Description

Central European Media (CETV) owns broadcasting assets in Eastern Europe.  On February 26^th when the stock was at $5.62, I wrote about CETV as a compelling long. I now believe that after going up almost 7x in value, it represents a compelling short.   We have arrived at a teachable moment for the longs and I believe they are about to be schooled. Here is the summary of the facts: 

• - CETV invests approximately $1billion in enterprise value for Ukrainian broadcast assets that it agrees to sell back to the original owner for $300mm a year later.
• - CETV invests approximately $200mm for Bulgarian broadcast assets that it can't even give away a year later.
• - CETV abruptly fires the CEO who had saved the company from bankruptcy and then later abruptly fires his replacement, who took the company from minimal EBITDA to over $300mm a year.
• - CETV hires an insider and close friend of Chairman, Ronald Lauder, as new CEO and then pays over $100mm for his content company.
• - CETV massively dilutes holders after a 90% drop in the stock and allows a 25% premium for the super voting shares - owned by the chairman.
• - Despite a much lower share price because of dilution, CETV now trades at approximately the same enterprise value it had before the crash even though its EBITDA has been halved.
• - CETV's long standing CFO abruptly quits.

The stock has worked far better and faster than I thought it would.  The business on the other hand is much worse - tracking closer to a mid $100mm level of EBITDA (down from my $200mm estimate). Revenue has collapsed almost 40% in the most recent quarter, dropping anywhere from 22% in the Croatia republic to 90% in the Ukraine.  The company has made only a half hearted effort to cut costs - aiming at reductions of just 10%-- less than almost any other company I follow.  For a company that faced potential liquidity issues, this lackluster effort is stunning.  In addition, the company bought the new CEO's (Adrian Sarbu) Romanian production company (which sells content to CETV) for about $110mm.  According to CETV, in 2008 (when times were good and they had a sweetheart deal with CETV, providing the bulk of their revenue) Sarbu's company did about mid teens in EBITDA.   I suspect the business is at best break even now.  7x peak EBITDA for the CEO's business strikes me as a bit rich.  Sarbu also received a huge compensation package on top of the buyout.  

Adding insult to injury was the massively dilutive sale of equity to Time Warner.  When I wrote my long report in February, the share count was 42mm.  Fearing a liquidity crunch (even though none was imminent for several years if ever), the board decided to sell 14.5m Class A shares for $12 a share and 4.5mm super voting Class B shares (that only Chairman, Ronald Lauder, and Apax own), for $15 a share - representing 45% dilution to holders. This deal happened after the stock dropped over 90% in less than a year.  It is worth noting the large (25%) premium paid for the super voting shares by Time Warner.  Part of the bull thesis is that Time Warner will eventually buy CETV for a big premium, which may very well happen though I doubt from these levels. Based on the precedent of this deal, a disproportionate share of the value may go to these super voting shares and not to ordinary Class A holders. 

Around the time of this transaction, the longtime CFO left.  The company had just fired CEO, Michael Garin, who had helped grow CETV from minimal EBITDA to over $300mm during his tenure.  Before Garin, the board had fired Fred Klinkhammer, who saved the company from bankruptcy when CETV's most valuable assets were seized.

While none of these things, in and of itself, makes CETV a short, they do demonstrate poor corporate governance on top of the terrible capital allocation that saw the company pay $1 billion for the Ukraine after the credit markets had collapsed and approximately $200mm for Bulgaria - a station which they can't even give away now.  And the Ukraine?   A scant year after the billion dollar purchase, it's in the process of being sold for $300mm to the same gentleman who stuffed CETV for $1billion.

The most optimistic operating scenario that I can come up with assumes that the company can get to the $400mm in EBITDA they were supposed to generate last year.  They actually did about $300mm - and won't make anything near that amount again for several years.    But let's say they do get back up there eventually.  A generous 10x multiple on that number will give you a $3.0billion enterprise value. Subtract $840million in net debt and you have about $2.2billion in equity value or near $35 a share. I do not believe they will get that level of cash flow for at least 3 years.  The credit bubble pumped up Eastern Europe's economies in a way that is unlikely to be repeated. CETV commanded a higher multiple than U.S. TV networks because it wasn't so threatened by the internet and pay TV.   But the fragmentation of media is working its way into CETV's markets as well.  In addition, the $400mm of EBITDA was predicated on massive growth in the Ukraine - an asset they will either sell all of for $300mm or, at best, keep half. An asset, which is currently hemorrhaging over $60mm in EBITDA.

10x the $200mm in EBITDA that they won't hit this year would yield a $19 price per share which I think is much closer to the high end of fair value.  Due to the dilutive acquisitions and dilutive offerings, CETV's stock price seems much lower than the $100+ it traded in it glory days, but its enterprise value is actually almost the same as it was pre Lehman, while the EBITDA it generates has been cut in half.  At $5-6 in February, the stock was a long dated call option on solvency and recovery for some truly good assets.  Here it is a massively overvalued macro play/short squeeze. At $5 CETV was my largest long. At $38, it is my largest short.

Catalyst

So why is the stock running? CETV is one of the few liquid ways to play an Eastern European recovery and I think is being used akin to a 2x levered etf by momentum players. If the markets reverse or even stall, I think the stock could easily go back to the mid teens - around the levels where TWX invested.  I also believe that the company is obsessed with deleveraging and could do a large equity offering. After all, they were willing to sell shares at $12 and $38 is a long way from $12.  Finally, Bloomberg lists the share count as 50.5mm. It is actually over 61mm.  The difference represents 2 turns of EBITDA - a meaningful amount that I would guess many longs are not aware of.