Buffett’s Bid for Media General’s Newspapers

FINM7402 Corporate Finance

CASE STUDY – “Buffett’s bid for Media General’s Newspapers”

Name: JINGXIAN HU

Student ID: 44446808

Potential Financial Benefits to Warren Buffett

The following reasons can be given:

• Buffett has a history with the newspaper industry: In 1940 Buffett had his first contact to the newspaper industry as getting a newspaper delivery boy’s job then in 1973 he bought Washington Post and four years later he bought Buffalo News as well. Even though he had quite a lot of losses in the Buffalo News he still retained his passion to the newspaper industry. Better still, his long investing history in newspaper industry gave him a good understanding of it and potentially can profit him in the future.
• A balance to his media empire: The newly purchased 63 newspapers would be a well balance of Buffett’s $200 million investment in 2011 on buying Nebraska and Iowa. Buffet’s strategy is quite clear as he excluded the largest newspaper called Tampa Tribune on his purchase of MEG. As we can see, all the other 63 newspapers are small town local papers that have little yet loyal readers base. In this case, the 63 newspapers have very slim chance of facing a competitive market as the major newspapers face. In the other word, it could increase revenue from those loyal subscriptions. Although Buffet thinks online media is a better form of the future media, these 63 small town papers could be used as a long term investment since small towns have a stronger sense of community. This gives him more opportunities on transforming from traditional newspaper to digital media. It means that it will cut down on printing and legacy costs in the future.

• Low-cost acquisition: The 63 newspapers are going to cost $142 million all up, which is approximately $2.25 million each, in nowadays market this is relatively a bargain.

Is MEG’s Newspaper Division Worth $142 Million?

Valuation: Depending on a 2 stage discounted cash flow (DFC) model, the total MEG’s newspaper division is valued at $203.88 million, and then a reduction of $30 million as the value of Tampa Tribune newspaper division, MEG’s newspaper division can be value for $173.88 million. The calculations can be found in the Appendix C (Discounted Cash Flow Valuation).

Assumptions:

• According to introduction of the listing six media firms, A.H. Belo Crop. and Gannett Co. are newspaper firms. It is reasonable to use those two company’s financial and trading data for estimating the appropriate leverage ratio and asset beta. Based on arithmetic method, the average leverage ratio has been calculated to be 20.5% (the value D/V of A.H Belo Crop. is 0%, 41% of Gannett Co., Inc.), and the average asset beta is 1.41 (1.49 of A.H Belo Crop.  and 2.11 of Gannett Co., Inc.).
• CAPM has been used to calculate cost of asset and cost of debt, using an asset beta of 1.41, a debt beta of 0.2 market risk premium of 6% and a risk and a risk free rate of 2.90% (30-year T-Bill Rate). The cost of asset is 11.36%, and cost of debt is 4.10%.
• As we can see from the Appendix A that shows the WACC calculations, MEG’s WACC is 11.07% with a 35% tax rate.

• Based on the two-stage model, in 2012 and 2013, there has been forecasted as normal years with negative growth rate, and assuming that the company will grow at a constant rate of 2% after 2013.
• Because return of equity for MEG was negative, constant growth can be assumed from revenue growth rates. MEG’s growth rate has been assumed to be 2%.

Are The Cash Flow Forecasts Reasonable?

MEG has been forecasted that achieving positive and constant growth from 2014, nevertheless, macro-economic and firm specific factors do not prove that. Considering external environment and internal factors of the firm, the following reasons can demonstrate that the cash flow forecasts are seemed to be excessively optimistic.

• The U.S. Newspaper industry have been falling down, in 1973, the daily circulation of newspapers was peaking at 64 million, and then fell to 44 million in 2011, so between 2005 and 2010, newspaper circulations has been dropping over 5 years (From exhibit 1 of Case). It is not expected that the trend will reverse with the newspaper industry facing strong competition from digital media. It means that MEG’s newspapers circulations also have been going down over the 10 years for 2001 to 2011 (From exhibit 5 of Case).
• In Newspaper industry, the revenue from advertising and circulation, and the major revenue came from advertising that represents nearly 80%. Revenue from advertisement has also indicated there was a major drop from 2005 to 2010.
• There are two key contributions of the newspaper industry that are newsprint and pulp, the price of them have fallen in 2008 and 2010 respectively after a peak. Even though

the prices of newsprint and pulp went down, they are still higher than the average of the past decade.

How Much Value, If Any, That Buffett Drives From The Credit Agreement.

In Credit agreement, Berkshire would receive $4.65 million as penny warrants, that if exercised would be convertible into approximately 17% of MEG's equity. In Appendix D, using the Black-Scholes option-pricing model to value the warrants, and the calculation presents a value of $1.19 per warrant. In fact, stock price jumped 33% from

$3.14 to $4.18 reacts the announcement about Buffett’s bid for MEG. It is reasonable to suppose the value of warrants would grow once MEG starts to focus on digital media and radio revenue in the mean time would increase in value. In addition, it would give BH a massive 10.5% of interest rate just from the $400 million term loan and the $45 million revolving credit facility to MEG along with the agreement of purchasing the 63 newspapers. The NPV of the term loan is $59.44 million if there are no payments in advance. The calculations present in Appendix B: net present value of the term loan agreement.

Appendix A: WACC Calculation

Appendix B: Net present value of the term loan agreement