|Shares Out. (in M):||359||P/E||0||0|
|Market Cap (in M):||983||P/FCF||0||0|
|Net Debt (in M):||1,010||EBIT||0||0|
With Central European Media Enterprises (“CME“ or “CETV“ or “Company“) risk/reward is very attractive.
CME has been the subject of several write-ups on this site over the years. Since the last one, stock has performed poorly, losing 80% of the value as a result of massive dilutions. With the huge drop in price and due to recovering markets, CME once again emerged as a great investment opportunity. There are numerous paths to value creation but I believe the most likely one is that CME's controlling shareholder, Time Warner, will try to acquire remaining shares in the next year or two.
So why this opportunity exists?
- - it is a small illiquid stock that is under the radar of most investors/analysts. There are only 136 million common A shares of which Time Warner holds close to half
- - many have been significantly burned on this stock since the crisis and due to a high level of debt investors don't find it interesting enough to analyze further
- - at the first glance it doesn't look that attractive given the negative earnings and average multiples
- - the fact that most of its value comes from the future growth makes it cumbersome to analyze and appropriately value
Despite recent run-up in the price ( 25% rise in last the 10 trading days) CETV represents a compelling investment opportunity with a multiple catalysts to drive the price higher. Today's market price neglects a longterm cash flow, durable competitive advantage of the business, operating leverage and a huge growth opportunity as a result of closing the gap between ad spending in the markets where CETV operates and ad spending in Western European markets and focuses mostly on the short term results. Taking these facts into account, CETV is trading at a considerable discount.
CETV is a media and entertainment company operating in 6 Central and Eastern European markets: Bulgaria, Croatia, Czech Republic, Romania, Slovakia and Slovenia. CME broadcasts 34 television channels to approximately 50 million people and it is the audience leader across all 6 markets.
The largest CME's shareholder is Time Warner which as of Q3 2015 holds ~45% of common shares or ~76% on diluted basis.
CME is the leading television broadcaster in each of its markets, with all-day audience share ranging from 22.6% in Romania to 36.4%(Q3) in Bulgaria and even higher percentage of prime time audience share in each of these markets. The Czech Republic and Romania are the largest markets with a lion's share of revenue and OIBDA(~80%). The Czech Republic broadcast operations are the crown jewel of CME business. Prior to the crisis and rebellion of Czech advertisers, CME business in the Czech republic set a world record in margins with 60% OIBDA as a result of good mix of audience share, market size and high level of GDP per capita in comparison to other CME's markets.
The dominant position in the audience share gives them leverage which makes CME by far the largest player holding on average approximately twice the size of market share of the next competitor. This is a result of pricing power that comes with the dominant market position but also the fact that public broadcasters have serious restrictions in the amount of advertising they may sell.
I would argue that audience share combined with a more than half of locally produced content gives CME considerable advantage over its competitors. CME gets cca. 60% of combined ~$900 million (2014) of advertising spending in these markets and this scale gives them ability to outspend every competitor in the relevant markets , keep the audience share , which, in turn, brings higher share of ad revenue and so the cycle continues. Also, the audience taste for locally produced programming represents high barriers to entry for any newcomer who, in an attempt to gain audience share, is exposed to considerable losses over prolonged periods of time. Only a handful of companies can handle such a challenge and it is not necessarilly the best use of shareholders capital.
This is the reason why in the CME's markets there should be no concerns similiar to those which big US media companies have with respect to Netflix. Given their small size it is probably the last place where Netflix and similar companies would invest to make locally produced content.
The brink of bankruptcy
CME used to be controlled by Ronald Lauder but he lost control and economic interest during the crisis when the Company was hit hard by combination of (I) decreased ad spending (II) stronger dollar (III) terrible capital allocation (IV) too aggressive pricing strategy.
Even though it seems that the macroeconomic conditions are to be blamed for loss of shareholder value, that is only partially true. No doubt, drop in personal consumption and dollar appreciation did their part, given the fact that ad spending is strongly correlated with disposable and discretionary income and that approximately half of CME's debt and programming cost was denominated in dollars at that time. But it was the actions of former management that led to substantial balance sheet deterioration and caused dilutions of such magnitude. With ill-timed acquisitions in Ukraine and Bulgaria and rebellion of Czech advertisers as a result of aggressive pricing strategy, former management drove the CME to the brink of bankruptcy.
Between 2008-2010 CME spent ~ $0.9bn on acquisitions just in those two markets. In 2008 they acquired remaining 40% of Ukraine business for 332 million dollars(+$22mm for some minor assets) and only two years later they sold the whole business for $308 million. The acquisition of Bulgarian bTV tops even that. Paying $410mm for business that makes $70-$80 million in revenue is quite an achievement especially considering it was done in 2010, after the collapse of financial markets, huge drop in ad spending and weak balance sheet at the time. The fact that in 2008(!) MTG paid even higher multiple for competitor Nova tv ( very common name for a broadcaster in that part of the world, not to be confused with CME Czech Nova or Croatian Nova) shouldn't make us feel any better.
Furthermore, former management caused a sort of rebellion of Czech advertisers and agencies when it attempted to increase the advertising prices. Aggressive pricing strategy was met with significant resistance of some advertisers and agencies in the Czech Republic and Slovakia which resulted in their withdrawing or withholding advertising from channels in those countries causing ad revenue to drop significantly. The most profitable CME's business that once had record OIBDA margins turned negative. Time Warner once again came to the rescue but at the high price for shareholders which were seriously diluted and stock lost 98% of the value since the peak. Finally, former management was fired but the damage had already been done.
Without mistakes made by the former management ( including the acquisition of CEO's production company) cash burn would have been much smaller due to significantly lower interest expense ( lower level of debt as well as lower average interest rate) and lack of decline in advertising revenue in the Czech Republic and Slovakia. Enough to dodge massive dilutions, if any. I believe it is important to emphasize this, given that current management hired by Time Warner doesn't show any signs of repeating mistakes of Adrian Sarbu and his team.
Current management has successfully led the turnaround of Czech business, diversified the source of revenue, i.e increased the revenue from carriage fees and have disposed non-core assets. After 7 years of negative FCF, CME is showing positive results and this year it will have ~55 million in free cash flow as a result of improved OIBDA and lower cash interest payments. Ongoing operational improvements ( 7 consecutive quarters of y-o-y margin expansions) provides an opportunity for the company to reduce its average cost of borrowing and extend its maturity profile. On several occasions management reiterated that refinancing its most expensive debt is a top priority while emphasizing their ability to refinance 15% PIK Notes at any time without penalty.
As a result of lower GDP, advertising spending in CME markets is meaningfully lower than in Developed markets and Western Europe. In 2014 TV advertising spend per capita was $18 vs. TV spending of $147 in the Developed markets. Even by excluding US market from that figure, due to the fact that US TV ad market is without time restrictions, and by using more comparable Western European countries with $60-$80 tv ad spending per capita, the convergence potential is still extraordinary.
Also, it is worth mentioning that in dollar terms 2014 tv ad spending was only at 56% of 2008 peak.
I believe it is save to assume that somewhere in the next 10 years CME business would be valued at $5bn. Just think about it - in the late 2007, early 2008 CME was worth that amount and the multiple was not extreme with company generating ~350 million in OIBDA. It should be expected that advertising spending will grow faster than economy and dollar should eventually become weaker than it is now.
According to the IMF, the combined nominal GDP of 6 countries is expected to reach $740 billion dollars in 2020. Total ad spending to GDP (ad intensity) peaked in 2008 at 0.47% and since than, as a result of crisis and ad market decline, it dropped to 0.26% in 2013, from which it has only slightly recovered to 0.28%. Conservatively using 0.33% for 2020 due to lower level of household debt growth and GDP growth based more on exports instead on private consumption, with unchanged 53% of tv ad spending and CME market share of 62%, implies $800 million in revenue from advertising. Add increased carriage fees and other revenue and we reach a $0.95-$1bn in total revenue.
The management said that they don't see any reason why CME shouldn't expect OIBDA margins from low 20s to low 30s in the future and given the pre-crisis margins ( middle to high 30s) I believe upper end of that range is more likely.
I used 12XOIBDA multiple but given the fact that CME operates on a market with better long term prospects one could argue it should be even higher. For example PRO7, which operates in the mature German speaking countries is trading at 15x ttm EBITDA and at 12x expected 2016 EBITDA. To put things into perspective - ad spending per capita in Germany is 2.5 times as large as that in the Czech Republic.
It is possible that IMF projections could be too optimistic and that growth is going to be slower or that dollar gets stronger, in which case it woud take more years to get to $740 billion in GDP. But even if it reaches that number in 2022 or 2024 it would still represent a high return investment.
With ~ $1bn in debt and high net debt/EBITDA ratio, the market perceives CME equity investment as highly risky specially regarding mismatch between the currencies in which the company generates its cash flows and currencies needed for debt service. I believe that market is wrong. A lot has happened since last year. From ~ $90 million cash burn in 2013 as well as in 2014, CME has gone to expected $55-$60 million FCF in 2015 ( if PIK interest would be paid in cash instead it would still be negative FCF but much bellow that in 2013 or 2014, about $30 million). Next year should be even better due to higher personal spending in countries where it operates, the recovery of the Czech market, incremental carriage fees which should result in higher OIBDA and possible $114 million cash injection from Warrants exercise ( exercisable at some point between Q2 of 2016 and Q2 of 2018) that could be used for debt repayments. As mentioned before, reducing debt and refinancing more PIK Notes with less expensive debt is the top priority for the management. With debt refinancing taking place at lower interest rate – probably at terms similar to the last two refinancing deals - 8.5% ( with a TWX as a guarantor) – one should expect higher FCF. Moreover, half of debt is now denominated in euros which lowers the currency risk. Improved cash position should start virtuous cycle of lowering interest expense that increases cash flow used for the payment of debt and so on. Thus in 2016 we could expect significant drop in net debt due to combination of possible Warrants exercise( probably in Q2), higher OIBDA and lower interest expense ( cash and PIK).
Also, TWX showed that it does not intend to let CME go bankrupt and that it is willing to guarantee its debt if necessary, which basically makes refinancing if not formality but much less risky.
The history indicates that Time Warner is interested to increase its ownership of CME and ultimately own the whole company. Since that both the highest and the average price (on adjusted basis, considering dilutions) paid by Time Warner is above the current one and since long-term growth prospects remain materially unchanged, paying a significant premium still may be considered a good deal for Time Warner.
Time Warner could increase its share either by buyout of minority shareholders or by further dilution. Although the possibility of dilution cannot be excluded, it does not seem to be likely. The current and former management diluted shareholders during the years of significant cash burn. Between 2009-2014 they burned close to 400 million dollars. Due to the high level of debt, the only options were disinvestments or raising new equity. Considered to be strategically important assets, Time Warner opted for the latter solution. Due to improving market conditions and positive FCF, not to mention $114 million cushion coming from Warrants somewhere between 2016-2018, such option could no longer be justified. Besides, with a number of activist investors they could face class action suits which eventually could become more costly then buyout of minority shareholders. In addition, they wouldn't accomplish anything as they would still have to buy out minority shareholders at a similar price.
It is worth stressing it out again –with former management gone, risk of need for new equity is significantly diminished.
The most plausible outcome is buyout of minority shareholders. There has been talk about buyout for several years, since TWX has become a shareholder. In retrospect, not to engage in buyout was a smart move due to much higher share price and cash burn that had led to need for raising new equity and increasing share count by convertibles and warrants. But now, when CETV is out of the woods, it makes perfect sense to buy out the minority shareholders. Paying 50-100% premium to current share price and gaining full ownership for $350-$470 million would seem attractive from their perspective.
Some activists have proposed a sale of the company. I consider it unlikely. My assesement is that they want to grow the business given the fact that CME operates in the markets with significant long-growth prospects. For TWX which mostly operates on the mature US market, CME is an important part of international growth strategy. On several occasitions, TWX stressed its desire to be more internationally focused ("Increasing our global presence is one of Time Warner's strategic priorities“) and to achieve the growth of the cable network segment increasingly from international operations and investments. With all the equity, debt and guarantee investments CME is by far the largest international investment of Time Warner.
Also, there is a possibility they would like to use CME as a platform to acquire and operate new assets in the region.
I see multiple catalysts over the next 6 – 24 months:
refinancing of 15% PIK Notes at lower costs, probably in Q2 2016
proceeds from warrant exercise, probably in Q2 2016
using excess cash for reducing the debt, probably in Q2 2016
increased revenue and OIBDA margins
Time Warner's tender offer to purchase all outstanding shares
|Subject||Model / Why now? / Multiple / Debt / PIK|
|Entry||12/27/2015 08:01 PM|
Few thoughts / comments.
1. Agree with Cameron57 that operating model based on unit economics is almost necessary here. Top down model is not sufficient.
2. I have been hearing about CETV tangentially in 2012-2014. The pitch has always been the same "TW would buy minorities". Never happend. Please note that that I am not saying that it would not happen now but ... what makes you think that smth in TW thinking has changed? Is it just lower share price?
3. 12x multiple seems rich to me. I saw your reference to German peer(s) but I am not sure that it does the trick. Relative valuation is all nice when you buy smth at 5x EBITDA and peers trade at 8x because it is still cheap on absolute basis (caveat: quality of the business of course matters). But when comps are at 15x (and it is not high-tech with strong operating leverage and scalability and great growth prospects) and one values smth at 12x, it still looks expensive to me (and not persuasive).
4. Debt. If I was hired by TW to advise on the acquisition of TWC, I would recommend this.
(a) wipe out the equity (including TW's own equity stake)
(b) negotiate a solution with debt holders (PIK holders; I would not touch bank debt; PIK notes are ~42% - 44% of debt => nice savings there already) which would result in one of these scenarios:
(i) reinstate PIK notes entirely as it is (worst case scenario for TW but they have already saved money because TW does not need to buy minorities)
(ii) keep PIK notes but reduce the interest coupon
(iii) try to get 10%-20% haircut on PIK notes.
I have not checked where PIK notes trade these days. What's the level? Has there be lot of turnover in the creditor base from original purchasers to stressed / distressed credit guys? I would expect so.
TW may say that it is not that big of sum of money (to wipe out equity and hairuct the PIK notes) and does not justify time and potential loss to reputation and potential court battle (btw, is PIK indenture governed by English law or NY law?).
Look at CEDC (2013) and New World Resources (2014) as potential playbooks in restructuring scenario here.
5. Finally, if you are bullish on CETV, what does offer a better risk/reward ratio - common equity or PIK notes? Frankly, in my opinion, equity here is out of the money and is at the mercy of TW and its warm heart.
Hope you find this interesting and worth thinking about.
|Entry||12/29/2015 08:03 PM|
Cameron, Ares, thank you for the feedback. I’ll try to address all your questions. If I missed anything or didn’t understand you correctly, please let me know.
1. I am aware that top-down model is a bit unorthodox here but I used it because I believe it to be more appropriate in view of the fact that advertising business is highly dependent on personal consumption and, in this case, the strength of the dollar. CETV's share of the market is such that they can't have considerable growth without the growth of the whole market. So looking at it from this perspective, in my opinion, makes more sense. Nevertheless, I used bottom up approach as well, to check what top-down model actually implies. It implies high single digit ad revenue growth in dollar terms over the next 5 years. On a constant currency basis(Lfl), in the first 9 months, CETV had something in that range – 7.3%. CETV's markets are in the early innings of recovery so very soon we could easily see double digit growth. I advise everyone to look at growth rates in some of these markets back in 2006, 2007, 2008. Just one ( a bit extreme) example: in 2007 Romania TV ad market grew by 50% to 60%. So, things can change very quickly and market doesn't seem to price in this possibility. It is traumatized by the last 6-7 years of experience.
2. The Czech audience share was pretty stable over the last years. Combined audience share went from 41.2% to 40.8% between 2011 and 2014. It is true that core channel – TV NOVA lost its share but it was offset by gains of other (new) CETV's channels. So ratings are pretty good and they didn't lose market share because of audience share. It was due to the poor management decisions with regards to pricing strategy that eventually got management fired. As a result of resistance of advertisers, CME's markets share dropped to 49% in 2013, a huge drop from 2011 level when it was 67%. They are going through recovery now, with 60% market share, and I believe that in couple of years it could reach 65%. During the same period, Romania in terms of audience share was stable and its market share actually increased.
3. So why haven't they taken CETV private years ago? I believe there are two main reasons: a) dilutions were cheaper way to increase ownership b) Ronald Lauder. CETV needed cash badly so TWX provided them with capital and got shares in return. By taking company private at the time, would require to pay shareholders and to inject cash into the company, which would have been more expensive. This way, they killed two birds with one stone. Also, I think Ronald Lauder was a big obstacle for taking CETV private. For him CETV was not just an investment. He is politically very active and this was a way to influence public opinion in that part of Europe. Until 2013, he owned or had control of over more than half of all the voting shares. I'm pretty sure that losing control made him very unhappy but it had to be done in the circumstances.
4. In 2009 TWX started with 30% and now they are heading to 77%. So trajectory is very clear. Due to much better FCF, I believe that old model of increasing ownership cannot be used any more. Don't forget, $114 mm injection is still to come so how can new Rights Offerings or Convertibles be justified? Furthermore, last year they didn't refinance convertibles with the new ones which tells you something. So, TWX options are more limited now and possibility of taking company private has increased. With improved market conditions, share price will rise so they better buy it sooner than latter.
5. If they wanted to wipe out the equity they should have done it in 2013 or 2014. With all the problems CETV had, it was perfect time for it. And equity holders really got burned. But now, with improved market conditions, Warrants exercises etc. it is much harder to do that. Risks ( reputational and financial) for TWX are too big. So although this possibility may still exist, it is much smaller and diminishes with every quarter.
6. I don't think 12X multiple is too rich for a company that has great long-term prospects( due to narrowing the gap with Western Europe ad spending) and wide moat. I think it is much more likely that ten years from now some average tech company will stay out of business than that will happen to dominant broadcasters in the Central and Southeastern Europe. Maybe their share will be smaller but as examples from Western Europe and US show, channel brands do matter. But OK, even with 10X multiple this is still great investment.
7. Common equity vs. PIK Notes? Sorry, but I wouldn't know. I don't know where PIK Notes trade these days and who( besides TWX) holds them. My non-US broker doesn't provide me with that sort of data and as a small retail investor I don't have Bloomberg or anything similar. If someone knows some free site with these kind of information, I would appreciate it. All I can say on this subject is that I don't find default risk high and that we might see CME starting to pay them down the next year.
I hope was of some help.
|Entry||12/29/2015 10:25 PM|
Thank you, Veki. This is definitely helpful. Looks like the situation has evovled / improved quite a bit and it is probably worth for me to do some digging.
If I find out more about the PIK notes, I will surely post here and share thoughts on those.
Thank you again!