MEG CV 2 case

Corporate Valuations case submission submissio n

Sayan Ray (U1273586)

2015

CASE STUDY SUBMISSION “Buffett’s bid for Media General’s Newspapers” NAME: SAYAN RAY ANR: U1273586

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Corporate Valuations case submission

Sayan Ray (U1273586)

Contents Why does Warren Buffett want to buy MEG’s newspaper division? ........................................................... 1 Is MEG’s newspaper division worth $142 million?  ....................................................................................... 1

How much value, if any, does Buffett derive from the credit agreement? .................................................. 2 What should MEG’s CEO Marshall Morton do? What are his options?  ....................................................... 3

APPENDIX ...................................................................................................................................................... 5

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Corporate Valuations case submission

Sayan Ray (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. Buffett’s strategy is amply clear from the fact that he left out T ampa Tr ibune fr om the pur chase   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 in crease revenu e fr om subscri ptions and cut down on pri nti ng an d 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

. Subtracting $30 mn as the value of Tampa Tribune, divi sion is valued at $222.65 mn  . The calculations can be found  MEG’s newspaper division can be valu ed for $192.65 mn  in the Appendix section. Th e pr esent valu e of the deal i s ther ef or e $50.65   mn Assumptions: o

MEG’s 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 MEG’s debt)

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Corporate Valuations case submission

o

Sayan Ray (U1273586)

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. 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.

c) Critical assumption to make value = $142 mn: To value the newspaper division at $142

mn, in our current valuation methodology we need to assum e a capital str uctu r e of 85% debt and 15% equi ty for thi s 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 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). 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 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. (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.

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Corporate Valuations case submission

Restructure debt

Sayan Ray (U1273586)

MEG has a Debt to Capital ratio of 95% and is $658 mn in debt. Ke eping 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 BH’s of fer 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 cr edit rati ng will in tu rn help M EG r efi nance the loan fr om BH at mor e aff ordable i nterest r ates.

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Corporate Valuations case submission

Sayan Ray (U1273586)

APPENDIX 1. Warrants valuation using the BS option pricing model 1.5

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 8 44.50%

(volatility)

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) =

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d1 =  N (d1) =

4.543738 0.9999972

d2 =  N (d2) =

3.285088 0.9994902

Value of the call =

# 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

4,650,000.00

Price per warrant Ttoal cost Share market price

$

Market value of shares acquired if warrants exercised Value of warrant to holder

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

$

0.01 $46,500.00 3.14

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Corporate Valuations case submission

Sayan Ray (U1273586)

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. Beta calculation a. Beta from comparables

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

Average Leverage

Equity Unlevered Beta

Revenue

Assets

Debt

Equity

D/V (a)

Beta (b)

A.H. Belo Corp. Courier Corp. (c)

$461.5 $259.4

$345.1 $213.0

$0.0 $21.5

$121.5 $154.3

0% 11%

1.49 1.21

1.49 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 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) + Eq uity  beta*Equity/(Debt+Equity)

5. Required rate of return from CAPM CAPM Market risk premium

6.00%

Risk free rate

1.76%

Equity beta Reguired return

10 year government bonds

4.75 30.26%

From CAPM

6. WACC calculation

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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% 95.00% 35.00% 30.26% 5.00%

Interest rate of current debt Deb to Value From CAPM

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)

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

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

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

Discounted FCFF

22.87913

16.64398

15.34735461

Value of the Total Newspaper division Value without Tampa PV of the transaction

222.6524 192.6524 50.65

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

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

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Corporate Valuations case submission

Sayan Ray (U1273586)

$ mn Initial outlay

Payments ($ mn)

Discount factor

NPV PVCF ($ mn)

1

10.50

1.02

10.25

2

10.50

1.05

3

10.50

4

354 59.44 Payments ($ mn)

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

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

Q

Q

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