Buffett’s bid for MEG Harvard Case Solution & Analysis

An asset purchase agreement involving the acquisition of MEG’s newspaper division for $142 million.

            Buffett is under consideration to acquire 63 newspapers of MEG at a price of $142 million. Buffett has also considered providing a loan of $354 million to MEG on the terms that are discussed in detail in the evaluation of the agreement part of this report. The valuation of the company is based on the free cash flow valuation model to forecast the right price of the 63 newspapers of MEG. In this deal, Buffett is going to acquire all the divisions of MEG except for Tampa Tribune that represents 18% of the total value of MEG.

            MEG group is suffering losses and its decline in the market share due to the availability of cheaper and advanced substitutes. The best substitute is internet and television that use to transfer the news quickly with any extra cost to the customer, therefore the customers are unwilling to read the newspaper that contain last day breaking news. The industry has declined, however, many of the people read newspapers because they can have all the news of last day together, therefore any news missed out can be read.

Projected free cash flows and assumptions:

            The annual free cash flows are derived with the help of earnings before interest and tax (EBIT), the starting point for free cash flow calculation is this. After starting with EBIT, a tax expense is deducted because tax is a cash expense and it is charged on EBIT because tax saving on interest is absorbed in WACC calculation. The depreciation expense must be added back to the profits because it is non cash item and the depreciation expense is given in exhibit 10. The capital expenditure is deducted from the figure net figure because it is the amount of expense that is required for improvement and expansion in property plant and equipment that is also given in exhibit 10.

            The change in working capital must be adjusted at the end and the annual free cash flows are derived from the addition and deduction of the above specified items. At the end a terminal value is derived through perpetuity formula and in this case the terminal value is valid for the year end value of 2016. It is assumed that after 2016 there is no growth in the real cash inflows because the sales amount increase with the rate of inflation but not more than that. The inflation rate is adjustable in the cost, therefore its effect is nil. The growth rate is zero and the terminal value is derived through perpetuity formula at the end of 2016 with 2016 free cash flows (Appendix 3).

            The net values from 2012 through 2016 are discounted at the weighted average cost of capital (WACC) that is required, return of all the investors of the company and it is derived from the weightages of cost of capital and cost of debt. In this case, the targeted debt ratio is 25% of the total value and 75% of equity. This is derived from the interest coverage ratio that is four times more.

            To calculate cost of equity, it is necessary to have beta equity, risk free rate of interest and the market risk premium. In this case, the risk free rate is 2.9%, market risk premium is 4% and beta equity in the company is 1.51 that the derived cost of equity equals to 9.0% (Appendix 2). The cost of debt for the bond with rating CCC+ is 10.26%. The WACC is 9.15% through the weightages and rates of cost of equity and cost of debt.

            The total value of MEG is around $217 million, including the Tampa Tribune (Appendix 3).

The value of the Tampa Tribune:

            The value of Tampa is considered to be 18% of the total value of MEG. The value of Tampa Tribune is although 18%, but its market share is higher than that. This is why the MEG group has decided to retain the division with it. The value of this division is around $39 million (Appendix 3). The group market shares are higher than its value therefore the division seems to be profitable for MEG...........

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