Corporate Valuations case submission

Sayan Ray (U1273586)

2015

CASE STUDY SUBMISSION

Buffetts bid for Media Generals
Newspapers
NAME: SAYAN RAY
ANR: U1273586

Corporate Valuations case submission

Sayan Ray (U1273586)

Contents
Why does Warren Buffett want to buy MEGs newspaper division? ........................................................... 1
Is MEGs newspaper division worth $142 million? ....................................................................................... 1
How much value, if any, does Buffett derive from the credit agreement? .................................................. 2
What should MEGs CEO Marshall Morton do? What are his options? ....................................................... 3
APPENDIX ...................................................................................................................................................... 5

Corporate Valuations case submission

Sayan Ray (U1273586)

Why does Warren Buffett want to buy MEGs newspaper division?

The following can be cited as reasons:

Addition to his media portfolio: In 2011 Buffett had invested in newspapers in Nebraska
and Iowa spending up to $200 million a transaction which analysts deemed as
overvalued. The current fleet of 63 newspapers would be a good addition to this media
portfolio because
o They are all small town newspapers with a limited but loyal reader base. Even
though their readership is small (5000 25000) they are unlikely to face the kind
of completion which national or big-city newspapers face. Buffetts strategy is
amply clear from the fact that he left out Tampa Tribune from the purchase which
is the largest newspaper of MEG.
o They could be used as a long term investment vehicle giving Berkshire Hathaway
(BH) time to wean subscribers to digital media and ensuring that the newspapers
increase revenue from subscriptions and cut down on printing and legacy costs.

Cheap acquisition: The 63 newspapers are acquired at approximately $2.25 mn each

which is relatively a cheap valuation.

Is MEGs newspaper division worth $142 million?

a) Valuation: Using a 2 stage Discounted Cash Flow (DCF) model MEGs total newspaper
division is valued at $222.65 mn. Subtracting $30 mn as the value of Tampa Tribune,
MEGs newspaper division can be valued for $192.65 mn. The calculations can be found
in the Appendix section. The present value of the deal is therefore $50.65 mn
Assumptions:
o MEGs WACC has been calculated to be 8.61% assuming an 11.5% cost of debt
(interest charge on current loan).
o CAPM has been used to calculate cost of equity. Using an equity beta of 4.75
(found from companies comparable to the newspaper division and re-levering the
beta), a market risk premium of 6% and a risk free rate of 1.76% (10 year
government bonds used as reference as they are closest to the maturity of MEGs
debt)

Corporate Valuations case submission

Sayan Ray (U1273586)

o For the 2 stage model, 2012 and 2013 have been forecasted as years of normal
(negative) growth and 2014 onwards it has been assumed that the company will
grow at a constant rate of 0.3% (an average of the growth rates between 2012 and
2016)
o Constant growth rate has been assumed from revenue growth rates as ROE for
MEG was negative.
b) Are the forecasts reasonable?
Considering macro-economic and firm specific factors the forecasts shown appear to be
overly optimistic. The following reasons can be cited for this:
o Revenue growth: It is forecasted that the company will achieve positive and
constant growth from 2014. However, macro and firm specific factors do not
indicate this:

Newspaper circulations have been dropping over the 5 years for 2005 to
2010 (From exhibit 1 of Case). The trend is not expected to reverse with
the newspaper industry facing stiff competition from TV and radio
broadcasting as well as digital media. MEGs own newspapers have faced
declining circulations (exhibit 5) over the 10 years between 2001 and 2011

Advertising revenue has also shown a steep decline in the years between
2005 and 2010

Newsprint and pulp key inputs for the newspaper industries, have
decreased in price after reaching highs in 2008 and 2010 (exhibit 2)
respectively, but are still around or higher than the 10 year average.

c) Critical assumption to make value = $142 mn: To value the newspaper division at $142
mn, in our current valuation methodology we need to assume a capital structure of 85%
debt and 15% equity for this division.
How much value, if any, does Buffett derive from the credit agreement?
Penny warrants: BH received penny warrants which if exercised would allow BH to have
control of approximately 18% (if exercised immediately, calculations present in
Appendix) of MEGs equity. Valuation of the warrants using the Black-Scholes option
pricing model gives us a value of $1.19 per warrant (calculations present in Appendix). If
exercised immediately, assuming a market price of $3.14, the warrants are worth $14.55
2

Corporate Valuations case submission

Sayan Ray (U1273586)

mn. As MEG starts to concentrate on its digital media and broadcasting revenue segments
post the sale of its printing segment, the warrants would increase in value.

Debt: The $400 mn term loan along with the $45 mn revolving credit facility to MEG
(along with the agreement to buy the 63 newspapers) will earn BH a substantial interest
rate of 10.5%. The NPV of the term loan facility is $59.44 mn (assuming there are no
prepayments).

What should MEGs CEO Marshall Morton do? What are his options?
The following are the key concerns for MEG.

MEG has to create a short term strategy to fund a $225 mn loan which is due in 8 days
time. (CAGR of -10.66%)

MEG needs to find a long term strategy to manage its print media which is making
substantial losses

MEG needs to restructure its debt. Currently, interest expense is one of the highest
expenses for MEG (8% of sales on average between 2007 2011).

The options in front of the CEO are:

Option
Sell the newspaper

Feasibility

division

Most preferred route under the circumstance. The print industry is

declining and MEG has not been able to turn around the segment.
Moreover a ready buyer, BH, has already expressed interest.

Newspaper business has been characterized to be in steady decline

due to changing readership patterns and competition from other
media. The company should concentrate on its broadcasting and
digital media segments.

Sell the broadcasting or

Both these segments together accounted for 51% of total revenue for MEG

digital media division

in 2010 and 2011. While the print media industry is declining (revenue
segment declined 43% in 5 years between 2007 and 2011), the broadcasting
and digital media are considered to be growth areas. MEG should hold on
to these segments and attempt to grow inorganically to increase market
share.

Corporate Valuations case submission

Restructure debt

Sayan Ray (U1273586)

MEG has a Debt to Capital ratio of 95% and is $658 mn in debt. Keeping in
mind that MEG is highly leveraged and already has a CCC+ or a speculative
bond rating, it will be difficult for MEG to restructure its debt to get easier
financing options.

Issue new equity

Issuing new equity will help the firm recapitalize towards a more optimal
capital structure. However considering that the share price of the firm is at
a historical low, this method is not optimal to get additional funding.

Declare bankruptcy

MEG can file for Chapter 11 bankruptcy but this option should be taken
only as a last resort. It is a costly and time consuming option which has to
work under strict oversight by the creditors (possible restrictive covenants).

Action points for the CEO

BH offer: Keeping in mind the extremely limited time within which the company has to
pay its debt or go into default, the CEO should accept BHs offer of debt infusion and
buying the newspaper division. This will give MEG time to implement a long term strategy
to develop its broadcasting and media divisions.

Capital structure: While industry average (0% debt companies excluded) D/V ratio is
approximately 40% MEG has a ratio of 82%. MEG has to decrease this and bring it to the
levels of the industry average.

Sale of Tampa: Keeping Tampa after selling the rest of the newspaper division does not
make sense. MEG should focus on a long term strategy of developing its broadcasting and
digital media segments and in line with this should attempt to sell Tampa as well. This can
help MEG pay off debt and bring its capital structure to more optimal levels.

Consolidate position in through M&A: MEG should explore opportunities to merge with
mid-sized media companies, focused into broadcasting and digital media. A merger would
help MEG to consolidate its position in this industry and possibly achieve a better credit
rating. A better credit rating will in turn help MEG refinance the loan from BH at more
affordable interest rates.

Corporate Valuations case submission

Sayan Ray (U1273586)

APPENDIX
1. Warrants valuation using the BS option pricing model
Current Stock Price =
Strike Price On The Option =
Expiration Of The Option =
Standard Deviation In Stock Prices =
Annualized Dividend Yield On Stock =
Treasury Bond Rate =
Number Of Warrants (Options) Outstanding =
Number Of Shares Outstanding =

1.5
1.5
8
44.50%
0.00%
1.76%
4650000
23100000

VALUING WARRANTS WHEN THERE IS

DILUTION
Stock Price=
Strike Price=
Adjusted S =
Adjusted K=

1.2
0.01
1.198303
0.01

Expiration (in years) =

d1 =
N (d1) =

4.543738
0.9999972

d2 =
N (d2) =

3.285088
0.9994902

Value of the call =

(volatility)

# Warrants issued=
# Shares outstanding=
T.Bond rate=
Variance=
Annualized dividend
yield=
Div. Adj. interest rate=

4650000
23,100,000
1.76%
0.1980
0.00%
1.76%

$1.19

2. Number of shares to be issued if warrants exercised immediately

Number of warrants
Price per warrant
Ttoal cost
Share market price
Market value of shares acquired if warrants exercised
Value of warrant to holder

$
$

4,650,000.00
0.01
$46,500.00
3.14

$ 14,601,000.00
$ 14,554,500.00

Corporate Valuations case submission

Sayan Ray (U1273586)

3. Net present value of the term loan agreement

$ mn (except % figures)
354.00
400.00
10.50
10.26%
32.00

Initial outlay
Principal payment
Interest payments
Discount rate
No of periods
NPV

Comments
Loan given at 11.5% discount on face value

YTM of CCC+ bonds

32 quarterly periods

59.44

4. Beta calculation
a. Beta from comparables

As of Dec. 31, 2011 (book values in millions)

Company
A.H. Belo Corp.
Courier Corp. (c)
Gannett Co., Inc.

Revenue
$461.5
$259.4
$5,240.0

Assets
$345.1
$213.0
$6,616.5

Debt
$0.0
$21.5
$1,760.4

Equity
$121.5
$154.3
$2,327.9

Average
Leverage
D/V (a)
0%
11%
41%

Equity
Unlevered
Beta (b) Beta
1.49
1.49
1.21
1.105275
2.11
1.393449

Average Unlevered beta

Debt beta
Levered Beta as per MEG' capital structure

1.249362
0.2
4.75

*Levered beta calculated algebraically from the equation, Asset beta = Debt beta*Debt(1-tax)/(Debt+Equity) + Equity
beta*Equity/(Debt+Equity)

5. Required rate of return from CAPM

CAPM
Market risk premium
Risk free rate
Equity beta
Reguired return

6.00%
1.76% 10 year government bonds
4.75
30.26% From CAPM

6. WACC calculation

Corporate Valuations case submission

Weighted Average Cost of Capital

Cost of debt
Weight
Tax rate
Cost of equity
Weight
WACC

Sayan Ray (U1273586)

10.26% Interest rate of current debt

95.00% Deb to Value
35.00%
30.26% From CAPM
5.00%
7.85%

7. Discounted Cash Flow valuation

Assumptions:

Constant growth rate = 0.3% (Taken as the average revenue growth over forecasted years
2012 2016). Constant growth from 2016 onwards.
Tax rate = 35%
WACC = 8.6% (calculation shown above)

EBIT*(1-Tax)
Non cash charges
Capex
Changes in Net working Capital
FCFF
Discounted FCFF

1.00
2012F
$9.2
$20.0
$5.0
-$0.6
$24.9
22.87913

Value of the Total Newspaper

division
Value without Tampa
PV of the transaction

222.6524
192.6524
50.65

2.00
2013F
$8.9
$16.0
$5.5
-$0.2
$19.6
16.64398

3.00
2014F
$13.8
$12.0
$5.9
$0.3
$19.7
15.34735461

All figures in $ mn
4.00
5.00
2015F
2016F
$18.3
$19.5
$9.0
$6.0
$6.0
$6.0
$0.3
$0.3
$21.0
$19.2
15.0714396 152.71047

8. NPV of term loan

Assumption: Loan is held till maturity

Corporate Valuations case submission

Sayan Ray (U1273586)

$ mn

Initial
outlay

Discount
factor

NPV
PVCF ($
mn)

1 10.50

1.02

10.25

2 10.50

1.05

3 10.50

59.44
Discount
factor

PVCF ($
mn)

17 10.50

1.51

6.93

10.00

18 10.50

1.55

6.77

1.08

9.76

19 10.50

1.59

6.60

4 10.50

1.10

9.52

20 10.50

1.63

6.44

5 10.50

1.13

9.29

21 10.50

1.67

6.29

6 10.50

1.16

9.07

22 10.50

1.71

6.14

7 10.50

1.19

8.85

23 10.50

1.75

5.99

8 10.50

1.22

8.64

24 10.50

1.80

5.84

9 10.50

1.25

8.43

25 10.50

1.84

5.70

10 10.50

1.28

8.23

26 10.50

1.89

5.57

11 10.50

1.31

8.03

27 10.50

1.93

5.43

12 10.50

1.34

7.83

28 10.50

1.98

5.30

13 10.50

1.37

7.64

29 10.50

2.03

5.17

14 10.50

1.41

7.46

30 10.50

2.08

5.05

15 10.50

1.44

7.28

31 10.50

2.13

4.93

16 10.50

1.48

7.10

32 410.50

2.18

187.92

Payments
($ mn)

354

Payments ($
mn)