Through the decades, Berkshire Hathaway (BRK.A) has shown an attraction towards newspapers. First, Sun Newspapers were purchased in 1968 (Sun would famously win a Pulitzer for its reporting of financial mismanagement at Boys Town) from Stan Lipsey. Then, in the summer of 1973, Berkshire paid about $10,600,000 for roughly 10% of The Washington Post Company (WPO).
Finally, in 1977, Blue Chip Stamps (subsequently merged into Berkshire) purchased The Buffalo Evening News for $34,000,000 and Stan Lipsey was the man placed in charge of the newspaper. Shortly thereafter, Charles Munger, Berkshire's Vice Chairman, approached Stan Lipsey about a legal newspaper in Los Angeles called The Daily Journal (DJCO). Lipsey investigated the paper and told Munger that the paper was outdated and needed modernizing. Nevertheless, Munger bought the paper for $2,500,000 in 1977. He continues to be the Chairman and controls roughly 41% of the stock, while Gerald Salzman is the long time CEO.
The Daily Journal Corporation owns newspapers in California and Arizona, the magazine California Lawyer, and Sustain, which sells software to courts and justice agencies. As is the case with all newspapers, the business has plateaud and started to decline. As cash has been extracted from the business it has piled up on the balance sheet. Munger has been putting this cash to work as economic conditions have caused attractive security valuations.
"Two Fortune 200 Companies"
Since the first quarter of 2009 The Daily Journal's SEC filings have indicated that the company owns common stock in two Fortune 200 companies, declining to say which ones. The most recent 10-Q says the following:
In February 2009 the Company took advantage of near panic selling in the stock market and redeployed some of its cash, which had been invested in Treasury securities and was generating only nominal interest, to purchase common stock of two Fortune 200 companies and certain bonds of a third.
Many have speculated that the two Fortune 200 companies were Wells Fargo (WFC) and US Bancorp (USB) based upon the timing of the purchasing. Based upon the subsequent value of these holdings we can see that these are, in fact, the two companies that Daily Journal owns shares of. We can even determine the exact amount owned of each.
click to enlarge images
It is pretty apparent from the above chart that these two securities fit the bill and that the portfolio is dominated by Wells Fargo. In fact within a high degree of precision you can calculate based upon the shifting value that The Daily Journal owns 1,596,956 shares of Wells Fargo and 134,091 shares of US Bancorp. These securities were purchased for $15,501,000 in February 2009. The weighted average purchase prices were in all likelihood $8.87 for Wells Fargo and $9.91 for US Bancorp. Although not needed, this certainly confirms the impeccable investing skills of Munger as he picked the two banks up almost at the exact bottom of the financial crisis.
The Rest of the Portfolio
As of June 30, 2010, The Daily Journal Corporation had cash and equivalents of $4,475,000 and US Treasury Notes and Bills of $10,639,000. The company also held corporate debt of $6,954,00 and the above common stock with a value of $43,879,000. Pre-tax unrealized gains in these investments were $30,406,000 ($28,378,000 for the common stocks and $2,028,000 for the corporate debt). Using a corporate tax rate of 38% implies deferred taxes of $11,555,000. The net value, after subtracting deferred taxes, of the portfolio was $54,392,000 at the end of the last quarter.
The Underlying Business
You don't have to be a genius to understand that newspapers are declining at a rapid rate. Newspapers whose content is specialized, such as The Wall Street Journal, or legal newspapers such as The Daily Journal have held up better but are in no way immune to the irresistible force of demographics. One bright spot for The Daily Journal has been public notice advertising. As foreclosures subside, so will the advertising. In the meantime the company has been aggressively investing in the Sustain business, although it is difficult to say whether or not those investments will produce meaningful results. The chart below summarizes all of the publications that The Daily Journal owns as of the most recent 10-K, which was published on September 30, 2009.
For the trailing year, the company has posted revenue of $39,287,000 and operating income of $12,092,000.
Declining or not, the business continues to throw off a prodigious amount of cash. For the first nine months of the current fiscal year (through June 30, 2010) operating cash flow was $7,171,000 compared to $5,695,000 for the nine month period ending June 30, 2009. The 25.92% increase was largely driven by a decrease in Accounts Receivable compared to an increase the previous year.
Despite that fact, the cash flow margin of 25.22% and 18.79% are head and shoulders above larger peers. By way of comparison, Gannett's (GCI) operating cash flow margin for the preceding nine monhs was 16.63% and the New York Times was 9.90%. This was in spite of $1,639,000 of development expenses at Sustain. The company expects those expenses to continue through at least Fiscal 2011. If successful (if is always such a big word) Sustain could constitute an immensely profitable asset. If development expenses are removed from the previous two periods, pretax margins at Sustain would have been 36.43% and 44.70% respectively.
Of course some level of on going development expense should be expected, but one should not discount the prospects for Sustain. The company initially invested in Sustain when it purchased 80% of the company in January, 1999 for $6,670,000 and have subsequently purchased the remaining 20%. Currently, public notice advertising constitutes 59% of revenues and Sustain accounts for about 10%.
Consolidated results show a revenue decline of 6.19%, an operating profit decline of 4.03%, and a decline in net income of 1.96% (which was due to an increase in dividend and interest income from $463,000 to $655,000). All results are for the nine month period ending June 30, 2010.
After subtracting taxes trailing year profit from operations (not from any investments) was $7,497,000. I see no reason to complicate the valuation of the business. Although Sustain may surprise in the years to come, let us assume that the profitability of the business declines at a 5% rate for perpetuity. Using a 10% discount rate, a 15% capitalization rate is implied or a 6 2/3 multiple for the business. This implies a valuation of $49,980.
Below is a chart aggregrating together Daily Journal's financial history since 1994. The data for the year 2010 represents only the first nine months of the current fiscal year.
Putting the Two Pieces Together
As one steps back and views the company as a whole it is rather amazing to see that today close to half its value comes from the underlying business ($49,980,000) and half its value comes from its cash and securities ($54,392,000). The total implied value is $104,372,000 or $75.59 per share (there are 1,380,746 shares outstanding). The current price of $69.96 (as of August 13, 2010) is not much of a discount to this valuation.
While investors would likely want to wait for a better entry point to purchase shares, it would be wise to continue watching the company in order to see where the cash extracted from the newspaper business is ultimately invested and perhaps find a more attractive future valuation.
Disclosure: The author currently owns shares in The Daily Journal Corporation (DJCO).