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MAX CAPITAL CORPORATION/FUTUREBLIND.COM

DECEMBER 12, 2006 1

Warren Buffett and close friend Katherine Graham,chairman of the Washington Post from 1973 to 1991.

WARREN BUFFETT &

THE WASHINGTON POSTBY MAX OLSON

here is no question that WarrenBuffett is one of the greatest inves-tors of all time. To study his investmentmethods, there are the Berkshire Hatha-

way annual letters, biographies, and do-zens of other books written on the sub-

ject of value investing. But, Buffetts spe-cific investments are rarely examined

within the context of the time he madethe purchaseand without the benefitof hindsight. To more fully understandBuffetts past successes, reverse engi-neering his purchases is essential. One

investment in particular interested me,both because I like the business and be-cause it is one of the only investmentsBuffett made where he disclosed an es-timate of intrinsic value. That business is

The Washington Post Company.

BACKGROUND

uffett began acquiring shares of theWashington Post in early 1973, and

by the end of the year held over 10 per-cent of the non-controlling B shares.

After multiple meetings with KatherineGraham (the companys Chairman andCEO), he joined the Posts board in thefall of 1974.

According to Buffetts 1984 speech TheSuperinvestors of Graham-and-Doddsville,in 1973, Mr. Market was offering to sellthe Post for $80 million. Buffett alsomentioned that you could have soldthe (Posts) assets to any one of ten buy-ers for not less than $400 million, proba-bly appreciably more. How did Buffett

come to this value? What assumptionsdid he make when looking at the futureof the company? Note: All numbers anddetails in this article are from the 1971and 1972 annual reports and Buffett:

The Making of an American Capital-ist by Roger Lowenstein.

ANALYSIS

he purpose of this exercise is to re-verse engineer Buffetts analysis of

the Washington Post Companyin oth-

er words, to construct a reasonable analy-

sis given the facts as of 1973 that willlead us to the same conclusion Buffettarrived at. Before I began my research, Ithought it would take much longer tocome to a conclusion than it actuallydid. After reading the annual reports anddoing some outside research on the com-pany and its history, I had a pretty goodfeel for how the business worked.

In 1973, the Washington Post Com-pany consisted of three distinct segments:the flagship newspaper, Newsweek mag-

azine, and five television/radio stations.The Washington Post (like most otherlocal papers at this time) had a strong,durable competitive advantage that wascertain to increase in the future. The pa-per had a dominant share of the Wash-ington D.C. market. But, despite itscommanding market share, the businessside was flagging. As a business, The

Washington Post was underperformingother major metropolitan dailies.

Newsweek also had competitive ad-vantagesthough they were not as great

as those enjoyed by a dominant big city

newspaper. At the time, Newsweek helda 30% share of the readership contestedby the three leading news magazines. In1973, the Posts other operating segment,network-affiliated TV stations, had ex-tremely high barriers to entry due to gov-ernment regulation. As a result, profitmargins at these stations were quite ro-bust.

From 1971 to 1972, the WashingtonPost Companys total revenue grew a lit-tle over 13 percent. Advertising revenue

in the newspaper segment had grownalmost 20 percent while magazine adsales grew 8 percent. Pre-tax marginsimproved from 8 percent in 1971 toabout 10 percent in 1972. These wereboth about 1 to 2 percent lower thantheir average in prior years. According toLowensteins book, the Posts margins

were significantly lower than those ofmost other big city newspapers in theearly 1970s.

Because of the relative steadiness ofthe Posts operations, I attempted to es-

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timate the future cash flows adjusting forgrowth, margins, and return on capital. Itried to use reasonable assumptions thatBuffett might have made at the time. Itried, as best I could, to prevent myknowledge of the companys post-1973performance from contaminating mythinking.

I assumed top-line (sales) growth of

12 percent for the next five years, 8 per-cent for the five years after that, and 4percent in perpetuity. I thought there

was a good chance margins would im-prove (at that time Katherine Grahambegan to focus her attention on improv-ing operations); so, I also assumed after-tax margins went up 2 percent overthese years. This would push the compa-nys after-tax return on invested capital to25 percent, which I used as the incre-mental return on capital in perpetuity. Inother words, for every dollar of reinvest-

ment in the future (4 percent per year),the Washington Post Company wouldearn a 25 percent profit.

After performing the discounted cashflow calculation, I came up with an equi-ty value of about $380 million using a 10percent required rate of return. Withoutmessing around with the inputs toomuch, this was fairly close to Buffetts$400 million figure. Judging by the bal-ance sheet alone, the companys book val-

ue and approximate replacement cost were$80 million and $100 million respective-ly. This means that when Buffett madehis purchase of the Washington PostCompany, Berkshire was paying no morethan 100 to 125 percent of book valueand less than replacement value for agrowing company with a large moat toprotect its profits. This low purchase

price was Buffetts margin of safety.The Washington Posts franchise andgrowth value alone was almost $300 mil-lion, more than triple the price of thestock. Even if I lowered my assumptionsto be more conservative, the value of thebusiness comes nowhere near as low asthe price the stock was selling for.

CONCLUSION

he importance of sustainable com-petitive advantages (large moat)

played a major role in the value of thisinvestment. However, the above-averagestock performance was made possible bythe bargain price that Buffett paid. If it

wasnt for the extreme market irrational-ity at the time, Buffett wouldnt have hadthe opportunity to buy such a great busi-ness at such a great price. Mr. Market

was in a terrible mood and Buffett usedthat to his advantage.

So, what was Buffetts rate of return

on his investment in the WashingtonPost Company? Using my estimated cashflows, the approximate annual rate of re-turn after an eleven-year holding period

would have been 28 percent. Accordingto Lowensteins book, Berkshires original$10 million investment from 1974 hadgrown to $205 million in 1985, for anannual return of 32 percent. In other

words, my guess was fairly close. Duringthis time, Buffett had convinced the Postto buy back almost 40 percent of sharesoutstanding; these purchases (at under-

valued prices) substantially enhanced re-turns. Over the same 11-year period, theS&P 500 returned 16 percent includingdividends.

I will end this article with two relevantquotes from Buffetts 1984 speech:

[On beta] I have never been able to figureout why its riskier to buy $400 million worthof properties for $40 million than $80 million.

And, as a matter of fact, if you buy a group ofsuch securities and you know anything at allabout business valuation, there is essentially norisk in buying $400 million for $80 million,particularly if you do it by buying ten $40 mil-lion piles of $8 million each.

[On margin of safety] You dont try andbuy businesses worth $83 million for $80 mil-lion. You leave yourself an enormous margin.

When you build a bridge, you insist it can carry30,000 pounds, but you only drive 10,000pound trucks across it. And that same principle

works in investing.

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