Tuesday, July 7, 2015

Graham Holdings: Undervalued Parent ex-Cable ONE

Graham Holdings (GHC), formerly The Washington Post Company, has transformed in the past two years as they’ve sold their namesake publishing business to Jeff Bezos, completed an asset swap with Warren Buffett’s Berkshire Hathaway and most recently spun off of their Cable ONE (CABO) broadband business to shareholders.  The Cable ONE spinoff came with a lot of attention as another round of consolidation happens in the cable space, it's basically assumed (and priced accordingly) that Cable ONE won't be independent for long.  The spinoff has created an opportunity to buy the remaining Graham Holdings stub for an attractive, low-risk price.  What remains is a cash and securities heavy balance sheet with a collection of diverse businesses including 5 television broadcast stations and for-profit educator Kaplan along with the largest overfunded pension plan in the Fortune 1000.

Owner/operator Donald Graham and his family control the company and have filled the board with many respected investing minds including Thomas Gayner (Markel), Barry Diller (IAC, Expedia), and Chris Davis (Davis Select Advisors).  Don Graham also has close relationships with Warren Buffet and was formerly on the board of Facebook giving him additional access to advice and deal flow.  I'll break out the assets/business segments by easiest to the most difficult to value, but with a market cap of about $4.1 billion, an investor is roughly buying the cash, securities, discount pension asset and TV broadcasting segment while getting a nearly "free" option on Kaplan's turnaround, SocialCode's growth and a hodge podge of other businesses.

Cash, Securities, and Over-funded Pension
After the spinoff of Cable ONE earlier this month, which paid a $450 million dividend back to the parent, Graham Holdings should have around $1.1 billion in cash (including restricted cash) plus $215 million in securities - backing out the $400 million in debt equals a net cash position of $917 million.  If history holds, the company will use its recently increased share repurchase plan (659,219 shares or ~11% of the share count) to continue cannibalizing itself - the share count is down nearly 40% over the last 5 years.

Graham Holdings enjoys the enviable position have having a massively overfunded pension plan, most know the back story of a younger Warren Buffet purchasing shares of The Washington Post Company in the 1970s and convincing Katherine Graham to shun the traditional pension plan asset allocation model and instead invest in a heavily concentrated portfolio, including a big slug of Berkshire Hathaway.  That advice proved valuable and now Graham Holdings is sitting on a $1.15 billion prepaid pension asset on its balance sheet.   While its difficult to monetize such an asset, it does give Graham Holdings flexibility and potentially could lower its cost of capital when continuing to acquire smaller industrial companies that may have legacy unfunded pension liabilities.  For the purposes of a sum of the part analysis, I'll apply a 50% haircut to pension asset, or $575 million.

Graham Media Group (TV Broadcasting)
The company owns five local television broadcasting stations located in Houston (NBC), Detroit (NBC), Orlando (CBS), San Antonio (ABC), and Jacksonville (Independent).  I've spent some time this year on other broadcasting companies, it's a fairly stable high margin business with several tailwinds (2016 elections, spectrum auctions).  There are plenty of pure play public comparables and its a segment I could see Graham spinning off in similar fashion as Cable ONE.  There is a lot of consolidation activity happening in the broadcast space and a spinoff would allow for a tax efficient sale of the business unit.
Graham Media Group will do about $210MM in blended '15/'16 EBITDA, putting a 9x multiple on that fetches a $1.9 billion valuation.

Kaplan (For-Profit Education)
The most controversial of Graham's business lines is the for-profit education segment, Kaplan, which makes up the bulk of the post-cable spin revenues but comparably a much smaller piece of the profit and current value.  The for-profit education sector is a hated one, and a lot of that is for good reason, many in the industry are simply diploma mills that use aggressive marketing to appeal to low income students who are easily taken advantage of and rely almost exclusively on government guaranteed student loans to fund their tuition.  Many don't finish school and end up with hefty loan payments and no degree, those that do finish, end up with a degree of questionable value and limited job prospects.

Kaplan's business is broken up into three segments: Kaplan Higher Education (US based online university and professional education prep), Kaplan Test Prep (SAT, ACT, MCAT, GMAT, etc), and Kaplan International (a growing diverse set of businesses across mostly developed countries).  The US business is under tremendous stress as enrollment numbers have been cut in half over the last five years.  The business is a potential turnaround, it has sold its physical locations to focus primarily on the online market, and with the job market picking up, sentiment and job placement numbers should improve, the for-profit space is a highly cyclical business coming out of a deep trough.  Turnarounds in the public markets are extremely difficult as investors/analysts focus on quarter to quarter results.  As part of Graham, Kaplan's results are slightly hidden from view allowing them to take a longer term view in the face of increasing regulations.

In the 2014 annual letter, Don Graham makes the case that increased regulation might have a positive effect on Kaplan by taking out the bad eggs/weaker players in the market and increasing the barriers for new entrants.  Politically, the for-profit sector has a place as its going to be too difficult for any politician to take a firm stance against expanding college accessibility (and loans) to low income students.  Kaplan's name hasn't been as tarnished as others and with the backing of a strong holding company should be able to survive to see the light at the end of the tunnel.
Public comparables for Kaplan are all over the place, but with a blended EBITDA of $152MM across the three business segments, I'd argue it's worth at least 7x EBITDA, or $1.06 billion, with some upside to the multiple and EBITDA as earnings normalize across the industry.

Other Businesses/Real Estate
Then Graham has a grab bag of smaller businesses, a couple of which seem to be an odd fit and a couple of which could turn into something more substantial in the coming years:
  • SocialCode: The most promising of the other business is SocialCode which describes itself as a social media marketing technology company that helps companies manage social advertising on platforms like Facebook, Twitter, LinkedIn and Instagram.  In the 2014 annual letter - stated it's now "significant to our company".  With social media companies ramping up the monetization of their platforms with advertising, SocialCode could be in a position to take advantage of that advertising dollar shift.  Don Graham's daughter is the founder and CEO of the company; The Washington Post did an interesting story on the company in late 2014 - they have 25% gross profit margins and over $300MM in revenue, given private market valuations for technology startups SocialCode has some upside optionality via a sale or spinoff, a nice option that I just wouldn't want to pay up for.
  • Trove: This segment is a news aggregator app similar to Flipbook where you can pick and choose news topics you're interested in, I've been playing around with it the last few days and it doesn't appear too useful.  I'll look for a topic I'm interested in, say a sports team, and a very generic "Trove" exists with dated articles. It's hard to tell what the revenue model is as well and how scalable that is for a company the size of Graham?  Maybe it's higher quality than I'm giving it credit for; again SocialCode and Trove would likely be a lot more valuable as private startups given today's frenzy in that market.
  • The Slate Group, The FP Group:  These are two online magazines, Slate is moving its content behind a paywall and having reasonable success but its hard to make money in the online publishing world.  Both are nice properties, but probably not worth a whole lot.
  • Celtic Healthcare, Residential Healthcare: Celtic and Residential both provide home health care and hospice services.  Given the aging demographics of the United States and the "mom and pop" nature of senior and home health care, there's an opportunity to roll up smaller players and make this a larger business.
  • Forney Corporation: An industrial company that makes safety related equipment for power plants that Graham acquired in 2013 from United Technologies.  Since then they've done a few bolt on acquisitions with Forney including Damper Design and FlameHawk in 2014.  Seems like a nice small business (potentially insignificant) but we don't have much information on its profitability or how it really fits with the rest of Graham Holdings.
  • Joyce/Dayton Corp: Another small industrial company that Graham recently purchased, Joyce/Dayton manufactures screw jacks, linear actuators, and the like for the energy, metal and mining sectors.  What's the bigger picture with these two industrial companies?  On the one hand Graham is selling and spinning off major business segments but collecting smaller ones under the Berkshire decentralized holding company management haven philosophy.
Graham's financial disclosures aren't the best, all of these businesses are grouped together making them hard to value separately (maybe now that Cable ONE has been spun out and SocialCode is "significant", it will become its own reporting segment).  To be extra conservative, I'll use the book value of the assets of the "other category" in the latest 10-Q of $488 million.

Valuation
Graham Holdings also has a small deferred tax asset, given their past tax savvy moves I'm comfortable using the full $74 million valuation allowance.
 
I come up with a value of $858 per share, which I consider a fairly conservative valuation depending how you choose to value SocialCode and the other businesses.

Risks:
  • Conglomerate/Controlled Discount: Until recently Graham Holdings wasn't concerned about conducting transactions that would expose value, but after a busy two years, will the deals now slow down?  We also haven't really seen what Tim O'Shaughnessy's capital allocation acumen is like since they haven't done a deal since he's come on board in late 2014.  Conglomerates deserve some discount, I feel like that should be adequately accounted for in my estimates.  Graham Holdings also has a dual share class structure with the class A shares in the hands of the Graham family and having 10-1 voting rights.
  • Nepotism: Donald Graham is a former DC police offer, now heads the company his mother once controlled, late last year he appointed his son-in-law, O'Shaughnessy (founder of LivingSocial), to be the President.
  • For-Profit Education Stink: It's a hated industry, and what Graham Holdings is primarily known for now, but if you zero out the value of Kaplan completely, you simply have a fairly valued company.
The downside seems pretty limited, the company will be in the market buying back shares and you have a BoD and management squarely focused on increasing shareholder value.  Graham Holdings has run up a little since the spin, I bought it on the day it started trading regular way (7/1/15), but I think it has upside from here and have the intention of making it a core long term position.

Disclosure: I own shares of GHC

7 comments:

  1. Good article, thanks!

    clint

    ReplyDelete
  2. great post - thank you.

    ReplyDelete
  3. Good article. Own the stock myself. What am I missing with regards to the education division? Looking at pg 91 of the 10-K I see Income from Operations at the education division of $65.463mm. 7x on that gets me a $458mm value for the education unit.

    Best regards,
    CJ

    ReplyDelete
    Replies
    1. I'm using EBITDA by backing out $61.7MM worth of depreciation and $24.9MM in amortization as listed in the press release. If using operating income, I'd use a higher multiple than 7x. The education division is admittedly a bit of a swag, hard to say what the normalized earnings/margins will be and what multiple to use?

      Delete
  4. Any updated thoughts?

    ReplyDelete
    Replies
    1. Other than it's incredibly cheap? Nothing much in terms of updated thoughts. Full disclosure, I sold to harvest some losses, hoping it stays down here so I can buy back in again. My one worry that has increased since the post is the nepotism and lack of a clear strategy, it's almost similar to another SOTP former favorite of mine in News Corp, no question that the sum of the parts is worth more than where it's trading, but it's not going to be recognized quickly due in part to the family ownership structure. But right now you're essentially getting paid to take Kaplan, market is assigning negative value to it, seems to be no end in sight to the death spiral in the for-profit education sector. And then they bought another small industrial, what's the strategy there? Price is always undisclosed on those, and was a little disappointed that they aren't breaking out SocialCode as a separate reporting unit yet. Overall, story is still mostly the same, worth a lot more if you're patient. Thanks for reading.

      Delete
  5. Thanks for writing! Very useful and much appreciated.

    ReplyDelete