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September 16, 2014 Volume XL, Issue VII & VIII Graham Holdings Company NYSE: GHC Dow Jones Indus: 17,131.97 S&P 500: 1,998.98 Russell 2000: 1,150.97 Trigger: No Index Component: S&P 400 (as of 9/19/14) Type of Situation: Conglomerate Discount Price: $ 730.88 Shares Outstanding (MM): 5.8 Fully Diluted (MM): 5.8 Average Daily Volume (MM): 0.02 Market Cap (MM): $ 4,084 Enterprise Value (MM): $ 4,546 Percentage Closely Held: Insiders 20% 52-Week High/Low: $ 745.11/568.04 5-Year High/Low: $ 745.11/320.88 Trailing Twelve Months Price/Earnings: 26.0x Overview Price/Stated Book Value: 1.5x Graham Holdings Company (―Graham,‖ ―GHC,‖ or ―the Company‖) is a self described education and Net Debt (MM): $ 90,836 media conglomerate operating largely independent Upside to Estimate of businesses in education, cable and broadcast Intrinsic Value: 73% segments, as well as smaller businesses in a wide variety of segments. The Company exhibits many of the Dividend: $ 10.20 traits that are typical of a holding company structure: a Yield: 1.4% disparate set of assets, a lack of sell side coverage, and an under-utilized balance sheet. Furthermore, as is Net Revenue Per Share: often the case in a holding company structure, recent FY 2013 $ 3,488 difficulties associated with one business have caused FY 2012 $ 3,456 investors to disregard strength in other businesses. In FY 2011 $ 3,526 our view, this has resulted in a sizable gap between intrinsic value and the value that the market is currently Earnings Per Share: assigning shares. FY 2013 $ 32.18 FY 2012 $ 17.72 The for-profit education business, which is part of the Company’s Kaplan Education unit, has been a FY 2011 $ 14.70 lightning rod for criticism is recent years, and sub- Fiscal Year Ends: December 31 segment EBITD (amortization is not broken out by sub- Company Address: 1300 North 17th St. 17th Floor segment) has declined 41% to $115 million in 2013 Arlington, VA 22209 from $197 million in 2011 as the Company has Telephone: 703-345-6300 struggled to deal with increasing regulation, declining CEO/President: Don Graham enrollment, and negative headlines. However, in our view the Company has reacted well to the recent Clients of Boyar Asset Management, Inc. do not own shares of Graham struggles, and is likely to emerge as best in breed when Holdings, Inc. common stock. the regulatory environment is more settled. Additionally, Analysts employed by Boyar’s Intrinsic Value Research LLC do not own shares of GHC common stock. Kaplan operates a growing international business and a test prep business that are insulated from the current regulatory scrutiny. - 43 - Graham Holdings Company While investors remain focused on the above mentioned problems, the cable and broadcast businesses continue to perform admirably, and in our view justify a higher share price on their own. The cable business (46% of EBITDA ex corporate and other) is focusing on raising below industry average ARPU by reducing spend on its video customers and shifting attention to more profitable high speed data customers, while the broadcast segment (21% of EBITDA ex corporate and other) is set to benefit from rising retransmission rates in coming years. Furthermore, a series of recent transactions that saw the divestiture of noncore businesses (most notably the sale of the Washington Post) and real estate have left the Company flush with cash (more than $300 million or $50 per share of which does not yet appear on the balance sheet), putting CEO Don Graham in a position to grow intrinsic value through prudent capital allocation. Graham has long been a disciple of Warren Buffett, and has made clear his intentions to attempt to follow in his mentor’s footsteps by seeking to acquire family run companies that generate robust cash flow through sustainable competitive advantages. At current prices, the Company trades at just 6.7x trailing EBITDA, and just 4.6x our projection for 2016E EBITDA. For investors that cannot get comfortable with the Company’s exposure to for-profit education, we note that the entire enterprise trades at just 8.3x combined trailing cable and broadcast EBITDA. We derive our estimate of intrinsic value based on a sum-of-the-parts value, which we believe to be conservative both in terms of multiples and projected growth. Based on these estimates, we believe GHC’s intrinsic value is $1,262 per share, representing upside of 73% from current levels. Further, we believe that this estimate of intrinsic value is likely to grow with time, as CEO Don Graham deploys the Company’s cash hoard. Company History Until recently Graham Holdings was known as The Washington Post Company. The Washington Post newspaper was founded in 1877 and passed through the hands of four different owners before declaring bankruptcy in 1933. Established businessman but inexperienced newspaper man Eugene Meyer purchased the paper out of bankruptcy, expanded advertising sales and distribution, and later entrusted the paper to his son-in- law, Philip L. Graham, who incorporated the business in 1947. Philip Graham expanded into radio, television, and magazines, moving the business away from a pure play newspaper and toward a diversified media holding company. In 1963, Katharine Graham – daughter of Eugene Meyer and wife of Philip Graham – became president of the Company following the death of her husband. In 1971 the Company went public through an offering of Class B stock, while the Graham family retained voting control through shares of Class A stock. In 1973 Warren Buffett famously began accumulating shares at a market cap of approximately $80 million versus his estimate of intrinsic value of $400 million. After accumulating over 10% of shares outstanding and explaining his philosophy on investing – as well as life – to Katherine Graham, Buffett joined the Board of Directors in the fall of 1974. Thanks to Buffett’s influence, the Company began to aggressively repurchase stock, increasing per share value, causing the market to notice and re-rate shares. The Company began to grow into its modern form in 1984 with the purchase of test preparation company Stanley H. Kaplan Educational Centers. In 1986, the Company bought cable systems serving 350,000 subscribers from Capital Cities/ABC for $350 million. Today the cable business is known as Cable ONE. In 1991, Katharine Graham’s son Don Graham was named CEO of the Company. Buffett’s relationship with Katharine Graham has been well documented in various accounts of his life. His proximity to the family made Buffett an important figure in Don Graham’s life, and to this day, Graham’s writings and speeches are filled with references to Buffett’s approach toward buybacks, value creation, long term owner orientation, business unit autonomy, and wisely deploying capital. In 2007 the Washington Post Company began describing itself as an ―education and media company‖ to reflect the declining importance of its eponymous newspaper and the fact that the Kaplan division was responsible for nearly half of Company revenue. The declining importance of print media was further demonstrated through the 2010 ―sale‖ of weekly news magazine Newsweek for $1. Buffett and Don Graham remain close to this day, although Buffett formally resigned from the board in 2011. While reflecting on Buffett’s long term relationship with the Company, in the Company’s 2011 annual letter Graham commented, ―no important decision at The Post Company has been taken for all those years without asking for Warren’s input.‖ Perhaps more important, Graham further commented, ―he talked me out of a couple of ill-conceived acquisition ideas that would have created problems.‖ - 44 - Graham Holdings Company Recent Developments – This is Not the Washington Post that Buffett Invested In We believe that investors currently view Graham Holdings as legacy Washington Post Corporation, rather than a diversified conglomerate focused on growing shareholder value through intelligent capital allocation. While it is too early to judge if management will grow into their self appointed role by compounding intrinsic value over time, we view their recent transactions as evidence that they are at least pointed in the right direction. Thus far acquisitions have been small in nature, but with $361 million in cash, and somewhere in the neighborhood of $300-$400 million more expected upon the completion of recently announced transactions (details below), we would not be surprised to see larger acquisitions in the near to intermediate term. A primary risk is that these acquisitions will be done at unattractive terms. We are hopeful that Graham’s many years of exposure to Buffett as well as the strong board of directors (more on this below) will be enough to keep him disciplined going forward. Washington Post Divestiture – Good Riddance In October 2013 the Company completely transformed itself by agreeing to the sale of the Washington Post and other newspaper division assets to Jeff Bezos (in a private capacity, not as part of AMZN) for $250 million. Subsequent to this sale, The Washington Post Co. was renamed Graham Holdings. At the time many commentators were shocked that Graham would part with an asset that was so closely intertwined with his family legacy and the American social fabric. For years prior, sell side analysts had pointed to the demise of the Post and newspapers in general and suggested that the Company would be better off monetizing this division and redeploying the proceeds into the Company’s higher margin and highly cash generative other major business lines. Newspaper Publishing Segment: A Rapid Decline ($ millions) 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 Revenue 873 938 957 962 890 801 679 680 648 582 EBIT 134 143 125 63 66 -193 -164 -10 -18 -54 EBIT margin 15.4% 15.3% 13.1% 6.6% 7.5% -24.1% -24.1% -1.4% -2.8% -9.2% EBITDA 176 180 163 100 106 -127 -90 22 9 -28 EBITDA margin 20.2% 19.2% 17.0% 10.4% 11.9% -15.9% -13.2% 3.2% 1.4% -4.8% EBITDAP 196 184 164 157 116 -39 -14 64 34 14 EBITDAP margin 22.4% 19.6% 17.1% 16.3% 13.1% -4.9% -2.0% 9.4% 5.3% 2.5% Prior to this transaction, newspaper assets had been changing hands at 3.5x-4.5x EBITDA, which implied a value for the Post around $60 million.