Is ROI the best measure of business success? It depends on your perspective…
Berkshire-Hathaway’s annual meeting took place in Omaha last weekend. Every hotel in town was sold out. This year, 30,000 people came to hear Warren Buffett’s homespun wisdom on the state of the markets.
There’s been a lot of talk lately about how the Oracle has lost his mojo. By Buffett’s own standards, his company’s returns haven’t been great of late. He measures the company’s performance by comparing the annual change in book value per share of Berkshire against the annual percentage change of the Standard & Poor’s 500. And by that measure, Berkshire has lagged the S&P in each of the last two years.
But hold on a moment. A dollar invested in Berkshire’s stock in 1968 would be worth nearly $6,540 today. The same dollar invested in the S&P 500 in 1968 would be worth just $59. That speaks for itself. Besides, 20 years ago, investments were 80% of Berkshire’s total assets. But now it looks more like an operating company – only 35% of its holdings could be characterized as equity picks. And there is always a lag in the time it takes for the stock market to catch up with the growth in intrinsic value of a company.
There’s another thing too. The Oracle has always loved well-managed, capital-intensive, old-fashioned, practical companies with deep moats around them to keep competitors out. He owns Burlington Northern for example. Stuff like railcars is guaranteed to lose value as it gets older – but the actual return can be great right through the decline. So the book value might not look healthy, but the money is still rolling in. Timing the exit, that’s the important thing when you play his game.
And that’s what brings us to newspapers.
For several years Berkshire Hathaway was the largest single outside investor in newspaper companies – though the bet amounted to little more than a rounding error on Berkshire’s balance sheet and besides, Buffett’s biggest investment of 20.45% in the Washington Post Company (WPO) was made over 30 years ago, way before Politico stole its talent and audience and Newsweek was sold for a buck. He bought nearly a million shares at $11, and held. By 2005 the value of WPO shares neared $1,000. The price then fell drastically but bounced back to around $600 on news of the divestment of the Washington Post newspaper in mid-2013.
It was yet another spectacular win for the Oracle, but the value didn’t come from the newspaper. From the late 80’s until 2005, WPO had derived most of its revenue and operating profit from its ownership of Kaplan Education, which in turn derives most of its revenue from federal financial aid in the form of student loans. So for all these years Buffet’s stock had been propped up by your taxes and mine. Who would have thought?
The Post has always been a rag – poorly designed, lazily edited and more self-absorbed even than its counterpart up the road in New York City. For years it has been unable or unwilling to solve a central positioning dilemma. More than 90% of its online audience live outside the Beltway, but yet it is a metro paper covering the District and communities in Maryland and Virginia. If it emphasized that local community more in its digital offering, it would surrender more of its audience to Politico. If it emphasized political analysis over local news, it would lose its base. After the paper was sold to Jeff Bezos for $250 million, a most generous valuation given that it lost $50 million in the first half of 2013 on $138.4 million in revenue, Buffett struck a deal to swap most of his 28% stake in Graham Holdings, the former owner of the paper, for the company’s Miami television station, cash and the Berkshire shares held by Graham. His long relationship with the Washington Post was over.
But he continues to own newspapers in Buffalo and his home town of Omaha. Just when I was thinking that he was still in because the cost basis of his holdings would force a punitive tax expense if he sold, in 2012 he purchased the Media General newspaper group. Here was another newspaper company without a plan. It had experienced a 31% decline in revenues over the previous four years and a 90% drop in stock price. When Berkshire Hathaway acquired the company it was just a week away from a deadline to repay a $225 million loan or trigger a crippling default. There was no way it was going to make it.
Buffett once said that “with few exceptions, when a manager with a reputation for brilliance tackles a business with a reputation for poor fundamental economics, it is the reputation of the business that remains intact.” So why did he do it?
First, of course, it was a very good deal. Berkshire’s offer consisted of an asset agreement to pay Media General $142 million for its 63 daily and weekly newspapers and real-estate holdings, and a credit agreement that included a $445 million term loan. He paid just two times cash flow for the papers. Since the New York Times still inexplicably trades at five or six times cash flow, it doesn’t appear that he overpaid. An appreciative Media General gave Berkshire warrants to acquire 19.9% of the remaining company, which owns several network television affiliates. The warrants were set at a penny a share – and largely because of Berkshire’s stake, that stock price has climbed by five times since the transaction was completed. Berkshire was also paid a $44 million premium for helping the company refinance at a cheaper rate. Oh, did I mention the initial interest rate on that $400 million loan? 10.5%. All this right here is how Mr. Buffett got to be so wealthy. By now the purchase price has been fully recovered, and some.
Second, based on what he has said, Buffett is a believer in small newspapers. In his 2012 annual Berkshire Hathaway shareholder letter, he wrote: “Papers delivering comprehensive and reliable information to tightly bound communities and having a sensible Internet strategy will remain viable for a long time.” Shortly after he purchased the Media General papers he said “it’s really hard in L.A. to have a sense of community.” That’s why he carved out the big Tampa Tribune from the deal – it went on the block separately.
It’s true, in the smaller markets that he seems to like, the household penetration of his newspapers is still as high as 45% in some cases. But print subscriptions in those markets are declining at a rate of around 4% a year and not one of his newspaper properties has a successful digital strategy in place. There’s a lesson there. If strong brands, no competition and charging for online newspaper content is the bet, I find myself in the unpleasant position of betting against the Oracle of Omaha. I never thought I’d find myself here. But the bridge is now free to all drivers, the brands don’t transfer well, digital classifieds competition is but a click away with a more attractive, more useful product and all the evidence is that even in small markets, local news is not strong enough to support a digital subscription business. So there’s not even the prospect of low, single-digit earnings growth. Just a faster and faster rate of decay.
But hey, what do I know? I’m still holding Yahoo!