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October 30, 2014

Berkshire Hathaway Media Group: Financial Engineering Makes the Deal

Warren Buffett, newspaper mogul of the 21st Century. The notion is enough to throw many off course.

A billionaire philanthropist buying into the woebegone American newspaper industry does make a good story and prompts the usual question: Why? Does he something others don’t?

As Buffett’s Berkshire Hathaway relieves Media General of its newspapers — “We’ve come to understand that most investors do not view the publishing sector as a place to generate the best returns on their capital,” Media General CEO Marshall N. Morton put it succinctly in April  – I think we can see this deal roughly in line with the spate of other newspaper deals that have gotten done in the last year or so.

Most of these deals do not rely that much on the actual value of the newspaper property. Rather than rely on other things — the value of underlying real estate has driven numerous of the deals – and the meager cash flow of the properties themselves is seen as a way to generate enough revenue to pay off low-interest, acquisition debt. In this deal, Buffett has taken more of a three-cushion billiards approach, much as the headlines announce “Berkshire Hathaway Bets Again on Newspapers with Media General Deal.” Each cushion rings up advantages for the company, even if the newspaper ownership itself is the most problematic.

Buffett is, at base, an opportunistic investor. See a business, or industry deep in the doldrums, and think you can leverage money out of a deal, one way or the other, and you’ve got an opportunity. The difference, if you are Berkshire Hathaway, you get a better deal than others, because of your financial capacity and willingness to take the long view. That’s what BH did with General Electric and Goldman Sachs, back when the world seemed to be ending in 2009. With that long-term position, he is perceived much more as an eagle than a vulture, yet he’s a predator nonetheless.

So, Berkshire Hathaway takes the newspapers off of Media General’s hands. At $142 million, he is buying 63 titles or about 21 actual “newspaper” properties. So that’s like buying a top-of-the-line house in each city, but you get a newspaper with with it. When the pool ball drops in the corner, BH Media needs to figure out a new game plan for those properties, one that I’ll bet will involve bringing a higher degree of technology application in cutting legacy costs faster and deeper.

It’s the early movements of the ball that make this deal more a feat of financial engineering than a newspaper deal. Three cushions provide investment relief:

  • Lend Media General $400 million, and extend a $45 line of credit, at 10.5% interest. That allows Media General to escape shorter-term financial pressures, and gives BH a good profit along the way.
  • Gain warrants that are convertible to about 19.9 percent of Media General’s outstanding shares. The new Media General is mainly a broadcast company, a sector with its share of issues, but with lots more projectable upside than the newspaper industry. So it’s gotten — as Buffett earlier got in General Motors and other “bail out” deals — a better deal than your average investor, as Media General re-charts its future.
  • Takes title to all the real estate these newspaper companies sit on.

Now the new BH Media Group can move forward with its properties — where and how will the Omaha and Buffalo properties fit here?  – and unencumbered by debt or short-term pressures. If you are a long-term investor like Buffett, you can afford to give “newspaper” properties a breathing period.

He, as well as anyone knows that the future will be mainly digital, though it will slower to unfold in Lynchburg and Winston-Salem than in competitive major metro markets. He can be buoyed by the profound industry move to charging for digital access, after decrying free digital access: “Newspapers have been giving away their product at the same time they are selling it and that is not a great model. You’re competing with yourself… you shouldn’t be giving away a product you’re trying to sell. That’s key to the future of the newspaper. giving away a product free in one place that you charge for in another.” We now have enough evidence to believe that core newspaper readers will transition over their payments for “circulation” as they themselves move to tablets and other devices, if publishers approach the transition smartly.

The problem is print advertising is far deeper; it’s in an unending and accelerating spiral. No doubt he is buying — by bypassing Media General’s Tampa Tribune — profitable entities. Indeed, we may find out, looking back, that Buffett is just another greater fool, having believed his buy was close enough to the bottom to justify. Or we may see the code broken well enough on new business models, as the BH Media Group takes a long, hard look at the realities of John Paton’s Digital First Media initiatives, to manage downturn and change well enough to stay in the black. As that drama unfolds, it’s the profits from a Media General broadcast bet, loan interest and potential sales of real estate that buffett this deal from the harsh day-to-day reality of newspaper downturn.

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