01 November 2005

A Cheap $750 Media Stock?

No, Google didn't double in price overnight, although it's climbing towards $400. Pigeon-holing GOOG as a media stock is narrow-minded. And I would never ever ever call Google cheap.

However, I think I stumbled across a cheap $750 media stock this morning while perusing the Morningstar homepage.

Washington Post Company WPO
Business Risk: Below Average
Economic Moat: Wide
Media analyst James Walden thinks Washington Post's ROICs should be greater than 25% (excluding goodwill) for the next few years, thanks to its recent investments in cable and education businesses. Washington Post also has a unique corporate culture that stresses long-term results, an important sign of an economic moat. From the Analyst Report: "Washington Post is best known for its flagship newspaper and Newsweek magazine. Perhaps less well-known is that the company also owns and operates several TV stations, which normally throw off loads of cash thanks to operating margins that approach 50% during election years. Beyond its solid line of businesses, one of Washington Post's greatest assets is its management. The executive team continually emphasizes long-term improvement over quarterly forecasts."

Here's a company profile from Marketwatch.com:

Washington Post Co. The Group's principal activities are to publish newspapers (principally the Washington Post), broadcast television, own and operate cable television systems, publish magazine (Newsweek magazine) and to provide educational and career development services. The Group publishes 'The Washington Post', a morning and Sunday newspaper and The Washington Post National Weekly Edition. The Magazine publishing segment publishes Newsweek, a weekly magazine. Through its subsidiaries, the Group owns six VHF television stations. The Group provides an extensive range of educational services for children, students and professionals through its subsidiary, Kaplan Inc. In Feb-2004, the Group acquired Texas School of Business.

But isn't old media withering? The sector has been battered by Wall Street, with WPO pretty much tracking the industry's decline. Newspapers are old-fashioned, their aged readership expiring daily. The future's in the intarweb, online, in blogs.

Geez. I hope not. I like my old media (though generally in its online form) as much as my new media.

The Washington Post is a top-quality almost-the-paper-of-record. The burning bloggy spotlight focused on undermining and criticizing the New York Times seems to leave the WaPo alone. That's gotta be a good thing.

Kaplan provides test preparation services, as well as increasingly prevalent online education and degrees. Instinctively, these seem like growing, high-margin businesses that are in no danger of disappearing. The competition for admission to colleges, graduate schools, even high schools, isn't going to subside anytime soon. Kaplan has a strong brand. I bet it contributes significantly to WPO's cash flow.

Enough with my liberal-artsy thoughts, feelings, and conjecture about WPO. Let's look at some cold hard numbers (that can be manipulated, fudged, and massaged by green shade-wearing CPA's as well as by your FCF-model-wielding blogger):

According to Smartmoney.com, WPO's current ROIC is 11.80%. That's higher than its competitors, SSP (11.54%), GCI (9.81%), KRI (10.60%), and TRB (6.91%), but is lagging NYT (15.72%). Morningstar must be measuring ROIC a bit different than Smartmoney to come up with its ROIC.

Nevertheless, whether WPO is getting almost twelve cents on every dollar it puts into the business, or more than a quarter on every dollar, these are quality results.

So this leads me to a down-and-dirty DFCF model for WPO to see what kind of on-the-spot valuation I can put on their stock.

I used the following information, grabbed from Morningstar.com, Marketwatch.com, and my head:
Share Price = $748.25
Outstanding Shares = 9.59M
Perpetuity Growth Rate (g) = 3%
Discount Rate (R) = 10%
Current FCF = $315.3M
Average FCF Growth Rate over Past 5 Years = 39.5%

Mixing all these numbers in a smoking cauldron left over from Halloween, I came up with a DFCF value of $3736.26 per share of WPO, almost five times the current share price. I admit the Average FCF Growth Rate of 39.5% is a little generous, but that's how my calculations played out. No matter, the professionals at Morningstar say that WPO is currently trading at below their fair value estimate, i.e. it's bargain at $750.

UPDATE. I missed a step on my DFCF model. I neglected to add in the sum of the DFCFs. The correct model comes up with $4824.54 per share of WPO. Now the FCF growth rate looks really high.

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