How quickly the tide can turn for newspaper investors, particularly when you don't read the fine print. Shares of McClatchy, Gannett, Scripps and a few others have been flying high for several weeks on evidence that the worst was behind them. Earlier this week, we got a sobering reminder that the worst likely lies ahead. That's right - newspapers are far from healed.

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Back To The Beginning
Earnings results aren't really the "news" I wanted to look at today. However, a quick review of some recent fiscal results sets up my message very nicely.

You don't have to look far to find a newspaper stock that topped estimates during the third quarter. Gannett Co. (NYSE: GCI), Media General (NYSE: MEG) and New York Times (NYSE: NYT) all topped estimates. The N.Y. Times, for instance, was expected to lose 1 cent per share (ex items), but instead the publisher earned 16 cents per share (ex items) last quarter. Gannett and Media General mirrored the Q3 upside surprise. (For more on analyst expectations, be sure to read Analyst Forecasts Spell Disaster For Some Stocks.)

Even more encouraging was the better, errrr, less bad ad revenue results. The N.Y. Times' 27% dip in year-over-year (YOY) ad revenue during the Q3 was better than the 30% dip from the Q2. Gannett's ad revenue in Q3 was 28% under last year's Q3 total, which was better than the 33% ad revenue dip seen during the first half of 2009. McClatchy (NYSE: MNI)? Same story - less bad.

As such, it's no surprise all the corresponding stocks made huge gains during calendar Q3. Unfortunately, it's not the whole story.

Reality Check
I hate to rain on anybody's parade, but a couple of obscured points need to be made.

The first one is the calendar. I'll cut the industry some slack for the first half of this year's 28% dip in YOY ad revenue simply because during the first half of 2008, we didn't know we were in a recession - spending was still relatively brisk. By Q3 of 2008 though, there was little doubt.

But what about election-oriented advertising in 2008? I'll acknowledge it's a factor, though it hardly excuses the results. Ad revenues for Q3 2008 were still 18% under Q3 2007 ad revenues despite it being an election year. It was the biggest decline we've ever seen from the newspaper business since the Newspaper Association of America started keeping tabs. The point? The bar for Q3's ad revenue this year was very low, yet the industry still saw massive declines.

Granted, a lot of companies in every industry have poor comps, but the newspaper business is sporting some impressively unimpressive comparables. I'm not quite sure how they're spinning the reality so well.

The second point hit home on Monday. According to the Audit Bureau of Circulations, the nation's newspaper circulation fell 10.6% on a YOY basis between April and September. Again, think about the calendar. Things were getting progressively worse in Q2 and Q3 of last year, while things were progressively better in Q2 and Q3 of this year. Yet, a double-digit dip in circulation? It's a little backward.

The Solution Fuels The Other Problem
The answer to the overarching revenue problem? Many newspapers have upped their subscription rates. A daily edition of the San Francisco Chronicle (including Sunday), for instance, now costs $7.75 per week versus $4.75 per week a year ago. The price of the New York Times is also higher than a year ago.

In their defense, many newspapers electively cut circulation numbers to conserve cash by lowering expenses, and they also raised prices knowing the circulation numbers would take a hit. There's a fine line between "want to" and "have to," though. None of these papers would have chosen to do so in the long run.

The long-term result of the maneuver is yet another reason the newspaper industry is unlikely to make a real recovery anytime soon. See, advertising rates are largely dictated by circulation rates. Less circulation means less ad revenue, which has been partially offset by higher subscription income. But, higher subscription rates fueled a major chunk of the drop-off in circulation; more of the same could come. It's a vicious catch-22.

Traditionally, ad revenue accounts for the majority of a newspaper's total revenue base. Some newspapers like the Dallas Morning News - owned by Belo Corp. (NYSE: BLC) - have upped the subscription proportion of the revenue base from 20% to 40%. I'd call it a stroke of luck, however, and a pipedream for other newspapers.

Not A Sustainable Model
More than anything, though, I would NOT call it a sustainable revenue model. No, unfortunately, the newspaper industry's overhaul still calls for the continued reeling in of revenue expectations - ad revenue in particular, perhaps for years to come. (For a related reading, check out The Impact Of Recession On Businesses.)

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