GHC - Graham Holdings

[accutronman]

Interesting article in today's NY Times on Graham Holdings which is what remains of the old Washington Post holdings after the sale of the Post.

 

The thing that caught my eye was the following:

 

"While Mr. Graham declined to be interviewed for this article, business

associates and analysts say that he has focused on reshaping his company

based on the philosophy of Warren E. Buffett, a longtime friend and

former board member of The Post. Even though Mr. Buffett recently sold

his $1.1 billion stake in Graham Holdings in exchange for one of the

company’s television stations, he still advises Mr. Graham and even hosted

Mr. Graham’s top executives in Omaha for their annual meeting in March.

 

Under Mr. Buffett’s tutelage, Mr. Graham has added several

unglamorous but profitable businesses to his portfolio, companies from

outside the realms of media and education. They include a screw jack

manufacturer in Ohio and a home health care business in Michigan. Some

followers of Graham Holdings say that Mr. Graham is so devoted to Mr.

Buffett’s investment advice he follows it more rigorously than Mr. Buffett

does himself."

 

[gfp]

I've been watching GHC closely lately as well.  If you read the filings it sounds word for word early Berkshire.  The share count just went way down and it sounds like he's about to get another $75 million or so from Cars.com.  Interestingly, Don Graham was absurdly close to a major early Facebook investment - too bad!

[accutronman]

Based upon owning 16.7% of cars.com and a total valuation of $2.5B, Graham should walk away with over $400M for the sale.

[gfp]

Oops!  I thought they owned 3% for some reason

[A_Hamilton]

How much in litigation liability does one associate with Kaplan Higher Ed?

[accutronman]

A.H. Belo owns 3.3%

[merkhet]

Looks like Graham Holdings is spinning off Cable ONE.

 

http://www.sec.gov/Archives/edgar/data/104889/000010488914000056/dex991.htm

 

Should be interesting.

[merkhet]

From Barron's

 

Here’s the math. The cable business could be worth $2.1 billion, or about seven times estimated 2014 Ebitda, or earnings before interest, taxes, depreciation and amortization. The tax-free spinoff of that business is expected in 2015. There’s a good chance the cable business, known as Cable One, mostly in small markets around the country, will become a takeover target in a consolidating industry. A buyer, such as Charter Communications, probably would seek a better deal on programming costs with content providers.

 

http://online.barrons.com/articles/graham-holdings-a-buy-but-big-gains-are-over-1415993827

 

Could be interesting if it comes out at a good price.

[Guest wellmont]

I've been watching GHC closely lately as well.  If you read the filings it sounds word for word early Berkshire.  The share count just went way down and it sounds like he's about to get another $75 million or so from Cars.com.  Interestingly, Don Graham was absurdly close to a major early Facebook investment - too bad!

 

Gross proceeds to the selling partners are $1.8 billion. Total proceeds to Graham Holdings, net of transaction costs, are $408.5 million, of which $16.5 million will be held in escrow until October 1, 2015. The Company will report a gain on the sale of its interest in CV in the fourth quarter of 2014.

[gfp]

Oops!  I thought they owned 3% for some reason

[Guest wellmont]

what will be interesting is how much debt they put on cable one. if they lever it up proceeds to $GHC could be around $1b or more. this move tells me they may do the same for kaplan and their remaining 5 tv stations. this could help monetize the over funded pension plan. not sure yet. but my hunch is that Graham might be loading up the balance sheet with cash for the next down cycle.  here is some capital allocation 101 for you. graham bought back the big chunk of stock BEFORE monetizing the assets. in hindsight that should have been a signal to me. :(

[magno111]

this is an excerpt of Q4 2014 coho capital  , there seem to be value. 1700-2000$ per share. Gabelli also mentioned a valuation around 2000$ at Barron's on 31 jan'15

 

We often find opportunities in companies undergoing transitions – see above. Graham Holdings (GHC), a consortium comprising education, cable TV, broadcast television and social media marketing is one such company. Until 2013 GHC was known as the Washington Post, a giant in the world of journalism. In 2013, the CEO of the company, Donald Graham, decided to sell its flagship newspaper to Jeff Bezos and thereafter the company became known as Graham Holdings.

 

The sale of the Washington Post was a watershed event for GHC. Despite the newspaper’s uneven profitability and challenging long-term trends it demanded a disproportionate share of management’s attention. After the sale, Mr. Graham began to remake GHC in the image of his long-term friend and role model, Warren Buffett, who previously served on GHC’s board of directors. Mr. Graham has continued to reshape GHC’s business through shedding non-core assets. In aggregate, GHC has raised over $1 billion dollars by selling real estate, stakes in online ventures, and cable wireless spectrum licenses.

 

One of Mr. Graham’s most significant transactions was a deal with Berkshire Hathaway in June of 2014 in which GHC retired 22% of its shares through acquiring Berkshire’s GHC holdings in exchange for cash, Berkshire stock and the Miami television station WPLG. We never want to be on the other side of a Warren Buffett transaction but given Buffett’s friendship with Graham, as well as Buffett’s long-term involvement with the Graham family, both professionally and personally, we view this exchange as a rare win-win deal. We should also note that GHC saved shareholders $250 million in federal and state taxes through the transaction.

 

GHC’s cable and broadcast television segments compose the bulk of the company’s value, but its education segment and social media marketing division could represent important components of value in the future. Each segment is described in detail below:

Cable TV Segment

 

GHC’s cable business, Cable ONE, is a collection of small market cable systems focused on less competitive rural areas in the South and the West. Cable ONE accounts for 23% of GHC’s sales and 46% of its profits. Cable ONE is competitively entrenched in its markets having established local economies of scale. Since Cable ONE has already constructed its infrastructure it can price services at a high enough level to earn an attractive return on capital yet low enough to keep competitors at bay – kind of sounds similar to the competitive dynamics in COT’s business.

 

Cable ONE has lost video subscribers to satellite but its broadband Internet service has served as a bulwark to help protect against subscriber losses. Even if you elect to cut your cable cord you still need an Internet connection to make your streaming service work. At present, Cable One installs 75% more new Internet customers each month than video customers. Without programming expenses, Internet customers have proven to be far more lucrative.

 

Unlike most cable operators Cable ONE has let returns on capital guide its decision making. By deferring the implementation of the latest equipment upgrades, Cable ONE has earned higher returns on capital than peers and has managed to generate positive cash flow in every year of existence except one.

 

Last November, GHC announced plans to spin off Cable ONE in 2015. As a bit player in a consolidating industry characterized by scale economics in account servicing and content costs, it makes no sense for Cable ONE to remain an independent entity. Given its home within GHC’s conglomerate structure, Cable ONE has always traded for a discount to its proper value. We expect this discount to close once the company trades independently later this year and would not be surprised to see Cable One scooped up by a larger competitor such as Charter Communications. An acquisition would yield significant cost synergies.

Broadcast TV Segment

 

GHC’s broadcast television unit consists of five major market television stations. The group is well run, has industry leading margins, and four of the stations are market leaders in local news. GHC’s broadcast television networks have a competitive moat given the FCC licenses and content partnerships with major networks required to operate. This provides GHC’s stations an oligopolistic position in their local markets, which is illustrated by the group’s lush 49% EBITDA margins. Broadcast television is responsible for 46% of GHC’s profits despite accounting for only 11% of company revenues.

 

Recent performance within the broadcast television segment has been impressive with revenue and operating income up 17% and 32% respectively through the first nine months of 2014. Revenues spiked last year due to the winter Olympics, increased political advertising and retransmission fees (the money TV stations receive from satellite and cable providers for the right to carry the company’s signal).

 

Broadcast television faces long-term challenges in viewership with increased competition for viewers from the Internet and streaming services. That said broadcast television has been resilient throughout the tectonic shift in the media landscape with local news, sports and political coverage playing important roles in viewing habits. Despite some erosion in viewer numbers, GHC’s broadcast television stations should continue to throw off tremendous cash flow with growth in retransmission fees providing a tailwind.

Education Segment

 

GHC’s Kaplan education division is its largest revenue producer responsible for 62% of the firm’s sales in 2013 and 14% of its profits. The division has been struggling for some time with more stringent regulations for online education providers weighing heavily on enrollment trends and profit margins. Many online education companies have been exposed under the new requirements and are no longer financially viable. We view Kaplan as one of the good actors in the online education space (a Senate report on the for-profit education space stated “Kaplan has also implemented the most significant reforms of any company examined.”) The industry shakeout should be healthy for both the business as well as potential students who will be able to choose from more reputable survivors. Perhaps paradoxically, an enhanced regulatory environment can sometimes result in structurally higher industry margins with tightened regulations serving as a barrier to entry for potential competitors.

 

Approximately 40% of Kaplan Education’s revenue is earned from abroad and consists of 20 businesses, with the largest revenue producers based in the U.K., Singapore and Australia. International growth has been robust with 9% sales growth through the first nine months of 2014. There is tremendous operating leverage within the business with 9% topline growth driving a 71% increase in profits through the first nine months of the year.

 

Kaplan Test Prep represents 13% of GHC’s Education division and is best known for its SAT classes. Apart from SAT prep, Kaplan Test Prep offers classes on graduate admissions tests as well as professional licensing exams. Kaplan Test Prep has an outstanding brand name within test prep providing the company some degree of pricing power. Pricing power has been eroding in recent years, however, due to stepped up competition from online providers.

 

At present, Kaplan is priced for permanent enrollment declines and depressed margins. EBITDA margins have nosedived 15% since 2010. We don’t expect a return to prior margins but expect some normalization to occur once industry headwinds subside. A recovery in growth and stabilization of margins could lead to significant upside in Kaplan’s valuation given the market’s dour assessment of for-profit education.

SocialCode Segment

 

SocialCode is a social media advertising and data analytics firm. Social media is reshaping the advertising industry with Facebook and Twitter reaching over 100 million people daily. SocialCode designs advertising campaigns to connect social media users with company brands. The company’s roster of clients includes 150 Fortune 500 firms. SocialCode has experienced explosive growth as of late with gross billings tripling through the first nine months of 2014.

 

GHC has not broken out SocialCode numbers separately but a recent article in the Washington Post helps highlight the potential value of the division. The article cites a venture capitalist who noted “SocialCode and Shift (competitor) are getting interest at very high multiples. SocialCode is considered one of the two premier partners for large, Fortune 500 companies looking for a social media strategy.”

 

Most important, the article shares some financial metrics that have heretofore not appeared in public, including SocialCode’s revenue at over $300 million and gross margins of 25%.

 

We think SocialCode could be a spinoff candidate with its dominant position and explosive growth sure to fetch a higher multiple as an independent entity than as a unit within a conglomerate structure.

Portfolio Holdings

 

GHC’s remaining assets include small manufacturing operations in combustion systems and screws as well as home healthcare management. The home healthcare segment in particular represents GHC’s historical preference for stable profit growers and is indicative of how we envision Mr. Graham deploying excess capital. Like Warren Buffet, Mr. Graham has focused his business purchases on competitively advantaged companies that can be held for the long-term. Similar to Buffet, Graham has shown a preference for decentralized management by leaving existing business leadership of acquired companies intact.

Balance Sheet

 

Many of GHC’s disposals of non-core assets were recent and thus do not yet appear on its balance sheet. Once fourth quarter results are released the balance sheet will show an additional $393 million in cash as a result of recently closed asset sales. GHC still has other real estate assets it can convert into cash, including seven acres of land along the Potomac River in the central business district of Alexandria, a six story office building in midtown Manhattan and a number of properties in Phoenix.

 

One of GHC’s most important stores of hidden value is its pension plan, which is overfunded by $1.2 billion dollars. This provides GHC unique currency in subsidizing future business ventures to grow book value.

Management

 

Apart from Mr. Graham who owns 20% of company shares, GHC is presided over by an all-star board of directors including Markel Chief Investment Officer Tom Gayner, Ronald Olson from the California law firm, Munger, Tolles and Olson LLP, IAC/Interactive Chairman Barry Diller, and Davis Select Advisors Chairman Chris Davis.

Valuation

 

To value GHC we use a sum of the parts approach.

 

For GHC’s broadcast television assets we apply a 12.1x multiple, in-line with industry peers, to a blend of 2015 and 2016 EBITDA. We utilize a blended EBITDA number to smooth out the revenue spike associated with the 2016 Olympics and election year advertising revenue. It is relevant to include this spike as elections and the Olympics provide a bump to revenue every two years. This equates to a valuation of $2.42 billion.

 

For Cable ONE, we assume the company will be valued at 8x 2016 EBITDA upon its spinoff, similar to recent transactions within the cable space. This equates to a value of $2.65 billion.

 

GHC’s education division is the trickiest segment to value. The higher education division has no doubt been impaired by the new regulatory environment but we believe Kaplan’s international and test prep divisions will remain strong competitors within their segments. For the higher education division, we assume EBITDA recovers to $65 million in 2016 and accord the company a 6x multiple, similar to peers, resulting in a valuation of $390 million. This assumes growth prospects and margins will recover somewhat but remain well below prior peaks. These are very draconian assumptions leaving plenty of upside in our model should results be more pleasing.

 

For Kaplan International, we assume a 2x 2014 price to sales multiple, relative to publicly traded comps in the international education space at 3.1x. This results in a value of $1.74 billion.

 

We believe Kaplan Test Prep will have to continue to offer price concessions to compete with online competitors. However, the company is the largest player and best known brand name in the space and its hybrid classroom/online offerings should help it maintain market share. At a conservative 6x EBITDA multiple we arrive at a value of $110 million.

 

Given SocialCode’s growth and leading position in one of the world’s most important and untapped advertising markets, we think a multiple of 15x gross profits is more than reasonable. Going off the revenues outlined in the recent Washington Post article and assuming top-line growth of 33% by 2016 equates to a value of $1.5 billion dollars.

 

For the balance sheet we add post tax cash receipts from recently completed transactions and assume anticipated real estate sales at below market “assessed value” designations. Next, we add expected cash flows for the fourth quarter and 2015 and net out existing debt and corporate overhead. This gives us a 2015 year end net cash balance of $1.36 billion.

 

Last, we think GHC will be able to utilize its overfunded pension for acquisition currency. There are no guarantees, however, so we apply a 40% discount for a value of $720 million.

 

Our sum of the parts analysis says GHC should be valued at $1,742 per share, 87% higher that GHC’s currently quoted price of $933.

 

Why Is It Cheap?

 

GHC is poorly understood for a variety of reasons. The company does not spend time on investor outreach and as a result has zero analyst coverage. The optics of the balance sheet screen poorly as a number of cash transactions have yet to hit the balance sheet and the overfunded pension is a hidden asset. In addition, GHC has a high stock price at $933 and thin trading liquidity with average daily volume of only 24 thousand. Most important, GHC is poorly understood. Up until the end of 2013 the company was primarily known for its flagship Washington Post newspaper and after its sale was primarily known for its education division. In reality, the company’s cable and television assets generate the majority of its profits, yet it is still valued like a newspaper.

Conclusion

 

GHC is a collection of structurally profitable assets managed by a shareholder focused management team intent on value creation through capital allocation. The company has a balance sheet loaded with cash and additional flexibility through its overfunded pension plan. GHC’s upcoming spinoff of Cable ONE should unlock value in the shares while significant optionality still exists through SocialCode and Kaplan Education. It is not often we can obtain a collection of safe assets, led by a shareholder friendly management team at a meaningful discount, but when we can we jump at the opportunity. We’re proud to make Graham Holdings part of Coho’s holdings.

[Liberty]

Will definitely be interesting to see if Charter picks this up. Maybe Liberty Broadband can be more directly part of that deal, with CHTR managing the asset? (Like Great Land)

[magno111]

Will definitely be interesting to see if Charter picks this up. Maybe Liberty Broadband can be more directly part of that deal, with CHTR managing the asset? (Like Great Land)

 

In oder to be a tax free spinoff it can't be bought in the first o second year ( I am not sure about time frame, but there is some time limitation...)

[dwy000]

Is the overfunded pension really an "asset" for the stockholders?  I'm not a pension expert by any means but I was under the impression that the what's in the pension is solely for the benefit of pensionholders and couldn't revert back to the company.  It just relieved them from the burden of future cash funding.  Maybe I'm wrong on that.

[magno111]

Is the overfunded pension really an "asset" for the stockholders?  I'm not a pension expert by any means but I was under the impression that the what's in the pension is solely for the benefit of pensionholders and couldn't revert back to the company.  It just relieved them from the burden of future cash funding.  Maybe I'm wrong on that.

 

well,  it gives me comfort in rates keep going down...

 

[Liberty]

I don't know much about this one, so forgive me if the question has an obvious answer..

 

Don Graham is 68 (afaik). Why does he all of a sudden wants to create his own mini-Berkshire? He's been close to Buffett all these years. What changed now? Was it just that the WaPo was taking all of his time, so he wanted to do it before, but couldn't?

[KJP]

Is the overfunded pension really an "asset" for the stockholders?  I'm not a pension expert by any means but I was under the impression that the what's in the pension is solely for the benefit of pensionholders and couldn't revert back to the company.  It just relieved them from the burden of future cash funding.  Maybe I'm wrong on that.

 

Graham Holdings has a defined benefit pension plan.  Upon termination of such a plan, an employer is entitled to any surplus assets so long as the plan documents provide for such a distribution.  See 29 U.S.C. 1344(d)(1); Hughes Aircraft Co v. Jacobson, 525 U.S. 432, 440-41 (1999);  Shepley v. New Coleman Holdings, Inc., 174 F.3d 65, 69-72 (2d Cir. 1999); Boost v. Chevron Corp., 36 F.3d 1308, 1315 (5th Cir. 1994).

[bookie71]

Also , over funded means no future liability.  Think of the 50 states, cities and businesses that are underfunded (Detroit is one)

[dwy000]

Is the overfunded pension really an "asset" for the stockholders?  I'm not a pension expert by any means but I was under the impression that the what's in the pension is solely for the benefit of pensionholders and couldn't revert back to the company.  It just relieved them from the burden of future cash funding.  Maybe I'm wrong on that.

 

Graham Holdings has a defined benefit pension plan.  Upon termination of such a plan, an employer is entitled to any surplus assets so long as the plan documents provide for such a distribution.  See 29 U.S.C. 1344(d)(1); Hughes Aircraft Co v. Jacobson, 525 U.S. 432, 440-41 (1999);  Shepley v. New Coleman Holdings, Inc., 174 F.3d 65, 69-72 (2d Cir. 1999); Boost v. Chevron Corp., 36 F.3d 1308, 1315 (5th Cir. 1994).

 

Ah, okay, thanks.  But assuming the plan isn't terminated, the company has no rights to the overfunding and the return from investing those overfunded assets can't accrue to the company itself - other than relief from furture funding requirements, right?

[thepupil]

Is the overfunded pension really an "asset" for the stockholders?  I'm not a pension expert by any means but I was under the impression that the what's in the pension is solely for the benefit of pensionholders and couldn't revert back to the company.  It just relieved them from the burden of future cash funding.  Maybe I'm wrong on that.

 

the most efficient way of monetizing an overfunded pension is to merge with a company that has an underfunded pension; that gets you the most value because there are no tax inefficiencies.

 

Otherwise there is some sort of excise tax for taking out the excess.

 

It is an asset, but there may be a large discount warranted (unless they can find a suitable company with an underfunded pension with which to merge).

 

http://www.taxpolicycenter.org/taxtopics/encyclopedia/pensions.cfm

 

However, when an employer terminates an overfunded defined benefit plan and surplus plan assets revert to the employer, those assets are taxed at the corporate income tax rate plus an excise tax of 20 percent. The excise tax rate is increased to 50 percent unless the employer transfers part of the excess assets to a replacement plan or provides a benefit increase under the terminating plan. This tax discourages firms from terminating overfunded defined benefit plans.

 

http://www.automatedpensions.com/edu/perspective.aspx?action=view&page=plan%20educator:OverfundedDefinedBenefitPlans

 

While it is permissible for the excess assets in a plan to revert to the employer after a Terminated Plan has paid out all its benefit obligations, Congress has seen fit to impose a confiscatory tax scheme of 90% or greater on such reversions (see 4980 Excise Tax discussion). Specifically, a 50% non-deductible excise tax applies to a direct reversion in addition to ordinary income taxes that apply.

 

 

 

 

[vinod1]

I don't know much about this one, so forgive me if the question has an obvious answer..

 

Don Graham is 68 (afaik). Why does he all of a sudden wants to create his own mini-Berkshire? He's been close to Buffett all these years. What changed now? Was it just that the WaPo was taking all of his time, so he wanted to do it before, but couldn't?

 

Good point Liberty.

 

I was scratching my head about the same thing. I would think that if he had this inclination we would have seen some portfolio activity even while Wash Post was in the fold.

 

Vinod

[netnet]

I don't know him personally, but having grown up in the DC area, I always had the impression that he did not do the normal things; he would "try" on roles instead of being just a rich kid heir.  He volunteered to go to Vietnam, which one could understand as a rich kid with the Graham, noblesse oblige.  But he also was a cop, a patrolman even, in one of the worst parts of Washington, D.C. I still wonder about that one.  Remember how his mother, blossomed under WEB's tutelage. Clearly until sold, he was obsessed with the paper, wouldn't you be? Family legacy, one of the top papers in the country, etc.

[KJP]

Is the overfunded pension really an "asset" for the stockholders?  I'm not a pension expert by any means but I was under the impression that the what's in the pension is solely for the benefit of pensionholders and couldn't revert back to the company.  It just relieved them from the burden of future cash funding.  Maybe I'm wrong on that.

 

the most efficient way of monetizing an overfunded pension is to merge with a company that has an underfunded pension; that gets you the most value because there are no tax inefficiencies.

 

Otherwise there is some sort of excise tax for taking out the excess.

 

It is an asset, but there may be a large discount warranted (unless they can find a suitable company with an underfunded pension with which to merge).

 

http://www.taxpolicycenter.org/taxtopics/encyclopedia/pensions.cfm

 

However, when an employer terminates an overfunded defined benefit plan and surplus plan assets revert to the employer, those assets are taxed at the corporate income tax rate plus an excise tax of 20 percent. The excise tax rate is increased to 50 percent unless the employer transfers part of the excess assets to a replacement plan or provides a benefit increase under the terminating plan. This tax discourages firms from terminating overfunded defined benefit plans.

 

http://www.automatedpensions.com/edu/perspective.aspx?action=view&page=plan%20educator:OverfundedDefinedBenefitPlans

 

While it is permissible for the excess assets in a plan to revert to the employer after a Terminated Plan has paid out all its benefit obligations, Congress has seen fit to impose a confiscatory tax scheme of 90% or greater on such reversions (see 4980 Excise Tax discussion). Specifically, a 50% non-deductible excise tax applies to a direct reversion in addition to ordinary income taxes that apply.

 

This is very good to know.  Thanks for the links.

[valueinvesting101]

Did Graham holding own Berkshire stock that was swapped in pension asset? Since they were able to reduce share count in that swap, it seems like Pension assets can be used for all shareholders may be in only in certain circumstances.