The Harvard Case Study \"Buffett\'s Bid for Media General\'s Newspapers\" Essay PDF

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Xu Hongsi

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FINM7402 Individual Assignment Student Name: Hongsi Xu Student Number: 44245739 Date: 10/05/2017

Q1. Potential Financial Benefit FINM7402

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1. Buffett(2013) himself said: Newspapers continue to reign supreme, however, in the delivery of local news, there is no substitute for a local newspaper that is doing its job(Badkar 2013). Berkshire didn’t buy the struggling big city newspaper Tampa Tribune, they focused on local newspapers, which is always a high competitive threshold monopoly company. It’s hard for other newspaper to penetrate into local markets as the capacity of each market is quite small. As Buffett owns three of the top 10 newspapers in the country by market penetration in large part(Berkowitz & Saba 2012). One small town only need one newspaper at one time. Small town newspapers worth a vote of confidence because of the strong sense of community of American(Wuthnow 2013). Local newspaper can bring them a sense of assimilation, so the group of people will be very sticky to local newspapers. That’s why there is always a group of people rely on local papers to see what’s happening around them. That’s not nationwide newspapers have.

2. Buffett not only bought the newspaper business, but also the newspaper's website, and the press apps for development on mobile phone and tablet PC. Because the business model may be out of date, but never the news and stories. And for the company's new owner, this move also eliminates the funds for re-development.

3. From the case study we can see the Asset Purchase Agreement contains the real estates of Media General. Though it didn’t explain it in details, 63 newspaper’s real estates worth a great deal in financial perspective.

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4. The term loan Berkshire offered to MEG, with $400 million loan and $45 revolving credit, with interest paid quarterly at 10.5%. After discount it equals to $354 million. But MEG has to pay back the principle of $400 million at maturity. There’s a price difference for Berkshire to earn.

5. The penny warrant Berkshire received in this case, gave them an opportunity to buy the stock of MEG at a very low level($0.01 per share), and they can sell it at a high price later to earn the price difference.

Q2. Decide whether MEG’s newspaper division worth 142 million a) WACC Calculation A.H. Belo Corp and Gannett Co. are the comparable set of firms. Because these two company earn their revenue by newspaper, like MEG’s newspaper division. The levered asset beta would be roughly the same for the same type of business. Assume the Debt-Value Ratio and Asset Beta equal to the average of the two comparable firms, Cost of Debt can be simply calculated by formula: rd = rf + MRP. Then we can get rWACC = 11.07%.

b) Get the growth rate The incremental WC is the difference between the working capital of two contiguous

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years. Assume NPV equals to 142 million, it equals to DCF + TV - FV. Where FV equals to the value of Tampa Tribune, which is the reduction. WACC = 11.07%, as the value of growth rate only influence the PV of TV, and the formula is given in the spreadsheet, we can get the growth rate equals to -0.8%.

c) Are the cash flow forecast reasonable? It’s reasonable. Because the numbers come from third party analyst and case writer, not from Media General’s optimistic groundless speculation.(Brick, Chen, Hsieh & Lee 2016) As we calculated from back to start in part b above, we can see that if we need the cash flow to be reasonable, the growth rate has to be near -0.8%. Then we can do a sensitivity analysis to see how the NPV would change based on different assumption of growth rate. We can see from the result that the higher growth rate, the higher the growth rate, the higher NPV.

Q3. Buffett Drives from the credit agreement or not There are mainly two parts of the credit agreement. The first part is the 8-year term loan, which I showed my calculation of it in a single spreadsheet. We get two different NPV: 51.2 and 46. The CCC+ bond yield is the rate of return based on risk evaluation of the market to MEG. If assumed we use 10.5% to discount, we get 51.2, bigger than the result we get while using 10.26%. There might be a difference between these values and the true risk, return of this case though. But FINM7402

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it’s a good investment for him and his company, as the value he gained will be between $46 million -$51.2 million based on different discount rate. The second part is the penny warrant. The question is when Buffett exercise, so we first assume he exercise at stock price of $3.14 per share with 8 years (96 months) to maturity, and the exercise price would be exactly $0.01 per share base on penny warrant. Although penny warrant is an American style option which can be exercised at any time, we can still use black-scholes model in this case(Geske & Roll 1984), as black-scholes is for European options can only be exercised at maturity, to get the intrinsic value. The speculative value is there for the remaining life of the option. The standard deviation can be used by the historical volatility of MEG’s share price, which is 67% from the case study. From the result we can see that the call option will bring Buffett a income of 3.13* 4.65 million = $ 14.55 million. That’s totally a $60.55 million - 65.75 million drives to him from the credit agreement.

Reference Badkar, M. (2013, March 2). Buffett Explains Why He Paid $344 Million For 28 Newspapers, And Thinks The Industry Still Has A Future. Business Insider Website. Retrieved April 14,2017, from: https://www.businessinsider.com.au/warren-buffettbuying-newspapers-2013-3?r=US&IR=T

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Berkowitz, B & Saba, J. (2012, May 17). Warren Buffett to buy Media General newspapers. Reuters Website. Retrieved April 14,2017, from: http://www.reuters.com/article/us-mediageneral-idUSBRE84G0M920120517

Brick, I., Chen, E., Hsieh, H., & Lee, C. (2016). A comparison of alternative models for

estimating

firm’s

growth

rate. Review

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Quantitative

Finance

and

Accounting, 47(2), 369-393.

Gara, A.(2015 September 28). Warren Buffett Saved Media General: Don't Dismiss Berkshire In A Fight Over Its Future. Forbes Website. Retrieved April 15, 2017, from: https://www.forbes.com/sites/antoinegara/2015/09/28/warren-buffett-saved-mediageneral-dont-dismiss-berkshire-in-a-fight-over-its-future/#63e1d5f863e1

Geske, R., & Roll, R. (1984). On Valuing American Call Options with the Black‐ Scholes European Formula. Journal of Finance, 39(2), 443-455.

Wuthnow, R. (2013). Small-Town America Finding Community, Shaping the Future. Princeton: Princeton University Press.

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