2015

CASE SUBMISSION – “Buffett’s

bid for Media General’s
Newspapers”
CLASS – CORPORATE VALUATIONS
NAME: SAYAN RAY
ANR: U1273586
Why does Warren Buffett want to buy MEG’s 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. Small town
newspapers have a monopoly over their reader base which allows for a longer
horizon for large scale capital expenditures (e.x. transition to digital media).
Buffett’s 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 MEG’s newspaper division worth $142 million?

a) Valuation: Using a 2 stage Discounted Cash Flow (DCF) model MEG’s total newspaper
division is valued at $155.93 mn. Subtracting $30 mn as the value of Tampa Tribune,
MEG’s newspaper division can be valued for $125.93 mn. The calculatins can be found
in the Appendix section
Assumptions:
o MEG’s WACC has been calculated to be 7.87% assuming an 11.5% cost of debt
(interest charge on current loan).
o CAPM has been used to calculate cost of equity. Using am equity beta of 2.29, 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 MEG’s debt)
 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 2%
o Constant growth rate has been assumed from revenue growth rates because 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. MEG’s 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.

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 MEG’s 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).
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 MEG’s 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.
 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.

The options in front of the CEO are:

Option Feasibility

Sell the newspaper  Most preferred route under the circumstance. The print industry is
division declining and MEG has not been able to turn around ths 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 which is cost effective and >>>>>>

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.
Restructure debt 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
maintain strict oversight by the creditors.

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 BH’s 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. A
sale at current valuations will yield _____ and 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.
 APPENDIX

1. Warrants valuation using the BS option pricing model

Current Stock Price = 1.5

Strike Price On The Option = 1.5
Expiration Of The Option = 8
Standard Deviation In Stock Prices = 44.50% (volatility)
Annualized Dividend Yield On Stock = 0.00%
Treasury Bond Rate = 1.76%
Number Of Warrants (Options) Outstanding = 4650000
Number Of Shares Outstanding = 23100000

VALUING WARRANTS WHEN THERE IS

DILUTION
Stock Price= 1.2 # Warrants issued= 4650000
Strike Price= 0.01 # Shares outstanding= 23,100,000
Adjusted S = 1.198303 T.Bond rate= 1.76%
Adjusted K= 0.01 Variance= 0.1980
Annualized dividend
Expiration (in years) = 8 yield= 0.00%
Div. Adj. interest rate= 1.76%

d1 = 4.543738
N (d1) = 0.9999972

d2 = 3.285088
N (d2) = 0.9994902

Value of the call = $1.19

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

3. Net present value of the term loan agreement

$ mn (except % figures) Comments

Initial outlay 354.00 Loan given at 11.5% discount on face value
Principal payment 400.00
Interest payments 10.50
Discount rate 10.26% YTM of CCC+ bonds
No of periods 32.00 32 quarterly periods
NPV 59.44
 4. Required rate of return from CAPM

CAPM
Market risk premium 6.00%
Risk free rate 1.76% 10 year government bonds
Equity beta 2.29%
Required rate of return 15.50% From CAPM

5. WACC calculation

Weighted Average Cost of Capital

Cost of debt 11.50% Interest rate of current debt
Weight 95.00% Deb to Value
Tax rate 35.00%
Cost of equity 15.50% From CAPM

6. Discounted Cash Flow valuation

All figures in $ mn
1.00 2.00 3.00 4.00 5.00
2012F 2013F 2014F 2015F 2016F
EBIT*(1-Tax) $9.2 $8.9 $13.8 $18.3 $19.5
Non cash charges $20.0 $16.0 $12.0 $9.0 $6.0
Capex $5.0 $5.5 $5.9 $6.0 $6.0
Changes in Net working
Capital $14.4 -$0.2 $0.3 $0.3 $0.3
FCFF $9.9 $19.6 $19.7 $21.0 $19.2
Discounted FCFF 9.154007 16.87249 271.9044624

Value of the Total Newspaper

division 155.931
Value without Tampa 125.931
 7. NPV of term loan

$ mn
Initial
outlay 354

NPV 59.44
Payments Discount PVCF ($ Payments ($ Discount PVCF ($
Q ($ mn) factor mn) Q mn) factor mn)

1 10.50 1.02 10.25 17 10.50 1.51 6.93

2 10.50 1.05 10.00 18 10.50 1.55 6.77

3 10.50 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