Gabelli & Company’s Cash Flow

Question 2 a Valuation (Appendix x)

Assuming that the Gabelli & Company’ s cash flow forecast in exhibit 10 of the case for Newspaper division is reasonable, the Free cash flows for the next 5 years are positive and are going to keep their level between 19 and 21 mn USD (see our calculation in appendix x.)

Assuming that a 0.2 debt beta^[1] is representative to the newspaper’s industry, and considering that A.H. Belo and Gannet Co. to the Newspaper division being valued, we create a benchmark and calculate an industry unlevered beta of 1.599 using the Hamada’s formula. A.H. Belo is operating 4 daily newspapers and associated web sites, and Gannett Co. has daily and weekly community newspapers. Therefore they have been considered as relevant benchmarks to find out the Newspaper division’s risk.  

We want to point out that the Hamada formula gave us a more accurate approximation to calculate the industry unlevered beta as the method assumes that debt is risk free. In our valuation we assume no debt as the Berkshire’s purchase agreement involves only the assets of the Newspaper division.  As there is no debt the cost of equity is taken as a discount rate and it is calculated by the CAPM method.  We have taken the US. Treasury Yield of 10 years maturity as Risk free rate of the project.  10 years maturity is an acceptable rate as it covers the forecast made by Gabelli & Company, and it is close to the average of the 5,- 10,- and 30 years maturity US. treasury bonds.^[2] Finally, with a 6% market risk premium^[3] we get a cost of equity of 11.4%. (see appendix x)

Based on the Discounted Cash Flow method and the Gordon Growth model we calculate the Net Present Value and the Terminal Value of the Newspaper division. The NPV of the 5 years planning period (2012-2016) is  77 mn USD and the Terminal Value is 109 mn USD, assuming a 1% growth rate. We have considered a conservative revenue growth rate supposing that the trend of the forecasted revenue growth rate in Exhibit 10 is reliable and that the business strategy is going to change in order to keep at least a 1% revenue growth rate for the long term. (See appendix x)

Assuming that the penny warrants are exercised immediately, we find a value increase of 14.55 mn USD. This intrinsic value is calculated from the total number of shares involved (4.65 mn), at 3.14 USD per share, and an exercised value of 1 cent each (see appendix x for calculation).

Finally, adding up the Net Present Value, the Terminal Value and the Penny Warrants’ exercise and subtracting the 30 mn USD value of The Tampa Tribune we arrive to a final valuation of 171 mn USD.

Assumptions appendix x

Question 2 b Sensitivity analysis

1. Cash Flow Forecast assumptions ( exhibit 10 of the case)

The Gabelli & Company forecast includes a negative perspective for revenues growth in the first two years of forecast (2012 and 2013). Nevertheless they are forecasting a 2% growth in their sales revenue between 2013 and 2016. On average they expect to recover by the end of 2016 the decrease on sales incurred in 2012 and 2013. This is reflected in the average of the growth rate for the five forecasted years (0.05%). It seems reasonable as the business model is expected to be changed; it is reflected in the revenue increase starting from 2014, and in the decrease of the operating costs reflected in the EBIT increase (125%) from 2011 to 2012, in spite of the negative revenues growth. Forecast sees it possible to keep the CAPEX and the WC constant in spite of the fall in revenues. It could be reflected in the increase (the more negative value) of the depreciation from 2012. It can be expected that the increase in CAPEX and decrease in OPEX may be caused by the change in the principal business strategy (i.e. migration from the newspaper edition to the digital edition).