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Feb. 29, 2016, 11:46 a.m.
Business Models

Another year, another Warren Buffett shareholder letter without much mention of his newspapers

“Circulation of our print newspapers will continue to fall, a certainty we allowed for when purchasing them.”

If capitalism ever gets its own American national holiday (and Black Friday is for some reason unavailable), let me suggest a late February date, to coincide with the annual release of Warren Buffett’s letter to Berkshire Hathaway shareholders. The Nebraska billionaire each year writes about the performance of Berkshire’s various companies, yes, but also wraps in astute observations about the broader economy, politics, and the comparative merits of flying into Omaha or Kansas City. It’s always a good read. (The now-retired Fortune editor Carol Loomis has helped give the letters their clear-eyed prose for decades.)

Being Nieman Lab, though, we’re always on the lookout for Buffett’s thoughts on the news business. Berkshire’s BH Media is one of the 10 largest U.S. newspaper companies, with 32 daily papers and 47 weeklies, mostly in smaller cities (Omaha, Richmond, Tulsa, and Waco are among the largest; most are much smaller).

When Buffett started buying newspapers in bulk in 2012, some of the medium’s defenders viewed it as a sign of the industry’s strength. It was an appealing argument: If Warren’s buying papers, they must be a pretty good business! And with the later purchases of The Washington Post by Jeff Bezos and The Boston Globe by John Henry, Buffett was often placed into a larger narrative of billionaires buying up newspapers to reinvigorate them for the digital age.

But we have enough distance now to see that Buffett’s buys were really of a different kind — closer to the sort of private equity ownership Ken Doctor describes as the financialization of the newspaper business. Buffett’s papers have faced the same sort of cuts as much of the rest of the industry, and they haven’t seen anything like the new-product energy coming out of Washington and Boston.

Anyway, I always look to Buffett’s shareholder letters to see what he’s thinking about the newspaper corner of his empire. (It is, of course, a very small corner in the context of all of Berkshire, but we take what we can get.) In his first letter after the purchase, he explained his reasoning:

Newspapers continue to reign supreme, however, in the delivery of local news. If you want to know what’s going on in your town — whether the news is about the mayor or taxes or high school football — there is no substitute for a local newspaper that is doing its job. A reader’s eyes may glaze over after they take in a couple of paragraphs about Canadian tariffs or political developments in Pakistan; a story about the reader himself or his neighbors will be read to the end. Wherever there is a pervasive sense of community, a paper that serves the special informational needs of that community will remain indispensable to a significant portion of its residents.

But then, in his 2013 letter, nothing. His 2014 letter: nothing.

In his 2015 letter, released this past weekend, newspapers finally got another mention! But it’s not one that’ll bring solace to printheads. It comes in a section headed “Important Risks”:

Let me mention just a few examples. To begin with an obvious threat, BNSF, along with other railroads, is certain to lose significant coal volume over the next decade. At some point in the future — though not, in my view, for a long time — GEICO’s premium volume may shrink because of driverless cars. This development could hurt our auto dealerships as well. Circulation of our print newspapers will continue to fall, a certainty we allowed for when purchasing them. To date, renewables have helped our utility operation but that could change, particularly if storage capabilities for electricity materially improve. Online retailing threatens the business model of our retailers and certain of our consumer brands. These potentialities are just a few of the negative possibilities facing us — but even the most casual follower of business news has long been aware of them.

I don’t think there’s much evidence that Buffett has been a bad newspaper owner — just an unremarkable one. And what the industry could use right now is some remarkable owners.

Interestingly, Buffett follows up that list of risks — self-driving cars, online retail, and the like — by mentioning Berkshire Hathaway’s beginnings:

None of these problems, however, is crucial to Berkshire’s long-term well-being. When we took over the company in 1965, its risks could have been encapsulated in a single sentence: “The northern textile business in which all of our capital resides is destined for recurring losses and will eventually disappear.” That development, however, was no death knell. We simply adapted. And we will continue to do so.

Berkshire Hathaway was a textile business based in New Bedford, Massachusetts when Buffett, then 34, bought control. Within two years, he was already converting it into a holding company more deeply invested in the insurance business than textiles. Those New England mills hung on a while longer, but Berkshire was out of the business entirely by the mid-1980s.

In his 1989 letter to shareholders, Buffett reflected on the biggest mistakes of his first 25 years of ownership. Apologies for the lengthy blockquote, but I think it’s useful context for his newspaper ownership:

My first mistake, of course, was in buying control of Berkshire. Though I knew its business — textile manufacturing — to be unpromising, I was enticed to buy because the price looked cheap. Stock purchases of that kind had proved reasonably rewarding in my early years, though by the time Berkshire came along in 1965 I was becoming aware that the strategy was not ideal.

If you buy a stock at a sufficiently low price, there will usually be some hiccup in the fortunes of the business that gives you a chance to unload at a decent profit, even though the long-term performance of the business may be terrible. I call this the “cigar butt” approach to investing. A cigar butt found on the street that has only one puff left in it may not offer much of a smoke, but the “bargain purchase” will make that puff all profit.

Unless you are a liquidator, that kind of approach to buying businesses is foolish. First, the original “bargain” price probably will not turn out to be such a steal after all. In a difficult business, no sooner is one problem solved than another surfaces — never is there just one cockroach in the kitchen. Second, any initial advantage you secure will be quickly eroded by the low return that the business earns. For example, if you buy a business for $8 million that can be sold or liquidated for $10 million and promptly take either course, you can realize a high return. But the investment will disappoint if the business is sold for $10 million in ten years and in the interim has annually earned and distributed only a few percent on cost. Time is the friend of the wonderful business, the enemy of the mediocre.

You might think this principle is obvious, but I had to learn it the hard way — in fact, I had to learn it several times over. Shortly after purchasing Berkshire, I acquired a Baltimore department store, Hochschild Kohn, buying through a company called Diversified Retailing that later merged with Berkshire. I bought at a substantial discount from book value, the people were first-class, and the deal included some extras — unrecorded real estate values and a significant LIFO inventory cushion. How could I miss? So-o-o — three years later I was lucky to sell the business for about what I had paid. After ending our corporate marriage to Hochschild Kohn, I had memories like those of the husband in the country song, “My Wife Ran Away With My Best Friend and I Still Miss Him a Lot.”

I could give you other personal examples of “bargain-purchase” folly but I’m sure you get the picture: It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price. Charlie understood this early; I was a slow learner. But now, when buying companies or common stocks, we look for first-class businesses accompanied by first-class managements.

American newspapers, even in their declining state, are still reliably cash-flow positive. They may not produce the 20-percent and 30-percent profit margins of the good old days, but the predictability of cutting — revenues down 8 percent? just cut costs 8 percent! — has made them attractive to buyers seeking cash. But even the private equity buyers of a few years ago appear to have lost some of their appetite. The question that remains is whether Buffett’s newspaper purchases will be an exception to the lesson he learned decades ago — or just something he (or his successor) will someday “adapt” away from.

Photo of Warren Buffett by Fortune Live Media used under a Creative Commons license.

POSTED     Feb. 29, 2016, 11:46 a.m.
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