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Absolute Return Podcast #51: Did Warren Buffett Throw in the Towel on the Newspaper Business?

By February 3, 2020 No Comments

February 3, 2020—Warren Buffett’s Berkshire Hathaway Sells its Newspaper Business to Lee Enterprises. Is Buffett Really Throwing in the Towel on Newspapers?

Volkswagen Makes Play for Navistar in a Bid to Consolidate the Trucking Industry. What’s Their M&A Strategy?

Casino Operator Penn National Invests $136 Million in Sports Media Brand Barstool Sports. What Makes the Deal Structure so Interesting?

Amazon Rejoins the $1-Trillion Market Cap Club as its Stock Hits a New All-Time High. Why Did the Shares Rally?

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Transcript:

Welcome investors to the Absolute Return Podcast. Your source for stock market analysis, global macro musings and hedge fund investment strategies. Your hosts Julian Klymochko and Michael Kesslering aim to bring you the knowledge and analysis you need to become a more intelligent and wealthier investor. This episode is brought to you by accelerate financial technologies. Accelerate because performance matters. Find out more at www.Accelerateshares.Com.

Julian Klymochko: Welcome investors, speculators, traders, short sellers, perhaps, and everyone else to Episode 51, one of The Absolute Return Podcast I am your host Julian Klymochko.

Michael Kesslering: And I am Michael Kesslering.

Julian Klymochko: Today is January 31, 2020. That is right, end of the month. Got some really cool things happening in the market this week.

    • First, we are going to chat about Warren Buffett’s latest deal in newspapers. Is he really throwing in the towel on this business? It’s a really interesting transaction that we’re going to chat about.
    • Volkswagen made an unsolicited play for Navistar in a bid to consolidate the trucking industry. What is their M&A strategy here?
    • Casino operator Penn National invested $136 million in barstool sports. What makes this deal structure so interesting?
    • Finally, Amazon hit the 1 trillion dollar market cap, marked again as its stock hit a new all-time high today. Why did their shares rally this week?

Warren Buffett

Julian Klymochko: The Oracle of Omaha, his conglomerate, Berkshire Hathaway, is selling its newspaper business to print media specialist Lee Enterprises for one hundred and forty million bucks. Now, these assets being sold include 30 daily newspapers, 49 weekly’s and 32 other print products. These newspapers, excluding the Buffalo News, they logged nearly $400 million in revenue and about 15 million in net income last year.

Buffett selling these for roughly nine point four times earnings or the inverse of that being ten point six percent earnings yield. What is interesting is that Lee is well apprised of these newspapers as they have managed them under twenty eighteen operating agreements that Buffett signed with Lee a number of years ago. So a lot of familiarity with these assets. Now, the most interesting aspect of this deal is that people would look at this headline and be like, Buffett’s throwing in the towel. A newspaper is a business that means a lot to him. He has been involved forever. He has acquired these assets over many decades and talks about as in his childhood he would deliver newspapers. That is kind of how he got a start and his first little chunk of change, which he went on to invest. But if you actually look into it, he is increasing his exposure to the newspaper business, but in a really interesting deal here. So you’ve often heard debt for equity swaps. But what’s happening here is somewhat like an equity for debt swap. He is selling the equity for 140 million in these newspapers, but then he is turning around and lending Lee Five hundred and seventy six million at a 9 percent. And this is versus the earnings yield on the newspapers were roughly kind of ten point five percent.

So lower earnings yield, but something more guaranteed. Obviously, it is a fixed coupon where he is lending Lee north of half a billion dollars. Not just that, but more security as a lender than an equity holder. So it’s certainly a very interesting deal, not only as Buffett not throwing in the towel on newspapers, but he certainly stepping up exposure. Then a really unique, interesting and perhaps better way to earn yield for Berkshire here, isn’t it?

Michael Kesslering: Absolutely. And it’s something that, as you had mentioned, is a little less volatile. It is just a different investment that he is making. I will note that this price is about $200 million less than what he paid for Twenty-eight newspapers in 2012. But as you’d mentioned, you know what’s in it for Lee? Well, there blended interest rate was around ten point five percent prior to this deal. Now they bring that down to 9 percent, so they will save themselves about 5 million dollars annually as well from Berkshire side is that the deal does not include the real estate at which these newspapers are located. What will happen is that we Lee will now lease these properties from Berkshire under a 10-year agreement for $8 million annually. So now, he is gone from being an equity holder in the newspaper business to being a debt holder, as well as the real estate provider or a landlord as well. I mean, just looking at lease shareholders, I mean, they loved it. Their stock price going up 67 percent on Wednesday, you know.

Julian Klymochko: Why do you think that is? Because there is a couple of things happening here. Number one, I don’t think it’s necessarily that shareholders are excited to get more exposure to more newspapers. I don’t think they’re excited about the assets. However, we should note that Lee Enterprise stock was quite distressed. It was trading around, you know, a buck and change down pretty significantly around a four year low. I think investors were more so excited on reduction in default risk, being able to refinance that debt. So it takes a near-term default off the table. So perhaps some short covering.

Michael Kesslering: Absolutely. The default risk in addition to these expected costs synergies. So really just a little bit larger scale that they will be able to get their costs or handle around their costs. I guess it is just less pessimism as opposed to excitement in the industry.

Julian Klymochko: Yeah, but nonetheless, small deal for Berkshire. I mean, how much cash do they have on their balance sheet? $120 billion or something. And they’re selling this for 140 million. So really a drop in the bucket nonetheless. Quote from Buffett here, he stated that. “We had zero interest in selling the group to anyone else for one simple reason. We believe that Lee is best positioned to manage through the industry’s challenges.” So there you have an interesting newspaper deal from the Oracle of Omaha.

Volkswagen

Julian Klymochko: Interesting M&A play in the industrial space with Volkswagen’s subsidiary Traton on tabling a $2.9 billion, thirty-five bucks per share all cash offer for American commercial truck and bus manufacturer Navistar. What Volkswagen is looking to do here, really the strategic rationale is an attempt to make inroads into the lucrative U.S. heavy-duty vehicle market. Plus, it’s just a classic consolidation play. Where they are looking to harvest those cost synergies or cost savings. Now, if successful, this deal would turn Volkswagen into one of the largest heavy-duty truck players, really rivalling Diamler and Volvo in terms of market share. Volkswagen subsidiary only has about 2 percent in North America and Navistar has 15 percent. This would establish some pretty serious scale at Volkswagen. Then on the Navistar side, they have been really struggling. This comes off like it’s a forty five percent premium, so sizable. However, their stock was near a 52 week low. It has been struggling quite a bit. They recently told investors that 2020 won’t be a banner year. They slash production by about 25 percent. That a sharp decline in orders, particularly of heavy-duty trucks. Now, this really left the company vulnerable, especially since there’s a number of activists involved here, isn’t there?

Michael Kesslering: Yeah, there is Carl Icahn, who we have talked about on this podcast multiple times, and one of his protégés Mark Rachesky. Between Icahn, Rachesky and Volkswagen, they own just over 50 percent of the stock. So really, Volkswagen has to convince Icahn. Icahn I will note that his cost basis is about $33 and 60 cents. So at the $35 unsolicited cash offer, that really does not do a ton for him, although I would note at one point in early 2016. The stock was less than $7 per share. I mean, it has rebounded quite well for him. But over the number of years that he’s been invested in this in stock.

Julian Klymochko: Yeah, a long time.

Michael Kesslering: Really has not been that great of a return. So he would definitely be looking for a little bit more of an up bid.

Julian Klymochko: In terms of M&A one on one. There is a bunch of interesting merger and acquisition type specific terms here. That is going on, so you mentioned that Volkswagen has a stake here, of course, Volkswagen owning 17 percent of Navistar. Now, this, in M&A parlance is known as a toehold. So Volkswagen already has a toehold, which makes an acquisition quite a bit easier if you already have, you know, a significant amount of control over the target already. The other thing is this was an unsolicited offer that Volkswagen made public, they published it to the media. Now, this is known in M&A terms as a bear hug letter where you make an offer, then you make it public. It effectively gets the share price moving and puts the company in play. The other thing that we should discuss is the notion of a bump or an increase in consideration. They never start with their best offer. You indicated, you know, what is Carl Icahn likely to take? Obviously, he likes to see his assets being sold at a premium. That is ultimately why is in the stock to make money. Volkswagen came in at 35 bucks per share. There is likely some flexibility on that to the upside.

I saw some on the street speculating perhaps another 10 to 20 percent increase, so more in to the forty dollar range and they could strike a friendly deal here. Certainly, that seems like a decently probable scenario, but we shall see on this one. The other thing that we should disclose is that we are long Navistar stock in our private equity alpha fund. And other than that, you know, it’s a really interesting M&A situation that is one to watch here.

Michael Kesslering: Absolutely. Lately we have seen quite a few bidding wars, I guess, in a natural amount in the last number of months. And do you see any potential for a bidding war in this situation outside of Volkswagen?

Julian Klymochko: It is really tough to say, because I believe some of the others that would be interested in this type of asset would have a much tougher time in terms of anti-trust approval. So that may, you know, temper their interest somewhat. So when industries really start to get concentrated like they are in auto parts, it takes a lot of the potential acquirers out of the picture. But clearly here, not a lot of market share issues as Volkswagen only has 2 percent in North America, making the path of regulatory approval far less risky than going with one of the other players that has significantly more market share.

Penn National

Julian Klymochko: Onto the next one, and this one is really interesting. What happened here is Penn National Gaming acquire a 36 percent state in popular sports media, publisher, Barstool Sports. If you are on Twitter or anything like that, you will definitely be aware of Barstool Sports. This deal was for one hundred and thirty six million in cash and stock as indicated.

Barstool Sports, they are really big into blogs, podcasts, social media, live events. Now they have 66 million users. So Penn National is certainly looking to harvest those users for their gambling services, specifically online, which we’re going to get into.

Other interesting aspect of this deal is it includes an option for Penn National to acquire at least a 50 percent stake in Barstool over the next three years for an additional 63 million. The main strategic rationale or one of the main ones is to help Penn National establish a presence in the nascent online sports betting market, which is really just still formulating in the US. There is a lot of, you know, regulatory movement there. It is a very fluid 20 states and D.C. have legalized online wagering. Some limit betting to casinos, while others allow online wagering, including mobile phones.

So what’s happening is that a lot of casino operators such as Penn, they are looking to basically copy what’s happened in Europe and Australia. And they’re really racing for U.S. customers, because the US Supreme Court in 2018 effectively cleared the way for states outside of Nevada, of course, to establish sports wagering. The prize here is online betting, which is currently available in New Jersey. And numbers show that about 84 percent of the nearly $5 billion in sports wagers in New Jersey last year were placed online, so it is a pretty significant amount. Obviously, Penn National’s shareholders love this deal. It gives them access to 66 million users. They are hoping to really make a big play into U.S. online gambling, specifically mobile. And this Barstool Sports deal is expected to help them do that, so their stock went up quite a bit, up 11 percent. Really interesting transaction, what do you think of it?

Michael Kesslering: Yeah, in this situation, Barstool, they are giving up equity for an injection of cash. What they are giving up as well is there right for Penn to be the only marketer, an advertiser on their platform, and as you had mentioned, that is 66 million users. So that is obviously quite valuable to Penn as well, with that ad revenue that they are giving up, that can be expected in the around six million dollars per year range, at least as of last year by my estimates. And what they getting for that? Well, effectively, Penn is now taking that, although they are taking away that $6 million worth of revenue, working up to about 11 percent of Barstool overall revenue. But they’re going to now piggyback and leverage that into their own product, which as you had mentioned. The online betting is such a high growth area of the market. Just in New Jersey, if they were able to capture about 10 percent of the market would be about $30 million annualized, and that is growing at an extremely high rate. So in a couple of years, that will be even higher. Assuming a few more states come on board, that number starts to look very profitable, and in terms of value creation, that would be a lot more valuable than that ad revenue that they’re giving up as well.

I mean, one other thing is when we talk about this effectively; it is an advertising deal for Penn. It really is not unprecedented as this is effectively them paying for the opportunity to build a brand using the bar Barstool platform. And really, this type of investment with a long term ad spend an equity kicker has happened in Canada as well with Post Media and Mogo. This happened a few years ago where Post Media agreed to provide $50 million worth of ads over three years to Mogo. In exchange, Post Media was then given warrants for a three-year term that would allow them to buy roughly 14 percent of Mogo shares, in addition to a royalty that worked out between 4 percent to 11 percent for those next three years, depending on whether that was incremental to what was brought in. It really is not that unique of a deal in that sense, but nonetheless, it’s very interesting and will be interesting to follow how much this Barstool brand can grow, because now Penn is situating themselves to take advantage of a lot of that growth and really take advantage of that value creation for sports betting with Barstool.

Amazon

Julian Klymochko: Just a blow out fourth quarter for one of the FANG stocks, Amazon just really crushing it, leading their stock to around 1 trillion dollars in market cap. So certainly, a very unique and what happened here is they announced their fourth quarter results, pretty exceptional revenue growth, 21 percent to eighty seven point four billion. Decent beat on estimates of 86 billion. Really the main driver here of growth and profitability, Amazon Web Services, AWS just a pretty exceptional business.

The revenue growth of 34 percent to about 10 billion and really has leading gross margins. And this is why you’re seeing margins really expand at Amazon. It is certainly not the retail business that is for sure. Other highlights, they now have 150 million, more than 150 million paid members in its prime membership. This is a 50 percent increase from the last time, they disclosed the amount of 100 million back in spring of 2018. Shareholders loving it, stock up nearly 8 percent on the news, today, all-time high, which is the biggest daily jump for Amazon stock since October of 2017. Jeff Bezos, world’s richest man, made 10-12 billion today. So he must be feeling pretty good.

Michael Kesslering: Absolutely. As well, it did close just below the one trillion dollar market cap by the end of the day. Unfortunately…

Julian Klymochko: I was talking fully diluted haha.

Michael Kesslering: But as well, you have mentioned the number of 150 million paid prime members. Now, to put that into context, I’ve seen estimates that each prime member has in a lifetime value of up to three thousand dollars. So looking at that, just the value of their prime business, what those numbers would be around $450 billion. Now, that is not factoring in AWS or their marketplace or any of their other ancillary lines. I mean, this is just a very remarkable company in how they built themselves. I mean, the other aspect as well that had a little bit of concerns when it was announced was their investment into one day shipping and how that would affect profitability, and what you’re seeing here is that it hasn’t affected profitability. They initially estimated that it would cost them 1.5 billion dollars to get themselves to one day shipping, and that ended up being slightly less. But when you look at it in terms of the context of the company, I mean, if you’re able to retain those prime members for any longer, that is just insanely valuable for them as a company, especially if it’s only a $1.5 billion investment for them.

Julian Klymochko: Right and Amazon truly is a very exceptional company. And you look at what Bezos was able to accomplish over the past 25 years since he started it as an online bookseller. And look at what percent of their business now is selling books online like point 0001 percent or something. They are the leader in the cloud. Right? Microsoft quite a bit behind them, Prime is obviously. Prime video, they are doing all sorts of stuff. They make thousands, if not tens of thousands of products that they sell online. So highly diversified business that looks somewhat unstoppable here. And a trillion dollar market cap for Amazon or almost a trillion, I should say.

And that is it, ladies and gents, for Episode 51 of The Absolute Return Podcast. If you loved it, always check out more at www.absolutereturnpodcast.com. Definitely, follow us on Twitter, You can find me. I am the people’s hedge fund champion, or manager, one of them. My handle is at @Jklymochko, J-K-L-Y-M-O-C-H-K-O, and yours is?

Michael Kesslering: And I @M_kesslering.

Julian Klymochko: All right, great. Well, I wish you the best of luck in your trading, speculating and investing this week. So until next time, we’ll chat with you soon.

Thanks for tuning in to the Absolute Return Podcast. This episode was brought to you by Accelerate Financial Technologies. Accelerate, because performance matters. Find out more at www.AccelerateShares.com. The views expressed in this podcast to the personal views of the participants and do not reflect the views of Accelerate. No aspect of this podcast constitutes investment legal or tax advice. Opinions expressed in this podcast should not be viewed as a recommendation or solicitation of an offer to buy or sell any securities or investment strategies. The information and opinions in this podcast are based on current market conditions and may fluctuate and change in the future. No representation or warranty expressed or implied is made on behalf of Accelerate as to the accuracy or completeness of the information contained in this podcast. Accelerate does not accept any liability for any direct indirect or consequential loss or damage suffered by any person as a result relying on all or any part of this podcast and any liability is expressly disclaimed.

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