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Washington Post Sells to Amazon Founder. Now What?

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By now you’ve heard that the iconic Washington Post, the newspaper that toppled Richard Nixon from the presidency in 1974, was sold at a pittance (relative to what it would have been 15 years ago) to the very wealthy and very capable founder of Amazon, Jeff Bezos.  I can’t tell you what will happen, but I can give you some food for thought.

  • This is not the first time Bezos has made big personal investments.  He bought huge pieces of Pets.com and Kozmo.com.  Both of those went bankrupt.
  • The Post, according to Don Graham, has suffered declining revenue seven years running.  In the first quarter of this year, the paper lost $34 million from operations.
  • Bezos paid $250 million in cash to buy the paper.   As a percentage of his personal net worth, that’s equivalent to the median American family paying $2,000 for a car.   It’s a very manageable amount of money for him.  If the paper runs losses for a long time, he can keep re-upping.
  • At the current subscription price of roughly $180/yr, Bezos needs another 750,000 subscribers to break even.

Why should anyone subscribe?

What can a subscriber to the Washington Post get that they can’t get anywhere else?

Warren Buffett has taken an interest in local newspapers as the only source of local information.  He said (p. 17):

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.

That’s one of two directions I think Bezos and the Post will settle on.  The Washington Post can still be the source for local news in DC.

Can it maintain national readership?

I think so.  Bezos said he’s going to pay close attention to what readers want: “Our touchstone will be readers, understanding what they care about – government, local leaders, restaurant openings, scout troops, businesses, charities, governors, sports – and working backwards from there.”  Just look at how much of that is local, how little of that is Watergate-esque!

But if he can afford to wait a while and to keep really good government journalism going at the Post, he may be able to bankroll a level of government journalism above anything being done by anyone else.  That would be a differentiator, and with a subscription model for digital or Amazon’s distribution system for print, that might be a story worth paying for.

Do you agree?  Let me know in the comments below, or share this food for thought with a friend.

The Greatest Stock Option Plan You’ll Probably Never See

If you’re running a company — a real one or a startup — you’ll want to remember the story of Fred Futile, CEO of Stagnant, Inc.

The compensation committee of Stagnant, Inc. saw fit to award Fred stock options equal to 1% of the shares then outstanding.  This was intended to give Fred an owner-like interest in the business and incentivize him to increase the value of the company.  Stagnant was at the time earning $1 billion each year on $10 billion of equity.  There were 100 million shares outstanding, so earnings per share were $10.  The company traded at a price to earnings of 10, so the option price was set at fair market value, $100 per share.  Here’s a table summarizing the vital statistics:

futile_options_v1

Now Fred did an ingenious thing.  Rather than work hard to change Stagnant into something more than the marginally billion-dollar business that it was, he used the year’s earnings to repurchase shares.  Look what happened:

futile_options_2

The one billion dollars of earnings bought ten million shares at $100/share.  Assume the company traded constantly at a P/E of 10 and you can see the trick: just by withholding money from shareholders, Fred was able to put his options in the money and make himself $11 million.  He didn’t have to improve the business at all.  And if that doesn’t surprise you, look at this:  if in Year 2, instead of holding constant, earnings had actually declined by 5% due to Fred’s negligent management, Fred would still have been in the money on his options:

futile_options_3

Fred was gaming the system then, to be sure, so let’s look at what would have happened if he had tried to reinvest the earnings into some seemingly worthwhile project that earned 5%.  We’ll add one row at the bottom for “return on equity”.  We started with $10 billion in equity, and then Fred will reinvest $1 billion at 5%.

futile_options_4

Do you see how the return on equity decreased?  Fred’s seemingly worthwhile project gave his investors a worse return on investment than if he had done nothing at all.  And oh, Fred is still making millions on his option plan.

The lesson here is that Fred’s option plan is flawed.  It’s okay to want to incentivize Fred with options, because as CEO he does have an impact on the overall success of the business.  But his options should have a cost of capital or time factor.  This way, it’s clear to Fred that if he can’t use company earnings to match the current return on equity, he should pay the money out to shareholders. Take a look at this new and improved option plan where Fred’s strike price increases at 11% each year:

futile_options_5

Now if he tries his repurchase scheme, he doesn’t get rewarded (at least, not as much; I left off some pennies and he’s still technically in the money here).

The same is true (even more true) if he tries his unsuccessful project:

futile_options_6

Option plans with hurdle rates should be used for every CEO or other executive that insists on option plans.  This much better aligns his or her incentives with those of the investors, and comes as close as you can get to having them just buy in to a large amount of stock, which would be best of all.

The inspiration for this article, including Fred Futile and Stagnant, Inc., is owed to Warren Buffett and his annual Letter to Shareholders, 2005 (click here to read and search for “Futile”).

Is Real Estate a Gruesome Business?

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Warren Buffett defines a “gruesome business” as one that requires a lot of capital and produces a low rate of return.  Is real estate gruesome?  Let’s see:

  • Does it “require significant capital to engender … growth” (WB, 2007; PB p. 14)?

Yes.  The median home price in America is about $220,000.  The average rent is about $800/mo.  So a home costs almost 23 years in rent.  That’s a lot just to get started.

A previous article talked about how potentially $1,700/mo can be spent just on maintaining a $250,000 property.  As a percent of rents, that’s definitely a lot.

And once your house is full, you can’t get much more revenue except by buying another house.

  • Is your house more like a candy bar or a cup of sugar?

Warren writes (1982; PB p. 15), “[Differentiation] works with candy bars (customers buy by brand name, not by asking for a ‘two-ounce candy bar’) but doesn’t work with sugar (how often do you hear, ‘I’ll have a cup of coffee with cream and C & H sugar please’).

Every house has a little bit of “candy bar” to it, since it’s so rare that any two apartments look and feel the same.  But every house also has a little bit of “sugar” about it when customers are looking for “off street parking, laundry, two bedrooms.”  I think most apartments are more sugar than candy bar.

  • Do you feel real pressure to be “the lost-cost producer” (2000; PB p. 15)?

How many of us landlords have reputations for being big spenders?  That’s right, none.

All this doesn’t mean you can’t make money in real estate, but it does mean you need to be very careful.  Here are some tips:

  1. Watch that purchase price.  Don’t pay too much for a rental property.
  2. Work hard to differentiate.  Make your ad glossy and your apartment smell good.
  3. Keep costs down.  Shop for insurance every year, refinance if you still haven’t, and spend money on projects that will save money over time, like good rain water management, durable surfaces, and upgraded plumbing.

The Warren Buffett quotes in this article come from his “A Few Lessons for Investors and Managers,” edited by Peter Bevelin.

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