Description

Investment Thesis:

While the market seems concerned about the sustainability of the terrestrial radio business, I believe Cumulus Media is a steady and growing business that is set to deleverage itself over the next few years and re-rate to a valuation more in-line with its actual business fundamentals. Further, a sizeable portion of Cumulus’s revenues are tied to talk radio; these revenues are not being threatened by Pandora and the other online radio offerings.  I have a $7.50 price target for potential upside of roughly 40% over the next 12-18 months with the potential for additional upside if some of Cumulus’s growth initiatives pan out.

Overview:

Cumulus Media is the largest pure-play terrestrial radio operator in the U.S., operating 467 radio stations in the U.S. (this includes stations owned by Cumulus as well as stations operated under Local Marketing Agreements). Cumulus’s lines of business are twofold: it owns its own radio stations and it operates LMA’s in which it provides content and advertising to radio stations in exchange for airtime. Due to long-standing regulation, radio stations do not have to pay royalties for music because they routinely break new music for artists. Cumulus’s main expenses include content production costs (DJ’s, talk-show hosts, support personnel etc.), its sales teams (local and national), and the physical costs associated with operating the stations. Cumulus’s split between national and local advertising revenues is roughly 25% and 75%, respectively. Cumulus owns radio stations around the U.S. in areas of various population sizes and with various ranges (each radio license authorizes the operator to project radio signal a certain distance based on the height of the radio tower). The company in its current form was created through the acquisition of Cumulus Media Partners (the share that Cumulus did not already own) and Citadel Broadcasting Corporation in 2011. The two acquisitions in 2011 transformed Cumulus into the 3^rd largest terrestrial radio operator in the U.S. with a diverse portfolio of stations around the country (Cumulus is now the 2^nd largest terrestrial radio operator). The acquisitions were financed with a combination of equity and debt and resulted in the company increasing its leverage substantially. The debt taken on included a first lien term loan which is now at libor + 350 bps with $1.3 Billion currently outstanding, a second lien term loan which is now at libor + 600bps with $785MM outstanding, and 7.75% senior notes with 610MM outstanding (the term loans can alternatively bear interest at the fed funds rate + 300bps and the fed funds rate + 550bps, at Cumulus’s option).

Recent Dial Global Acquisition:

Cumulus recently announced the acquisition of Dial Global, a large radio content provider for $260MM. The acquisition was largely financed by selling 53 radio stations to Town Square and agreeing to swap 15 Cumulus stations with Town Square in exchange for 5 stations. Cumulus thus only had to use $22MM in cash to fund the deal. Dial Global has a very diverse portfolio of content, including syndicated music programming, talk radio hosts, and sports programming (NCAA, NFL, NHL, etc.). The deal adds a quality portfolio of radio content to Cumulus’s current offerings and will allow Cumulus to leverage the content across the radio stations that it owns. Management has guided to the transaction adding $150MM in revenues and $30MM in EBITDA over the next two years. Further, management has stated that it anticipates roughly $40MM of cost synergies, with almost half of those synergies expected to be realized in the first year.

Management:

Cumulus is arguably one of the best-managed radio operators in the industry with a management team that is heavily incentivized to drive shareholder value. Lew and John Dickey have been running the business for the past 15 years and have proven themselves as knowledgeable and effective managers in the industry. Lew Dickey (CEO/Chariman/President) focuses on the strategic aspect of the business and John Dickey (Co-COO/EVP) focuses more on the operations and content side of the business. The remainder of the management team is composed of industry veterans who previously worked at various other radio stations. Lewis Dickey owns roughly 17.3MM shares of the common stock and John Dickey owns roughly 3MM shares of common stock, which represents a combined stake of about 12% of the company. A large portion of management’s compensation is in options that are stuck at $4.34; these grants represent substantial sums to the management team so they should serve as a strong incentive to realize shareholder value.

What the Market Sees:

I believe this situation is quite similar to Best Buy toward the end of 2012 where it was trading at a depressed valuation and the market wrongly assumed that Best Buy was doomed as a result of amazon and other online retailers being able to offer lower online prices. With terrestrial radio, the market sees an old paradigm that is being challenged by a variety of new competitors in the form of online music; these include Pandora, Spotify, Rdio, Slacker, and ITunes Radio, among others. As an example of this perspective, when Lew Dickey was recently interviewed on Bloomberg about the Dial Acquisition, Betty Liu asked if Pandora and Spotify were taking market share in people’s cars away from traditional radio; Lew Dickey responded by pointing out that the data does not support that conclusion at all (http://www.businessweek.com/videos/2013-09-05/cumulus-media-ceo-dickey-on-dial-outlook-for-radio). Many also worry about the effect of satellite radio growth over the past decade on terrestrial radio’s audience base. I believe Cumulus and several of its peers are trading at unlevered free cash flow yields in the mid 20’s because the market believes that these businesses will struggle to maintain their audiences going forward in the face of the recent crop of competition.

Divergent View:

I believe that terrestrial radio, despite the threatening challenges it is facing, is going to be able to maintain its audience base for the foreseeable future and continue to generate solid earnings. A recent study performed by Arbitron found that 92% of those 12 and older listened to terrestrial radio on an average weekly basis. Further, 86% of Generation Y listened to terrestrial radio on an average weekly basis. Other key findings from recent studies pertaining to the industry:

• 69 percent agree "streaming services do not replace radio."
• 80 percent say radio is helpful in discovering new artists or songs.
• 82 percent say the first thing they do when they get in a car is turn on the radio.
• 72 percent believe radio is more community-oriented than TV.
• 85 percent say radio is more accessible than at any time before and 78 percent say

               they can access radio anywhere.

• Radio advertising is viewed more positively than ads on TV, internet and mobile

              apps.

• 72 percent believe that radio feels more "human" than the internet and 65 percent

             believe it is more "personal" than TV.

• 71 percent say radio is a part of their daily routine.

http://imageshack.us/photo/my-images/594/6rst.jpg/

The chart above provides some context for just how large radio’s reach is across the U.S. population.

http://imageshack.us/photo/my-images/15/lxok.jpg/

The chart above demonstrates that terrestrial radio has actually added listeners over the past decade, despite the rapid growth of online radio and satellite radio.

http://imageshack.us/photo/my-images/542/ulw2.jpg/

As the chart above illustrates, terrestrial radio’s reach has been incredibly resilient over the past 40 years, despite the onslaught of various competitors.

Basic Value Proposition of Radio:

• Local medium – dj’s that know the local area and talk about local happenings/events, ads that are relevant to the local area
• One of the biggest places radio is used is in the car on the way to work – can be lonely and people connect with radio hosts – makes the commuting experience more enjoyable
• New songs are introduced periodically as they come out – as opposed to services like Pandora where if you listen to the same station often it gets very repetitive
• Dj’s are there not just to select music but also to entertain listeners – i.e. morning shows where there are a lot of daily bits such as pranks, quizzes, etc.
• A large portion of radio is talk-radio – this includes political programs, news programs, sports programs, etc. – online radio does not offer this and thus cannot compete on that front
• Ads are about as frequent as they are on online radio platforms
• Radio stations can provide a sense of community – connection with dj’s/hosts, other listeners, etc.
  

All of the above-mentioned facts and figures are sourced from radio station primers produced by Katz Media (http://www.raisingthevolume.com/radioprimer/). I would encourage anyone interested in Cumulus to read the first three reports as they demonstrate that the fundamentals of the radio broadcasting industry remain solid: radio continues to dominate as the medium of choice when people are in their cars and people continue to listen to radio on a regular basis.

Advantages of Scale in the Industry:

In the terrestrial radio business, there are several advantages to having significant scale:

• Ability to syndicate owned content nationally across a portfolio of stations
• Ability to leverage national advertising salespeople to sell ads for the entire portfolio of stations
• Ability to acquire smaller portfolios of stations relatively cheaply and take advantage of significant cost synergies
• Less reliance on any particular industry/region for advertising – less susceptible to economic headwinds
• Ability to engage in LMA’s and use national sales staff to generate additional revenue

As the 2^nd largest radio station operator in the country, Cumulus has an opportunity to leverage its scale and purchase small radio stations at attractive prices, utilize cost synergies, and increase the revenues and profitability of the stations through its national sales staff and content platform.

Opportunities for Growth:

Cumulus has several key opportunities for growth going forward:

• Recently launched a lifestyle country music station – Nash FM – can generate solid revenue and turn into a valuable brand that can be leveraged with promotions and special events – 5 of the top 10 selling albums last year were country albums
• Daily deal website called sweetjacks.com – also advertise it on their radio stations – can use their local sales staff to sign businesses onto the platform
• Continue to make smart acquisitions of small portfolios of radio stations/syndicated content at attractive prices – i.e. Dial Global Acquisition – financed with the sale of non-core stations

Fundamental Economics of the Business:

Unlike online radio and satellite radio, terrestrial radio stations do not have to pay royalties to artists; they only have to pay royalties to music publishers and songwriters, under the theory that radio stations help break new music for artists and thus should not have to pay to play it. This enables terrestrial radio stations to manage their costs and have a very profitable business model, whereas royalties paid to artists are currently causing serious problems for Pandora and other online radio stations. This dichotomy is due to long-standing laws that have been challenged by the music industry many times over the years but without any meaningful progress. While there has been talk of a renewed effort to require terrestrial radio stations to pay royalties to artists, I view this as unlikely given the long list of issues that politicians are currently facing that are higher priority items (http://www.nytimes.com/2013/07/26/business/media/congressman-vows-to-introduce-bill-on-radio-royalties.html?_r=0). For this reason, terrestrial radio operators are able to take advantage of favorable operating metrics whereas online radio and satellite radio have struggled to produce steady profits despite their dramatic growth in listeners since the turn of the century.

Valuation:

At its current EV of roughly $3.6 Billion, Cumulus trades at roughly 10x 2013 EBITDA and 8.5x 2014 EBITDA. While this may not seem particularly cheap, Cumulus is rapidly deleveraging its balance sheet and I expect that it can pay down $700MM of debt over the next 3 years. I valued Cumulus using a DCF with essentially Street Estimates, an 8x terminal EBITDA multiple, and a WACC of 12.5%. I believe that an 8x EBITDA multiple is reasonable because I expect Cumulus to generate roughly $525MM in EBITDA in 2017 and roughly $505MM of unlevered free cash flow. Thus, assuming total debt of $2 billion and an 8x forward EBITDA multiple at year end 2016, Cumulus would trade at roughly a 15% levered free cash flow yield which seems fairly reasonable considering leverage would only be about 3.5x total debt/EBITDA and the business would still be growing at a reasonable rate. Further, many broadcasting companies currently trade at around 8x forward EBITDA or slightly higher. I also valued Cumulus using the perpetual growth method with a terminal growth rate of -.25% and got to a value of $6.50 per share.

Risks:

• Relatively high leverage at about 7.5x debt/2013 EBITDA, though this has been reduced somewhat by the Dial transaction
• Rapid rise in interest rates – both term loans are floating rate
• As described above, I believe that radio listenership is going to remain strong going forward but Cumulus continues to face significant competition from Pandora, satellite radio, etc.
• Macroeconomic headwinds – radio advertising is correlated to the general economy so a severe economic downturn could create problems for Cumulus due to leverage
• Laws requiring terrestrial radio stations to pay royalties to artists – unlikely given current political environment and higher priority issues
• Inability to effectively integrate acquisitions – should not be a problem since management is very capable

Catalyst

 Catalysts:

• Market begins to re-rate Cumulus as it becomes clear that the business is stable and growing, despite inroads by newer alternatives to terrestrial radio
• Continued economic recovery drives advertising spending
• Continued deleveraging of the business
• Strong 2014 election advertising season