Valuing the Washington Post, Revisited

Yesterday, we drew up a laundry list of the Washington Post Company’s assets and discerned the free cash flow (FCF) of Kaplan, its wholly held education subsidiary. Relative to the average FCF multiple of its peers (19.75x), one could make the case that Kaplan itself is worth more than the current market cap of WPO (which stood at 3.38 billion today, 2/27/09).

Yet, that 19.75x FCF valuation may look like a steep price, too high to provide the investor with a sufficient margin of safety. Even if the conservative investor grants that the education business is counter-cyclical and has good growth prospects, he may require future earnings to be more visible than Kaplan’s in order to justify that multiple.

Another way to value Kaplan’s intrinsic value is via a discounted cash flow analysis. Looking through the 10-Ks, we see that Kaplan had FCF of 189.8 million in 2008, 127.7 million in 2007, and 112.7 million in 2006. The older 10-Ks do not break out the depreciation and amortization expense for Kaplan alone, so it is difficult to discern Kaplan’s FCF growth rate. If we posit a modest 10% growth rate in FCF for Kaplan’s next decade, and a lower 5% for the next, and then discount those cash flows at 15% and demand a 25% margin of safety, the investor should feel comfortable buying the whole business for 12 times Kaplan’s 2008 FCF plus its equity. What’s Kaplan’s equity value? Given Kaplan’s acquisition streak, the 10-K shows over 2 billion in goodwill for Kaplan alone. The financial statements do not break out shareholder equity for Kaplan, so we’ll estimate it at half of their stated goodwill, or 1 billion. Thus, an investor seeking a 15% return and satisfied with a 25% margin of safety should be willing to pay 3.28 billion for Kaplan (2.28 billion for the cash flows and 1 billion for the equity).

Of course, while Kaplan is arguably WPO’s crown jewel, its other assets have significant value as well. Cable ONE had FCF of nearly 170 million in 2008. The television stations had over 90 million in FCF. The newspaper and print businesses were breakeven on free cash flow or slightly negative. Even after the market sell-off, its pension was overfunded by 320 million (as of Dec. 31) and its future return expectations reasonable (or, in my lights, low).

If we value Kaplan lower than its competitors, at 3.28 billion, put a cheap 8x FCF multiple on the growing cable business, and a 6x FCF multiple on the television stations, we get a value of 5.18 billion. Add in the 333 million in marketable securities and 320 million in the over-funded pension plans, and the value stands at 5.83 billion. And that’s assuming that we get all of their print and online publications for free.

In sum, we expect that an investor seeking a 15% return and 25% margin of safety would pay at least 5.83 billion for the Washington Post Company, or $622 per share. Though it may not be a dollar priced at 20 cents (like when Buffett first bought WPO), it looks to us like a dollar selling for less than 50 cents.

Disclosure: No position in the aforementioned companies at the time of this post.

Valuing the Washington Post

Newspapers these days are a tough business. The publically traded ones have significantly cut their dividends, with Gannett being only the most recent. The less fortunate (read—those highly levered) have entered bankruptcy, to be chopped into pieces sized for the auction block. Nor has the Washington Post Company been immune to the challenges of this recession, having seen a significant decline in advertising revenue in recent quarters (with print ad revenue down 21% at the Post and 22% at Newsweek ).

As most are aware, the print newspaper business is in serial decline. As Warren Buffett has noted, “when they take people to the cemetery, they’re taking newspaper readers, but when people graduate from high school, we’re not gaining newspaper readers.”

The Washington Post Company however is much more than a newspaper business. In fact, in our lights, less than a quarter of its intrinsic value lies in its newspapers and magazines. Contrary to appearances, the Washington Post Company is an education business. And the numbers bear this out. In 2008, 52% of its consolidated revenues derived from its wholly-owned subsidiary Kaplan, which operates in three business segments: for-profit higher education, test preparation services, and corporate training. In addition to Kaplan, WPO’s assets include: Cable ONE, a cable service with nearly 700,000 subscribers across 19 states; its namesake newspaper and affiliated publications, which include their website and related investments (e.g., Slate.com, The Root, The Big Money); a 16.5% stake in online classified ad provider Classified Ventures LLC; Newsweek and its thirty affiliated publications; The Daily Herald, which publishes The Herald in Everett, WA as well as other affiliated publications; six VHF television stations located in Houston, Detroit, Miami, Orlando, San Antonio, and Jacksonville; a 49% stake in Bowater Mersey Paper Company; and $333.3 million in marketable equity securities (as of 12/31/08), which includes $218.8 million of shares in Berkshire Hathaway. Whew.

To give a detailed intrinsic value that accounts for all these parts would require more work than we’re prepared to offer today. But let’s just focus on Kaplan. Kaplan generated 206.3 million in operating income in 2008, with 67.3 million in depreciation, and 15.5 million in amortization. After subtracting 99.3 million for capital expenditures, Kaplan had free cash flow of 189.8 million. In 2007, Kaplan posted free cash flow of 127.7 million; in 2006, 112.7 million. For now, let’s ignore Kaplan’s growth rate and the counter-cyclical character of the education business (McKinsey’s research shows a 90% increase in education spending during the past two recessions).

Looking at Morningstar’s numbers, we see that competitor DeVry currently trades at 18x FCF. Capella Education at 21x FCF. Career Education at 12x. Corinthian Colleges at 48x. ITT at 6x. Strayer at 28x. If we throw out the high and the low, we get a sector average of 19.75x FCF. Applied to Kaplan’s 189.8 million FCF, we get a value of 3.75 billion. As of 2/26/09’s close, the whole Washington Post Company traded for less than 3.5 billion.

Now, we recognize that to some, a 19.75 multiple on FCF may seem high. So tomorrow, we’ll take a closer look at the rest of the Post’s assets and give a more comprehensive estimate of its fair value.

Disclosure: I, or persons whose accounts I manage, own shares of Berkshire Hathaway at the time of this writing.