Warren Buffett’s annual shareholder letter is always a major event at Burgundy and this year was no exception. The release of the letter on March 1st, a Friday afternoon, meant that many of us spent our weekend parsing Buffett’s every word and examining every one of his investment ideas. We wouldn’t have it any other way. For all his 82 years, Buffett shows no sign of slowing down. He’s still in the game and still relevant, which makes us extremely curious and attentive to his views on investing.
While we encourage all students of the value investing discipline to read the original letter in its entirety, we bring attention to the section entitled “We buy some newspapers…newspapers?” This section serves as a case study for contrarian thinking and value investing in action.
Buffett begins by acknowledging an apparent contradiction. He predicts that “circulation, advertising and profits of the newspaper industry overall are certain to decline,” and yet Berkshire Hathaway acquired 28 daily newspapers at a cost of US$344 million over the past 15 months. One would be forgiven for asking the obvious: if newspaper industry profits are certain to decline, why invest in 28 dailies? Here are some insights.
1. All businesses in an industry may not be created equal.
Traditionally, newspaper businesses benefited from a “virtuous circle,” in which newspapers were the “primary” source of news, whether that news was international, national, or local in flavour. The lack of competition from alternate news sources almost guaranteed a high and predictable readership. This led to strong advertising revenues and extraordinary profits, “whether it was managed well or poorly,” but especially when newspapers had a monopoly position over the region (which inevitably was the case).
The competitive landscape of the newspaper industry changed with the emergence of alternate media sources. Today, people turn to their television or the Internet for more efficient access to information, which has led to a decline in newspaper readership and predictability, and thus falling advertising revenues. Profits are no longer inevitable.
However, there is one newspaper business model that has retained its competitive edge. Specifically, the 28 newspapers Berkshire acquired are involved in the business of delivering local news, “whether the news is about the mayor or taxes or high school football.” Buffett’s thesis relies on the fact that, unlike national and international news, there is no substitute media source for local news. It’s a less competitive business that guarantees readership and therefore advertising revenues – a business model that repeats and echoes the “virtuous circle” of the industry’s early days.
2. Attractive business models provide opportunities to grow shareholder returns in the long term.
Buffett recognizes that traditional newspapers such as The Wall Street Journal have moved (or are in the process of moving) towards online “pay models” or paywalls, in which Internet users are unable to access news content without a paid subscription. While Buffett admits that the viability of this model is not yet clear, he provides the example of the local Arkansas Democrat-Gazette, which “adopted a pay format early, and over the past decade…has retained its circulation far better than any other large paper in the country.”
Buffett recognizes a tremendous opportunity for growth for local newspaper businesses – over and above the stability of the local readership base – should the online pay model turn out to be a “sensible Internet strategy.” This is because only a few local papers have explored online pay models over the past year, and “whatever works best – although the answer is not yet clear – will be copied widely.”
3. Price is important.
Buffett is very clear to identify purchase price, or the cost of US$344 million for 28 daily newspapers, as an important part of Berkshire’s investment decision. Buying local newspaper businesses at a discount to intrinsic value provides Berkshire with a meaningful margin of safety for the investment, especially since “Berkshire’s cash earnings from its papers will almost certainly trend downward over time.” In his words: “at our cost…I believe these papers will meet or exceed our economic test for acquisitions. Results to date support that belief.”
Buffett mitigates the earnings risk inherent in local newspapers by acquiring the businesses at a purchase price that more than compensates for this risk. While Buffett indicates that Berkshire may “purchase more papers of the type we like,” which is an assessment of quality, he qualifies the statement by saying that these businesses will only be acquired at “appropriate prices – and that means at a very low multiple of current earnings.”
The integral components of an investment decision-making process include a bottom-up assessment of the economics of a business within its competitive landscape, an understanding of the opportunities for growth and a discipline around purchase price. At Burgundy, we continue to apply Buffett’s lessons each day to our investment decision-making process.