Corporate Valuations case submission

Sayan Ray (U1273586)

CASE STUDY SUBMISSION

Buffetts bid for Media Generals
Newspapers
NAME: SAYAN RAY
ANR: U1273586
2015
Corporate Valuations case submission
1

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
1

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 de
emed as
overvalued. The current fleet of 63 newspapers would be a good additi
on 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 strat
egy 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 Hathawa
y
(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 newspa
per
division is valued at $222.65 mn. Subtracting $30 mn as the value of Tam
pa Tribune,
MEGs newspaper division can be valued for $192.65 mn. The calculations can be fou
nd
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 b
eta 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)
2
o For the 2 stage model, 2012 and 2013 have been forecasted as year
s 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 posi
tive 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 o
f 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 pre

sent in
Appendix) of MEGs equity. Valuation of the warrants using the Black-Scholes opt
ion
pricing model gives us a value of $1.19 per warrant (calculations present in App
endix). If
exercised immediately, assuming a market price of $3.14, the warrants are worth
$14.55
Corporate Valuations case submission
Sayan Ray (U1273586)
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mn. As MEG starts to concentrate on its digital media and broadcasting revenue s
egments
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 i
nterest
rate of 10.5%. The NPV of the term loan facility is $59.44 mn (assu
ming 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 w
hich 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 Feasibility
Sell the newspaper
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
digital media division
Both these segments together accounted for 51% of total revenue for MEG
in 2010 and 2011. While the print media industry is declining (revenu
e
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
4

Sayan Ray (U1273586)

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 opt
ion 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 h
as 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 d
oes not
make sense. MEG should focus on a long term strategy of developing its broadcast
ing and
digital media segments and in line with this should attempt to sell Tampa as wel
l. 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 bet
ter 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)
5
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

Expiration (in years) =

8
Annualized dividend
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

Number of warrants
4,650,000.00
Price per warrant $
0.01
Ttoal cost
$46,500.00
Share market price $
3.14
Market value of shares acquired if warrants exercised
$ 14,601,000.00
Value of warrant to holder $ 14,554,500.00
Corporate Valuations case submission
Sayan Ray (U1273586)
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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 period
s
NPV
59.44
4. Beta calculation
a. Beta from comparables
Average
As of Dec. 31, 2011 (book values in millions) Leverage Equity
Company Revenue Assets Debt Equity D/V (a) Beta (b)
Unlevered
Beta
A.H. Belo Corp. $461.5 $345.1 $0.0 $121.5 0% 1.49 1.49
Courier Corp. (c) $259.4 $213.0 $21.5 $154.3 11% 1.21 1.105275
Gannett Co., Inc. $5,240.0 $6,616.5 $1,760.4 $2,327.9 41% 2.11 1.393449
Average Unlevered beta
1.249362
Debt beta
0.2
4.75
Levered Beta as per MEG capital structure
*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 6.00%

Risk free rate 1.76% 10 year government bonds
Equity beta 4.75
Reguired return 30.26% From CAPM
6. WACC calculation
Corporate Valuations case submission
7

Sayan Ray (U1273586)

Weighted Average Cost of Capital

Cost of debt 10.26% Interest rate of current debt
Weight 95.00% Deb to Value
Tax rate 35.00%
Cost of equity 30.26% From CAPM
Weight 5.00%
WACC 7.85%

7. Discounted Cash Flow valuation

Assumptions:
Constant growth rate = 0.3% (Taken as the average revenue growth over forecaste
d years
2012 2016). Constant growth from 2016 onwards.
Tax rate = 35%
WACC = 8.6% (calculation shown above)
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 -$0.6 -$0.2 $0.3 $0.3 $0.3
FCFF $24.9 $19.6 $19.7 $21.0 $19.2
Discounted FCFF 22.87913 16.64398 15.34735461 15.0714396 152.71047
Value of the Total Newspaper
division 222.6524
Value without Tampa 192.6524
PV of the transaction 50.65
8. NPV of term loan
Assumption: Loan is held till maturity
Corporate Valuations case submission
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$ mn
Initial
outlay 354
NPV
59.44
Q
Payments
($ mn)
Discount

Sayan Ray (U1273586)

factor
PVCF ($
mn) Q
Payments ($
mn)
Discount
factor
PVCF ($
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
10.50
1.63

20

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
10.50
2.03
5.17
14

29

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
410.50
2.18
187.92

32