Are Newspapers Dead at Lee Enterprises?

Lee Enterprises (NYSE: LEE) has taken on a job that Warren Buffett believes is impossible. Lee is trying to save American newspapers from technology, economics, and changing behavior.

Berkshire Hathaway (NYSE: BRK.A) is selling all of its newspapers to Lee Enterprises for $140 million, The Washington Post reports. Berkshire’s exit marks the end of an era because Buffett has been in the newspaper business for 50 years.

Buffett bought his first paper in Omaha in 1969 and joined the Washington Post’s board of directors in 1976, The Buffalo News reveals. Berkshire Hathaway (NYSE: BRK.B) bought The Buffalo News in 1977.

“We had zero interest in selling the group to anyone else for one simple reason: We believe that Lee is best positioned to manage through the industry’s challenges,” Buffett claims in a press release. “No organization is more committed to serving the vital role of high-quality local news, however delivered, as Lee.”

Berkshire Hathaway Makes Money from Dying Newspapers

Buffett has some faith in Lee Enterprises. Berkshire Hathaway will loan Lee $576 million and refinance $400 million in Lee Enterprises’ debt, PitchBook reports.

Thus, Buffett walks away from the newspaper business with $140 million in cash, and the potential to make another $976 million. I think this deal shows why Buffett is one of the smartest investors around. To explain, Buffett turned a money-losing asset; newspapers, into cash and the potential to make more money.

To clarify, Berkshire Hathaway makes some money $140 million up front. Additionally, Berkshire can make more money if Lee Enterprises figures out how to turn the papers around. If Lee Enterprises fails, Uncle Warren still pockets $140 million, and gets a $576 tax write off.

Thus, this deal shows Buffett is still a great businessman and deal maker. However, it does not tell us if newspapers are a viable business.

What Value do Newspapers Have?

Mr. Market has no faith in either Lee Enterprises or the newspapers. For instance, Mr. Market priced Lee Enterprises (NYSE: LEE) at $2.21 on 3 February 2020.

Mr. Market has no faith in either Lee Enterprises or the newspapers. For instance, Mr. Market priced Lee Enterprises (NYSE: LEE) at $2.21 on 3 February 2020.

Back in the 1980s, I think Lee could have received a $100 billion valuation from such a portfolio. Today, Lee’s Market Cap is less than the cash Lee is paying Buffett for the newspapers.

Lee’s portfolio of 49 daily newspapers includes historic publications including The St. Louis Post-Dispatch and The Casper Star-Telegram. Legendary press baron Joseph Pulitzer got his start at The St. Louis Post-Dispatch.

Is Lee Enterprises making money?

Lee Enterprises (NYSE: LEE) financial numbers show why Buffett is leaving newspapers. Lee’s revenues and gross profits are shrinking fast.

For instance, Lee Enterprises reported a quarterly gross profit of $76.18 million on 30 September 2019. That gross profit was down from $76.68 million on 30 June 2019 and $83.11 million on 30 September 2018.

Lee’s revenues are shrinking dramatically. For example, Lee reported quarterly revenues of $139.75 million on 30 September 2018; that gross profit fell to $127.28 million on 30 June 2019, and $123.67 million on 30 September 2019.

Stockrow estimates Lee Enterprises’ revenue growth fell for five straight quarters. In fact, Stockrow estimates Lee Enterprises revenues shrank by 11.51% in the quarter ending on 30 September 2019.

Consequently, Lee Enterprises reported an operating income of $14.41 million and a common net income of $82,000 on 30 September 2019. Thus, Lee Enterprises is making pennies on the dollar from its newspapers.

Predictably, Lee Enterprises’ newspapers are burning cash rather than generating it. For instance, Lee reported a negative ending cash flow of -$4.87 million and an operating cash flow of $13.89 million on 30 September 2019.

What Value does Lee Enterprises Have?

Currently, I think Lee Enterprises has no value. For instance, Lee Enterprises had $8.64 million in cash and short-term investments on 30 September 2019.

However, Lee had $555.20 million in Total Assets, non-current assets of $494.9 million, and a $60.30 million in total current assets on 30 September 2019. Therefore, I think Lee Enterprises’ real estate and physical property is worth more than its business.

Buffett is tapping that value by loaning Lee Enterprises’ money. To explain, Lee Enterprises can mortgage or sell newspaper offices and printing plants to get the money to pay Uncle Warren.

However, Berkshire Hathaway will keep its newspapers real estate and lease it to Lee for 10 years, The Washington Post reports. Hence, Buffett keeps the valuable assets at Lee and unloads the money losing newspapers.

Lee has identified $20 million to $25 million in cost synergies at the Berkshire newspapers. I think cost synergies is a euphemism for cutbacks and job killing.

How Newspapers Survive

American newspapers are collapsing because their revenue is disappearing. PEN estimates U.S. newspapers lost over $35 billion in ad revenue between 2005 and 2019.*

As a result, newspapers have eliminated 47% of newsroom jobs, PEN claims. In addition, over 1,800 newspapers or 20% of U.S. newspapers have died since 2004.

PEN estimates there are around 1,000 “ghost” or zombie newspapers in America. To explain, a zombie newspaper employees no journalists and publishes no local or original news. Instead, a ghost newspaper publishes advertising, wire-service stories, and press releases.

Ghost Newspapers and Zombie Advertisers

Ghost newspapers survive because of zombie subscribers and zombie advertisers.

 Zombie subscribers are those people who subscribe to the newspaper no matter what it publishes. I think some people will subscribe if the paper publishes only the scripts of old Andrew Dice Clay comedy routines.

Meanwhile, zombie advertisers are legally or morally obligated to buy advertising. For example, states have laws requiring local governments to publish legal notices and publish advertisements in the local paper.

Those laws publication even if the paper has no subscribers. Other zombie advertisers include businesspeople who feel obligated to support the local paper.

How Low Interest Rates Keep Newspapers Alive

Zombie advertisers and subscriptions provide just enough revenue to keep the newspaper running. However, zombie advertising and subscriptions do not generate enough revenue to support a functional newsroom.

A related problem is that newspaper operators have to borrow money to finance their operations. Presently, debt is cheap for newspapers because of low interest rates. Notably, the Federal Reserve Open Markets Committee voted to keep interest rates at 1.5% to 1.175% in January 2020, The Week notes.

Low interest rates make debt cheap which keeps newspapers operating. Consequently, I predict we will see many newspapers go out of business if interest rates rises and debt costs increase.

Newspapers could face a real crisis if the Federal Reserve gets new leadership that believes higher interest rates are necessary. Notably, Federal Reserve Board of Governors opposed interest rate cuts in the past. However, the Fed’s Open Market Committee unanimously supported keeping interest rates low on 29 January 2020, CNBC reports.

Yes, Newspapers are Doomed

I think the present advertising market dooms newspapers. Therefore, investors need to avoid Lee Enterprises (NYSE: LEE).

However, I think the Lee deal shows why Berkshire Hathaway (NYSE: BRK.B) is a great investment. The newspaper sale shows Berkshire can make money from horrible businesses such as newspapers.

Notably, Berkshire Hathaway reported a quarterly gross profit of $50.23 billion on revenues of $64.972 billion on 30 September 2019. Thus, I think anybody who wants a stock with a high margin of safety needs to consider buying Berkshire Hathaway.

Meanwhile, those who want to lose money need to buy Lee Enterprises (NYSE: LEE). Economic reality and technological progress doom both Lee and the American newspaper business.

*Losing the News: The Decimation of Local Journalism and the Search for Solutions