Buffett’s Bid for Media General’s Newspapers – Case Solution

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Buffett's Bid for Media General's Newspapers Case Answers

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Executive Summary – Buffett’s Bid for Media General’s Newspapers

Warren Buffett’s Berkshire Hathaway’s (BH’s) offer to Media General Inc., a newspaper publishing and broadcasting company, consists of an asset purchase agreement and a credit agreement. It offered to buy 63 newspapers from Media General for $142M in cash and provide debt financing to the struggling firm.

The newspaper division has faced declining revenues and increasing costs from 2007 to 2011. This is in line with a changing consumer consumption pattern and is an effect of the technological disruption that has changed several industries.

Hence, we recommend that Media General accept the proposed acquisition, given the debt condition, the market condition, the change in the industry, and time constraints in the form of the debt repayment deadline.

Following the acquisition of the newspaper division, it would make sound economic sense to go completely digital and stop the physical production and sale of newspapers. The revenues from the newspaper vision were down 43% from 2007 to 2011, and Media General’s CFO did not expect to see cash profits in the foreseeable future.

The digital-only strategy would necessitate the sale of tangible assets, making the company asset-light and without the increased costs related to production. The proceeds could be used to pare down the debt and to invest in the development of a digital platform that consumers love.

The main risk associated with this strategy is whether the platform would be able to build a solid online readership base, especially considering that the newspapers are read in local communities.

Moreover, there could arise questions related to the current management capability to manage such a proposed technological shift. If these risks prove true, it would be difficult to achieve a turnaround and the expected cash flows.

Having arrived at an intrinsic value of $283M for the business through a DCF model, the bid by Warren Buffet is significantly lower. We have assumed a 2% perpetual growth rate. (The digital division of Media General has had an annual growth rate of approx. 2% from 2007-2011).

Following the acquisition, we expect the new shareholders to focus on profitability (rather than growth), given the history of Warren Buffett as an investor. A strong focus on profitability and a sustained bottom-line-focused strategy could be instrumental in changing the fortunes of the company.

1. Why does Warren Buffett want to buy MEG’s newspaper division?

Persistent demand for Community or Local Newspaper – The recent market downfalls affected many of the newspaper companies that declared bankruptcy in the year 2010 (including eight major and hundreds of smaller companies). However, Buffett believed that there was a strong demand for local newspapers in small cities and towns with less competition from national newspapers.

More than 80% of people in small cities and towns rely on the local newspaper for news, indicating a loyal customer base that will ensure a constant or stable stream of revenue in an industry with high capital expenditure or fixed costs.

Banking crisis for MEG, an opportunity for Buffet – Buffett proposed the offer for MEG’s newspaper division 8 days before the time limit to raise $225M in order to get a short-term bridge amendment that waived certain covenants and extended the maturity date of the bank loan for $363M that was due in March 2013 by two years to March 2015, and they had no backup plans to pay back the loan.

If we look at the timing of both events – bankruptcies of quite a few companies in the sector and bank loan maturity, this was the perfect timing to propose his terms to MEG, which had a high probability of getting accepted.

A sweet deal – Buffett acquired MEG’s 63 newspapers for $142M, giving an effective valuation of a mere $2.25M per newspaper

A good addition to their newspaper portfolio and affection for the newspaper industry – In Nov. 2011, Buffett acquired the Omaha World-Herald newspaper and several newspapers in Iowa and Nebraska for $200M. MEG’s newspaper division would be a great addition to Berkshire’s newspaper portfolio. Besides, Buffett started his career as a paperboy in the newspaper industry in the 1940s and later went on to buy the Washington Post and Buffalo News.

Accumulated Non-operating losses, non-cash impairment charges, deferred tax valuations allowance, and a deferred tax liability have significantly contributed to decreasing cash flows (especially in the year 2008) as an unusual loss in 2008 was $920.8M.

2. Is MEG’s newspaper division worth $142M?

a) Using a DCF, we have valued the newspaper division at $283M, which is much higher than the price when Warren Buffet acquired the company. The calculations and a sensitivity table for variable long-term growth and WACC can be found in Appendix 1 and 2.

Assumptions:

• WACC is 8%, with the cost of equity at 15.5% and the cost of debt at 11.5%
• CAPM has been used to calculate the cost of equity using an equity beta of 2.29, a market risk premium of 6%, and a risk-free rate of 1.76% (10-year US treasury yield)
• The capital structure used to compute WACC represents the “target” structure (structure of debt and equity post-acquisition)
• Forecasted cash flows for 5 years based on existing CF projects and calculated Terminal Value (TV) using a growth rate of 2% (g)

b) Considering industry-related and firm-related factors, the forecasts do not seem to be reasonable.

A growth rate of 2% is…