Washington Post Company (WPC)
1973:
Total Market cap $ 80 million.
Most security analysts, media brokers, and media executives estimated WPC's intrinsic value at $400 to $500 million.
Here was Buffett's reasoning.
1. Owner's earnings for that year:
Owner's earnings =
net income $13.3 million
+ depreciation & amortisation $3.7 million
- capital expenditure $ 6.6 million
Owner earnings = $10.4 million
Long-term U.S. government bond yield 6.81%.
The value of WPC = $10.4 / 6.81% = $ 152.7 million; this is almost twice the market value of the company but well short of Buffett's estimate.
Buffett's further reasoned that:
Over time, the capital expenditures of a newspaper = depreciation and amortization charges.
Therefore, net income = approximately to owner earnings.
Knowing this, the value of WPC
= net income / risk-free rate
= $ 13.3 million / 6.81%
= $ 195 million.
His other assumptions:
1. The increase in owner earnings will equal the rise of inflation.
2. However, newspapers in the 1970s have unusual pricing power; because most are monopolies in their community, they can raise their prices at rates higher than inflation.
3. If it is assumed that WPC has the ability to raise real prices by 3%, the value of the company is
= net income / (risk-free rate - 3%)
= $ 13.3 million / (6.81% - 3%)
= about $ 350 million.
4. WPC's pretax margins were 10%, which were below its 15% historical average margins. If pretax margins improved to 15%, the present value of the company would increase by $135 million, bringing the total intrinsic value to $ 485 million.
Buffett bought WPC at an attractive price.
Market cap $ 80 million.
Based on the above calculations, Buffett bought the WPC for at least half of its intrinsic value.
However, Buffett maintained that he bought the company at less than one-quarter of its value.
Either way, he clearly bought the company at a significant discount to its present value.
Buffett satisfied Ben Graham's premise that buying at a discount creates a margin of safety.
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