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Will Fairfax recover?

Fairfax (ASX: FXJ) is heading into unknown territory. The company’s primary source of earnings and profit over the past 10 years has been its leading newspapers, the Sydney Morning Herald, the Age and the Financial Review.

The relatively recent introduction and dominance of internet-based classified sites, such as Carsales.com.au (ASX: CRZ), realestate.com.au (ASX: REA), and seek.com.au (ASX: SEK) has spread consumer attention for ads between an ever increasing array of media. Fairfax has struggled to adapt to the structural changes in the industry and has seen revenue slip from $2.9 billion in 2008 to $2.3 billion in 2012. Over the same period earnings have dropped nearly 40% from $830 million to $506 million, with no signs that the decline is slowing.

To combat the drop in profitability, the company outlined the way forward during an investor presentation day last week. Fairfax announced the introduction in July of a digital paywall for its flagship internet news sites — smh.com.au and theage.com.au — which currently generate 3.7 million unique visitors per month. The paywall will restrict users to 30 free articles per month and will charge $15 per month for unlimited reading.

Having a quick glance over smh.com.au and theage.com.au, one comes to a striking realisation: Fairfax is trying to charge for a service that is completely free (versus its partially free option) elsewhere on the internet. News.com.au, operated by News Corp (ASX: NWS), and abc.com.au appear to have many of the same stories as the Fairfax websites and have not announced any subscription requirements.

Based on the strength of News Corporation of late and the ownership by the public broadcaster of ABC, it’s doubtful that any subscription model will be introduced in the near future. The paywall introduced by Fairfax may end up providing a boost in readers to free news sites such as news.com.au. Notwithstanding this, Fairfax has realised that it must make radical changes to its business model in order to stay relevant during the transition from newspapers to online.

Part of the Fairfax strategy in recent years has been to create and purchase niche websites catered to individual sectors such as parents, travel, food, fashion and celebrity gossip. Critical to diverting traffic to the websites (which are monetised via advertising and promotions) is the strength of the flagship websites noted above. If the paywall captures only 10% of the current readership and forces 20% to other sources, advertisers will demand lower prices, offsetting some of the revenue increase from subscriptions.

Fairfax has some history with paywalls. It has successfully incorporated a mobile/tablet app and internet-based content into its Australian Financial Review newspaper package and potential upside from may come from the ability to couple the new paywall with existing online services.

Foolish takeaway

Fairfax has been forced into radical changes to its business model in recent years due to the structural change in the news industry from print to online-based consumption. The changes have not been successful so far and there is a significant risk of earnings declining further in the coming years as new online initiatives take hold. Fairfax is a company with more downside risk than upside potential and investors may be better rewarded by investing in media companies poised to benefit from the decline of Fairfax market share in the future.

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Motley Fool contributor Andrew Mudie does not own shares of any companies mentioned in this article.

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