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The Washington Post is not as cheap as you think.

The stock is officially one of the ten most hated stocks in the US. These stocks have more than 35% of analysts rating them “sell”. The opinion of analysts notwithstanding, Mason Hawkins, Tom Russo, Ruane Cunniff, Chris Davis, Tom Gayner , Charles de Vaulx and Warren Buffett own shares of the company.


I BUSINESS & HISTORY

I’ll skip the first century or so of company history. In 1991, Donald Graham took over as CEO of the Washington Post after having been its publisher for a decade. Graham spent the next twenty years building a cable company and an education division to offset the decline in the newspaper business.

1997: Cable ONE founded

2000: The acquisition of Quest Education Corporation with 30 for profit schools brings Kaplan (and the Washington Post) into the higher education industry.

With the help of Warren Buffett who chaired the executive committee for more than 35 years, Don Graham succeeded in growing the two new divisions at a rate that outpaced the decline of the Newspaper. Revenue per share quadrupled.

2012, we are left with:

1) Cable ONE (Cable TV and ISP)

2) Post-Newsweek broadcasting (TV stations)

3) Newspaper (the Washington Post)

4) Kaplan (Education)


II PRICE

Shares trade on the NYSE at $ 390. There are 7.6 million shares outstanding for a market cap of $ 3 billion.

The company owns some Berkshire stock worth $ 300 million and has $ 390 million in cash. The company also has a pension fund that’s worth $ 600 million more than the estimated pension liabilities. I'll be writing about that when we come to the newspaper division.

The company does not consolidate a 49% interest in Bowater Mersey Paper Company and a 16.5% stake in Classified Ventures, LLC (Cars.com, Apartments.com, and HomeGain.com).

On the liabilities side, we find $ 450 million of deb. $ 400 million of that comes due in 2019.

In short, the company has a bulletproof balance sheet and an enterprise value of about $ 2.7 billion.


III VALUE


I’ll estimate the fair value of each of the four divisions and add it all up at the end.

Cable ONE provides cable service to approximately 0.6 million homes, representing about 44% of the 1.4 million homes passed by the systems. In addition to basic video, Cable ONE has 260k digital video subscriptions, 450k high-speed data subscriptions and 180k VoIP (digital voice) subscriptions. Cable ONE operates in 19 states, including Arizona, Tennessee, Texas and Washington. In short, about 450k subscribers (75%) also use their cable connection for Internet and/or phone calls.

Cable ONE also owns unused WiMAX spectrum in the areas it serves.

WaPoCableONE.png?psid=1

I belive Cable ONE would attract multiple bidders at $ 3300 per sub. At that price, an acquisition would be immediately accretive to the per-share earnings of any of the comps. $ 2 billion is conservative:

We use $ 3300 per subscriber Cable ONE has a high (and growing !) percentage of HSD subs

We ignore the value of the unused WiMAX spectrum.

Cable One serves 45% of homes passed and has room to grow organically.

Cable ONE offers 50Mbit data connections. The infrastructure is best in class.

The comps are generally levered to the hilt. Cable ONE is not.

Cablevision recently paid $ 4500 per subscriber for Optimum West.

NPG cable was sold to Charter for $ 4100 per subscriber.

TWC just bought Insight communications for $ 3B. Insight serves 700k homes.

I have seen estimates of intrinsic value based on operating income. Operating income understates earnings power because Cable ONE hasn’t raised prices in years. The standard deal is $75 (first year) for TV, 50 Mbit and VoIP. The price thereafter is $ 105. In the US, the average price of triple play is $ 150.


The Post-Newsweek division owns television stations in Houston, San Antonio, Detroit, Miami, Jacksonville and Orlando. Publicly traded comps are Nexstar (NXST), LIN media (TVL) and Gray television (GTN).

WaPoTV.png?psid=1

$ 850 million is conservative because:

Compared to the others, the company reaches 7.5% of the American population with just six physical stations. Costs should be lower (margins higher). The others need many more stations to reach as many people.

Three of the six stations (KSAT in San Antonio, WPLG in Miami and WJXT in Jacksonville) are ranked number one their area. That’s not the average ranking of the comps.

In 2011 there were no elections and/or summer games. $ 850m is 8x depressed 2011 income.


The Washington Post is a newspaper.

WaPoNewspaper.png?psid=1

At $ 1000 per subscriber, the newspaper would attract multiple bidders. $ 700m is conservative because:

Unlike the comps, the Post doesn’t charge (yet) for its online content.

The Washington Post has an overfunded pension plan while the comps do not. Adjusting for pension liabilities, the value per sub would be at least 30% higher.

The Washington Post is a brand with global value.


Kaplan, Inc., a subsidiary of the Company, provides an extensive range of education and related services worldwide for students and professionals.

WaPoKaplan.png?psid=1

$ 2.5 billion is conservative because:

Kaplan is much less dependent on federal funding than the comps. There are significant professional and international operations.

$ 2.5 billion is roughly 1x revenue. The others trade above that.

In the US, as tuition fees rise, more students will need federal loans to pay for their studies. Kaplan is one of a small minority of schools that are eligible for title IV funding. All the for-profits are. It's easy to forget that they currently serve a small (10%) part of higher education students. The majority (> 85%) of not-for-profit schools aren't eligible for title-IV funding. Their students can't apply for federal loans.

The not-for-profits rely on state funding and serve 85% of the higher education students. If states cut their budgets some more, tuition fees go up. If just 10% of the students now attending state-funded institutions switch to schools that are eligible for title-IV.... that's a potential 2 million US HE students for Kaplan. They now have 85k.


Adding it up and checking for sanity.

I have conservatively estimated the liquidation value of each division. Adding it up gets us a conglomerate worth $ 6.05 billion. With 7.6 million shares outstanding we get a value of $ 800 per share.

Since January 2010, the company has spent $ 800 million buying back stock and paying dividends. At the current enterprise value of $2.7 billion, we have a yield of 15%.

The IRS ignores GAAP and uses their own estimate of owner earnings to tax a company. In 2011, the company reserved about $ 100 million for income taxes. The average effective tax rate for a fortune 500 company is roughly 20%. This implies the IRS has its own estimate of owner earnings of $ 500 million. At the current enterprise value, WPO is trading at less than 6x IRS earnings.

I believe Cable ONE has significant untapped pricing power. The earnings of the Newspaper and the TV stations were depressed in 2011. An estimate of value based on some multiple of recent earnings will underestimate fair value of the company.

No, the Washington Post company (WPO) is not as cheap as you think. It’s much cheaper.


IV MANAGEMENT

The CEO is paid about $ 500 thousand per annum. He owns 3 million shares (A shares and B shares) worth $1.2 billion. Don Graham has 2500 times his annual salary tied up in the business. His interests are clearly aligned with the interests of minority shareholders.

With the A shares comes a right to pick 70% of the board members. On that board, you'll find:

Barry Diller (member of the board of Coca-Cola and chairman of Expedia)

Chris Davis (guru)

Ron Olson (Berkshire boardmember)

Tom Gayner (guru)

Anne Mulcahy (former CEO of Xerox)

Lee Bollinger (President of Columbia University and chair of the Federal Reserve Bank of New York)

It's a board fitting for Proctor & Gamble, General Electric and Exxon. It's not a board you would expect to find at $ 3 billion mid-cap. If anything, minority shareholders should be thankful to the family for using their superior voting power to form a board of impeccable quality.

In january, the compensation committee set the fair value price at $1,165 per share. No cheap options at this company.


V CATALYSTS

The company is retiring shares at a rate of $ 400 million per annum. Donald Graham owns 3 million shares and Berkshire Hathaway owns 1.7 million shares. This leaves 2.9 million shares costing $ 1.2 billion. Should the next three years resemble the last, by 2015, it will be Donald Graham, Ron Olson and myself on the board. The annual fee I get for sitting on the board will be more than the cost of my shares. A decent return.

Summer games and elections have a positive effect on advertising revenue at the TV stations and the Newspaper.

Less unemployment will have a positive effect on the default rates of tittle IV loans.


VI SPECIFIC RISK

The Graham family has control. In this case, control means they get to choose 70% of the board. I think it’s fair to say it's is a decent board.

Legislation. The TV stations and the Cable company depend on local licenses. The way these licenses are awarded may change. That could damage the franchise.

Legislation. Federal funding of higher education (title IV loans) is subject to new, stricter rules. The for-profit schools enroll students that need loans to pay for tuition. These new rules are not a risk. They're a fact. The company has adjusted. Interestingly, 90% of the not-for-profits aren't eligible for title IV funding. Their students won't be able to get federal loans to pay for tuition because their school isn't eligible. Why don't the not-for-profits apply ?

Market risk. Bears argue the breakup value of the company is irrelevant unless the divisions are actually sold. I believe this is irrational. You don’t need to sell your car to know its value.

Market risk. Conglomerates trade at a discount. Investors will tell you diversification reduces risk. For some reason, they'll pay a premium for pure play stocks.


VII WHY IS THIS CHEAP ?

Index funds and analysts avoid the Washington Post. It’s not a pure play on anything.

The CEO has been selling shares. This is simply not true. Donald Graham hasn't sold a share in his life. Family members have. The shares are held in his name.

For good reason, investors dislike newspapers and avoid for-profit education. The TV stations and cable division are ignored.


Read more:

Recent 10-k

Transcript of Shareholder day with Tom Russo asking questions and the presentations for each division.

Proxy statement

Hated stocks

As usual, Ben Comston did a good job analysing WPO.

Donald Graham has some interesting remarks about near-term results.

Buffett and the Post.

Disclosure

This is not a recommendation to buy or sell anything. I own shares of the Washington Post company. I have no position in any of the other companies mentioned. Any and all questions welcome as usual.

About the author:

batbeer2
I define intrinsic value as the price I would gladly pay to own the business outright. With current management in place. For most stocks, that value is 0. As of September 2012, I'm the author of the monthly Buffett-Munger Best Bargains Newsletter. I can be reached at fvandenbroek AT gurufocus DOT com

Visit batbeer2's Website


Rating: 4.3/5 (41 votes)

Comments

softdude2000
Softdude2000 - 2 years ago
Thanks for another good article.

(1) Cable one with $75 fee for triple play is great deal. but this is only introductory offer for first year. After that it costs $105. But it is also true they didn't raise fees for 2.5 years.2

(2)how is tv station business affected by internet growth? Any ideas in general and WPO in particular.

Thanks for the comments.

batbeer2
Batbeer2 premium member - 2 years ago
Hi Softdude2000

Thanks for the comment and kind words.

1) You're right.

2) The future is a mystery. Having said that, I believe we would have airborne TV today even if the Internet had been invented in 1950. Due to the availability of more alternatives, it wouldn't be as profitable as it has been.

Going forward, I believe there is a place for airborne one-way communication. One-way communication will always carry more information for a given block of frequencies. Getting coverage is easier too. You just need one high-power mast (plus a license for the frequencies).

With two-way (UMTS or Wifi) connections you need a license for the frequency plus lots of antennas to listen for the inbound signal. The antennas need to be upgraded regularly and need some connection with a physical network.
tonyg34
Tonyg34 - 2 years ago
Like the sum of parts valuation but have concerns about investing in no (or negative) growth companies.

Most recently revenue declined at all of its divisions except cable TV, where it was flat.

Kaplan is half of revenue but is now accepting fewer students/rev down 14%/still being investigated

Could the paper today find the financial resources necessary to dispatch reporters on a story lasting two years, as Watergate did? Is the Post strong enough financially?

Has the concept of journalism changed that much? Politico has taken the Post's claim to fame away from them.

there was this article about WPO(

http://www.gurufocus.com/news/144499/washington-post-buy-a-media-company-and-receive-a-free-forprofit-education-company)

in the comments I brought up concerns about underlying business moats and possible effects of gov regulations. I haven't really changed my opinion. WPO is still Kaplan with some media liabilities.

so yes this company is under valued, but if you hold it long enough the underlying business will catch up with the stock price.

batbeer2
Batbeer2 premium member - 2 years ago
Hi Tonyg34, thanks for the comments.

>> so yes this company is under valued, but if you hold it long enough the underlying business will catch up with the stock price.

OK, let's assume this is a value-trap worth $ 6B today. They're retiring shares at a rate of $ 400m per annum. If in five years the fair value drops 95% to $ 300m and the share price drops just 50% to $ 200...

I could probably live with the problems of being the outright owner of a $ 300m value-trap. Of course, should the share price drop faster, that would serve to speed up the proces.

Another, less speculative, way of looking at this: Management could stop buying back shares today and raise the dividend to 15%.

At current prices, is management wrong to direct the excess cash towards buy-backs instead ?


Re Moats:

The TV stations => You need a license for the frequency, a tower and change in people's habits.

CableONE => They own the fastest physical data connection into your home. A twisted pair of copper wires won't carry as much data. You need to dig a trench with fiber to the home to beat WaPo.

The newspaper => More than half the people in Washington read the paper at least once a week. Your distribution costs alone are going to be much higher if you want to start competing.

Kaplan => Your stockbroker probably went to one of their schools (80% global market share) before he/she got their license.


>> Kaplan is half of revenue but is now accepting fewer students/rev down 14%/still being investigated

1) Since when is it a problem to have more customers than you wish to serve ?

2) Presumably, they're turning away the students that they think are going to have problems servicing the loans. Those students then go to one of the competitors..... I think it's rational. This way Kaplan won't have as much problems managing the loans later on.

3) IMHO the drivers that enabled Kaplan to grow tenfold are still there. Thankfully, that is immaterial to the thesis. If I find the time and inspiration, I'll do an article on Kaplan alone.


>> Could the paper today find the financial resources necessary to dispatch reporters on a story lasting two years, as Watergate did? Is the Post strong enough financially?

Has the concept of journalism changed that much? Politico has taken the Post's claim to fame away from them.


Without knowing a lot about Politico, I think it's unlikely that company is in a better financial position to dispatch reporters for a couple of years than WaPo.


>> Most recently revenue declined at all of its divisions except cable TV

As explained in the article, the newspaper and TV divisions depend on advertising revenue. 2011 was a year without major elections and/or olympics. This year may be different in that regard. Miami Heat is doing well in 2012... this too will help revenue (TV stations in Florida !).
swnyc2
Swnyc2 - 1 year ago
Dear Batbeer2,

I see Bezos is buying the Washington Post newspaper for $250 million.

If you include the 5% after hours rally, the stock has appreciated almost 50% since you wrote your article -- double the return of the SP500.

Congratulations on your good call. (I wish I had bought some shares!)

I'm curious, though, if you were a bit surprised by the price?

In you article (written more than a year ago), you conservatively estimated the newspaper's value at $700 million.

So, I was wondering. Do you think:

1. The newspaper business has substantially deteriorated since your article,

2. Bezos is buying it at a 65% discount,

3. there is something wrong with your original valuation, or

4. some combination of the above?

batbeer2
Batbeer2 premium member - 1 year ago
Hi Swnyc2,

It seems there is something wrong with my valuation. I will need to look into the details of the deal though. I'm especially interested in the pension fund. The fund was originally "filled" with cash generated by the newspaper and is now overcapitalized. If one were to consolidate the fund with the newspaper, it would be quite profitable. They report the performance of the fund separately though.

In short, I need to look into the details to see what exactly Bezos is buying for $250m but at first glance, it seems my estimate of value of the paper was too optimistic.

batbeer2
Batbeer2 premium member - 1 year ago
Hi Swnyc2,

Some thoughts:

1) The Boston globe recently sold for $75m. Circulation of the Boston globe is roughly half of WaPo's.

2) Buffett bought the Omaha World Herald for $200m with about 30% of the subscribers WaPo has.

3) WPO will retain the excess assets of the pension fund. Only the assets for the current workforce will be transferred to Bezos. That's good for WPO shareholders.

It seems private transactions for newspapers are all over the place. In any case, they don't sell for a fixed per-subscriber price. In fact, unless Buffett is the buyer, they sell for significantly less than the EV of the publicly traded ones.

My estimate of Intrinsic value was based on the EV of the publicly traded peers. As it turns out, this has no bearing on the price these newspapers fetch in a private transaction.

I don't fully understand it.... yet. Food for thought. We will know precisely what Bezos got (and not) next time WPO reports its balance sheet ex WaPo.

>> The stock is officially one of the ten most hated stocks in the US.

I guess that's no longer the case.
AshishGupta
AshishGupta premium member - 1 year ago
WPO sold something that was worth 0 (or negative) for $250 Million. That's a good deal. Now WPO can focus on its main business - Education.
vgm
Vgm - 1 year ago
As an aside, I might presume Buffett was approached first as a potential buyer - given his close association with the family and the business, as well as his recent penchant for picking up newspapers.

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