Buffett Bid for Media Gen

Newspaper
Rajiv Bhutani
IIM Raipur
2018
Buffett’s Bid for MEG Newspapers
 Learning Objectives
• DCF Valuation: This case analyzes a declining industry where firms
shrink: Reduction in NWC become a source of cash
• Finance & Business Strategy: Link between finance & Strategy –
Firm might transition to new distribution channel and production
format, thereby generating different CF, TV and growth rates
• Financial Distress: Financing Challenges & its costs for highly
leveraged firms on edge of default and role played by people like
Buffett
• Comprehensive Review: Valuation Analysis, Optimal Capital
Structure, Bank Lending, Bond and Option Pricing, risk
management (hedging)
 Questions to Analyze
• Why Buffett want to purchase this? How will he
make money?
• Is MEG's newspaper division worth $ 142 mm –
Value using DCF: Steps include calculating
WACC, FCF, TV and NPV
• Value Credit Agreement
• What are the Options before the CEO?
• What Happened and what lessons can be learnt
 Buffett’s Motivation – Financial
• Penny Warrants: 4.65 MM MEG shares worth
19.9% of company. Gain of 4.65*(4.18-0.01) =
19.4 MM
• More upside possible
• Providing liquidity to a struggling firm
• 400 MM loan at 11.5% discount, so MEG
receives 354 MM for this
 Buffett’s Motivation – Qualitative
• News generation will never disappear entirely
• Proverbial Fourth pillar of democracy
• Buffett says: “There are still a lots of things newspapers can do
better than any other media”
• Demand for local newspapers covering local news
• He owns other newspapers viz Washington Post, Buffalo News,
Omaha World Herald – So, he understands the dynamics
• Everyone betting against the industry – Be Fearful when others
are greedy, and be greedy when others are fearful
• Maybe he is buying an undervalued asset
Buffett – How will he make money?
• Deal could be about Credit Agreement – “Feat of Financial
Engineering”
• He could be buying at Fire-Sale prices – He is buying at 4X EBITDA
(142 MM offer/34.2 MM EBITDA in 2012)
• He has left large pension obligations
• Maybe be he expects actual circulation and expected cash flows
will be better than expected
• He also gets real estate which will provide a floor price (value) to
the transaction
• He might be able to change the business by focusing on digital
strategy – He saw a fundamental flaw in strategy in which digital
copy was free but hard copy costed money
Buffett – How will he make money?
• Devil’s Advocate:
• Circulation is declining rapidly even in Buffett’s
newspapers
• Median public newspaper is losing money with many
bankruptcies
• Newspapers assets have been losing value rapidly –
Philadelphia Enquirer and Philadelphia News went
from 515 MM in 2006 to 55MM in 2010
• It has outmoded distribution strategy and high costs
 Value the Asset Agreement
• What exactly is Buffett buying, what is he not
buying?
• Answering will help us find appropriate
comparable firms and an appropriate asset
beta
 Value the Asset Agreement
• Points to Note:
– Valuing an asset not equity. So, don’t subtract Debt from NPV
– Projections in Exhibit 10 include Tampa Tribune’s cash flows but Buffett is not
buying them
– So, must subtract $ 30 MM from NPV
– Deal will close in mid-2012: how to handle half-yearly cash flows and half-
yearly discounting
– We assume that deal closes in January 1
– How should MEG value losses on the sale of newspaper division (assuming BV
> 142 MM offer)
– Not enough information but loss on sale will have limited value since MEG
took large asset impairments in 2008/09
– Also because, MEG CEO said firm will not pay taxes for foreseeable future,
given accumulated operating losses
 Value the Asset Agreement – WACC

• Lets Compute WACC

• Select Comparables
• Exhibit 12 gives details about 6 firms, their
business description, leverage and equity beta
• Gannett Revenues of 5.2 Bn Vs 300 MM for
MEG
• Can we simply use information for leverage
and asset beta for MEG??
 Value the Asset Agreement – WACC
• Using MV leverage ratio, equity beta, and an
assumed debt beta of 0.2, lets compute asset beta
for the comparable firms
• Average for Belo and Gannett is 1.41
• 2 methods to calculate WACC = 11.07%
• Round off to 11.1%
• Sensitivity Analysis for WACC as a function of
assumed leverage ratio and asset beta
• Ranges from 10-12%
 Value the Asset Agreement – FCFs
• Two Important Questions:
– Who prepared these forecasts?
– Why they prepared them?
• In this Case:
• Analyst, not the seller and were done for valuation purposes
- to price MEG's equity in sum-of-parts method
• So, forecasts are probably less biased (less optimistic) than if
they came from MEG
• However, since these are from an outsider, they might have
limited information and thus be less accurate compared to
MEG's forecasts
 Value the Asset Agreement – FCFs
• Questions about the Forecasts:
• Revenues fall initially, but begin to grow in later
years…….Why??
• Industry is declining – Are local papers truly different
from urban papers?
• Also, circulation has been falling
• Maybe, with online subscription based model, forecasts
seem reasonable
• Aim: See relationship between business strategy,
operations and financials
 Value the Asset Agreement – FCFs
• Operating Margins increase from 4.9% to 10%
• Historically, margins were around 11%
• Economics of online publishing might improve
over-time, which would lead to fewer PPE
costs
• Fuel costs, newsprint, distribution all will
decline
• CapEx has been cut drastically to 16.3 MM
 Value the Asset Agreement – TV
• What is reasonable TV growth rate assumption?
• TV = FCF*(1+g)/(WACC-g) = (19.2*(1+g))/(11.1%-g)
• Now compute NPV
• Reverse-Engineer: What TV growth is needed to justify 142
MM valuation? -0.8%
• So, if long term growth is > -0.8%, Buffett will make money
• Sensitivity Analysis
– TV growth is much less important here compared to other cases
like case of high growth firms
– Base case: TV = 55% of firm’s value (94.9 MM out of 172.7 MM)
 Value the Asset Agreement – Credit

• 45 MM revolving Credit facility

• Term loan of 400 MM
• Penny warrants
• Board Seat
 Value the Asset Agreement – Credit
• If Term loan is priced correctly at 10.5%, it has a value of 46 MM ( 400-354)
• Is 10.5% right risk-adjusted value on this loan?
• Remember: Loan will be made to a restructured MEG
• Bond Rating for 10yr corporate bonds. Currently CCC+ is at 10.26%
• Buffett is getting 10.5% (this has 5 MM value)
• Does it make sense to use CCC+ since it reflects risk of a diversified company
with newspapers?
• Also, loan has 8yr maturity, bonds have 10yr maturity
• There is some slope between 8 and 10 yr
• So, 46 MM from loan and 19 MM from warrants = 65 MM from credit
• So, Buffett is actually paying 142 – 65 = 77 MM for newspapers
• Reverse Engineering ---> g of -23%
• Desperate seller Vs Liquidity provider
 Should MEG Accept?
• It rallied 33% on day of announcement
• Credit agreement is very expensive
• Might not be able to repay Buffett
Should MEG Accept? - Alternatives
• Find Another Buyer: Time and still will need to refinance the
loan
• Sell other Assets
• Restructure Existing Loans: Existing creditors just
renegotiated loan few months ago
• Sign a New Loan: Time limit and Adverse Selection
• Sell Equity: Co will have to sell 75 mm shares
• Restructure Operations: Takes time. Co has already laid off
40% people, cut dividends/Capex
• Declare Bankruptcy: Might be only option if Buffett offer fails
 What Happened?
• Deal happened!!