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Harlequin slump causing heartache

From Monday's Globe and Mail

Harlequin Enterprises Ltd., famous for its bodice-ripper novels, is under pressure to reverse a slump that is denting its parent Torstar Corp.'s profit picture.

The romance fiction publisher has been suffering from soft sales, and investors are holding their breath to see how — and if — the company can turn itself around by embracing more international markets and adding new lines of books.

The first clues could come when Torstar Corp. reports its 2004 year-end earnings on Wednesday.

“I think the Harlequin turnaround is going to be more a 2005 story,” rather than anything that will show up in the fourth quarter of 2004, said Kona Shio, an analyst at Conscius Capital Partners. “Obviously it's going to be a tough challenge ... it's not a small task.”

The key problem for Harlequin, Mr. Shio said, is that the company is shifting from its roots in the stable, high-margin business of selling books in series. It is now adding single-copy sales, a much more competitive and difficult business.

Diego Castelli, vice-president of Harlequin's overseas operations, said the addition of the single-copy business is part of the company's overall diversification plan, which includes adding new formats and new markets to maintain growth.

The company will hit rocky patches on that road, he said, and he blames the recent softness on a shift by traditional Harlequin readers to buying big blockbuster books —such as The Da Vinci Code and various Atkins diet books — from other publishers. The key to boosting the division's performance will not be cost cutting, Mr. Castelli said. The bottom line is that “we've got to sell more books.”

Harlequin is already a massive international business, with annual sales of more than 160 million books in 23 languages in more than 100 markets.

In early February the company launched a new joint venture in Brazil, replacing an agency agreement it had in place there. That could potentially add a substantial new block of business, Mr. Castelli said, in a country with a population of about 175 million and a rising literacy rate.

The other key focus of expansion is in Asia, he said.

Alan Middleton, a marketing professor at York University's Schulich School of Business in Toronto who has studied Harlequin, said an expansion in the massive Chinese market could be a “huge upside” for the company. Harlequin has experience gained in Eastern Europe in pricing a product for low-income countries, Mr. Middleton said. If it uses that skill to develop appropriate books for China, Harlequin could do very well, he said.

Mr. Middleton said Harlequin is kind of an odd fit with Torstar's traditional domestic newspaper business, and as a result there is always talk that the company might sell the division.

But there is no obvious buyer, he said, because Harlequin doesn't appear to fit with traditional international publishers like Bertelsmann AG or Pearson PLC. That's partly because Harlequin's product “is not a book, it's a packaged good” that needs direct marketing support.

And even if Torstar did sell, Mr. Middleton said, there is no obvious place for it to spend the proceeds. Consequently “they're a bit trapped” into keeping Harlequin and trying to make it work.

Harlequin brings in about two-fifths of Torstar's revenue, but the division's revenue has been shrinking, along with its profits. In the nine months to Sept. 30, Harlequin revenue fell almost 9 per cent to $409-million, while operating profit dipped 24 per cent to $72-million.

Torstar's newspaper business has been less volatile, showing a solid 6-per-cent growth in revenue in the first nine months of 2004 (to $690-million), and a 15-per-cent rise in operating profit (to $78-million).

The central asset in that group is the Toronto Star, Canada's largest paper with a daily circulation of about 455,000, about 658,000 on Saturday and 447,000 on Sunday.

But Torstar is also a powerhouse throughout the rest of Southern Ontario, with large daily papers in Hamilton, Kitchener, Guelph, and part ownership of the Metro commuter paper in Toronto and the Sing Tao Chinese language daily.

It also owns the 63-paper Metroland community newspaper chain — the most profitable part of its overall business.

Analyst Bob Bek of CIBC World Markets Inc. says Metroland should continue to be Torstar's money spinner in the fourth quarter and into 2005, but the Toronto Star could also do well. Despite the intense competition from five other paid and free dailies in Toronto, “the rate card in the city has stabilized,” Mr. Bek said. “Everybody is playing nice with each other. . . .We've seen in the past some more aggressive price cutting on ads, which doesn't appear to be the case right now.”

Still, in January Mr. Bek lowered his 12-month price target on Torstar to $23 from $25, citing new currency risks that could hit the company in 2006. Torstar has been using hedges to protect its U.S. dollar cash flow, but these expire at the end of this year.

Torstar stock dropped to near $20 after it released its third-quarter results in October, down sharply from around $30 early last year. It has recovered to the $23 range in recent weeks. Analyst are, on average, projecting Torstar to report share profit of $1.46 for all of 2004, and $1.59 for 2005. In 2003 the company reported share profit of $1.59.

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