or another. This translates into a large target market for app subscribers. For example, for the SMH, we see three key sources of possible new app subscribers:

  • Existing print readers – There are 741,000 readers of the weekday SMH and 1,014,000 weekend readers who are potential app subscribers (786,000 average readers across weekend and weekday).
  • Existing web site users – Website smh.com.au has 2.4 million monthly unique browsers, according to Nielsen Netratings.
  • New subscribers from areas currently not covered by print distribution – such as Australians living overseas, who currently use the SMH website but may be prepared to pay for an app. We estimate that around 30 per cent of smh.com users are based overseas.

One hurdle that Fairfax needs to overcome is that the SMH website works really well on the iPad. Therefore, Fairfax needs to incentivise iPad and tablet owners to subscribe for an app rather that just use the website.  

This will require:

  • Attractive pricingthe pricing point needs to be low, as newspaper apps are essentially competing with content that is often available for free on the web.
  • Newspaper functionality – the ability to flick through pages and provide a ‘newspaper type’ experience rather than a web type experience is a key differentiating feature. We expect app functionality to improve overtime to include embedded video and other functions.
  • Cut back free website content – we expect newspaper publishers to increasingly limit the availability of free online content, in order to try to push readers towards higher yielding apps where they can be better monetised. News Corporation is already going down this route with The Times in the UK now behind a paywall.

Advertising yields – inclusion in readership figures important

Advertising yields are the key to monetising app subscribers, with publishers hoping to be able to achieve yields close to those of print, rather than the low yields available online.

Initial comments from USA Today suggest that in early campaigns it has been able to achieve yields on the iPad at approximately half the level of print and five times online. App subscribers are already included in official newspaper circulation and readership data in the US and publishers are pushing for the same treatment in Australia. We believe that this will help support advertising yields on apps, as publishers will be able to sell print and app advertising together on a combined cost per thousand basis.

It will also be possible to offer a high degree of targeting through app advertising, as publishers will have a significant degree of information on subscribers, which should help boost advertising yields.

Revenue sensitivities – using the SMH as an example

We have conducted some sensitivities to see how many SMH apps Fairfax would need to sell by financial year 2015 in order to replace revenue lost as a result of circulation declines over that period. Key assumptions and sensitivities are:

App subscription price – We model a subscription price of $7 to $10 per month. We assume a 30 per cent royalty payment to Apple (standard for mobile apps).

Advertising yield – We model iPad advertising yields between 25 to 100 per cent of print yields. We focus on display advertising, which is sold on a direct cost per thousand basis. We do not consider classified advertising, which is subject to different drivers.

Newspaper circulation declines – we model a base case scenario that print newspaper readership declines at two per cent per annum from financial year 2010 to financial year 2015. This is above the average rate of circulation decline of one per cent over the last five years to reflect the fact that we expect the introduction of tablet devices to accelerate print circulation declines. We assume that 75 per cent of readers that give up the newspaper migrate across to an app.

Lost newspaper advertising revenue – we calculate average display advertising revenue per SMH reader of $20 per month. This is based on 786,000 readers per week (741,000 weekday and 1,014,000 weekend). On the basis of two per cent readership decline, we assume $4 million lost SMH print display advertising revenue per annum.

Lost newspaper circulation revenue – we calculate average sales revenue of $25 per SMH copy sold per month and $7.50 per reader (not every reader buys a paper). On the basis of two per cent readership decline, we assume $1.4 million lost sales revenue per annum. We assume variable cost of sales account for around 20 per cent of sales revenue and factor this into our calculations.

Lost website revenue – We assume that every new SMH app subscriber either migrates down from the existing print readership base or up from the existing web user base. For every web user that migrates up, we expect some online advertising revenue to be foregone. We estimate current online display advertising revenue of $2.30 per web user per month (i.e yield 10 per cent of print) and assume that this is lost when a web user migrates up to an app. We base our revenue per user figures on 1.1 million average daily web browsers rather than the 2.4 million monthly browsers outlined in the previous section to strip out duplication, such as users accessing from multiple devices and infrequent users.

On the basis of the above assumptions we calculate that SMH needs to sign up somewhere between 80,000 to 220,000 app subscribers by financial year 2015 to generate enough new app revenue to replace revenue lost as a result of circulation/readership declines. This equates to 4.5 per cent to 12.2 per cent of the current combined SMH print and online reader base subscribing to an app by financial year 2015 (based on 786,000 print readers and 1.1 million online users as outlined above). At a midpoint of $8 subscription price and ad yield half of print, we estimate 140,000 new app subs are required (8 per cent of current SMH print and online readership base).

Scope to reduce costs – but not any time soon

If a sufficient number of print readers can be transferred across to electronic editions, it should be possible to start to reduce the print cost base. For example, print runs could be cut back and printing outsourced to third party providers. However, we do not expect this to be possible for a number of years and as a result have not carried out any modelling on this at the current time.

We believe that iPads and tablet devices are unlikely to provide the ‘salvation’ required to return newspapers to high levels of growth. However, we do believe they offer a new option for monetising readers that would otherwise be lost to online, as well as a potential upgrade path for existing website users. Further out there is the ability to reduce printing and distribution costs as users migrate to electronic versions of the paper.

Important information:This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. For this reason, any individual should, before acting, consider the appropriateness of the information, having regard to the individual’s objectives, financial situation and needs and, if necessary, seek appropriate professional advice.