Thesis: Entercom Communications (“ETM” or the “Company”) is a cyclically and secularly challenged business trading at 10.5x 2018 EBITDA, with leverage of 6.3x. ETM bought CBS Radio last year (deal closed Nov 2017), with mgmt believing that it could stabilize revenue declines at these stations and return them to growth. While it is to soon assert that ETM has failed in this regard, the early fact pattern is not supportive. In fact, industry headwinds that surfaced 1Q’17 have grown meaningfully stronger over the past year, dragging down not only the acquired CBS stations, but also ETM’s legacy business. While I commend management on their historical track record of growth at legacy ETM and their commitment to the stock (evidenced by open market share purchases), I fault them for hubris in: (i) failing to fully acknowledge the meaningful differences and unique challenges facing the CBS stations they acquired (versus their legacy ETM stations), and (ii) currently failing to acknowledge the cyclical and secular headwinds their industry is facing. Mgmt remains adamant that theirs is a growth business, certain to capture share from other ad mediums. Their arguments for the secular share gains of radio from other mediums are the same I have been hearing about from Clear Channel (currently bankrupt) for years. The fact remains that no matter how strong radio operators believe their argument is for money to move to radio, radio has been a perennial share loser – and these losses are accelerating. Layer that against a backdrop of the softest local core advertising market we have seen since the recession, and it paints a poor picture for this radio operator levered >6x. Given weakness in core trends, I believe radio should trade at a discount to TV, as radio is 100% exposed whereas large TV operators generate >50% of their EBITDA from contractually locked-in retransmission fees. With TV stocks (NXST/GTN/SBGI/TGNA) trading at 7-8x EBITDA, I believe ETM should trade <7x EBITDA, which implies >50% downside for the stock. While ETM's stock has underperformed YTD, note that it is only down 9% over the LTM including dividends, despite numbers having come down ~40% over that time period (see model in long ETM write-up on VIC from 8/8/17) against financial leverage of >6x EBITDA.
Core Advertising: The primary pillar of my short thesis is that ETM mgmt and the market are failing to reflect just how soft and threatening core ad trends are for ETM and other radio broadcasters. Overall, local core advertising to radio and TV broadcast was down MSD% in 1Q. This trend has NOT improved in 2Q. ETM reported 1Q same-station revenue down -7.5%. Mgmt makes a debatable adjustment to this KPI, backing out the impact of USTN (discussed in greater detail below), to assert that 1Q adjusted same-station revenue was ‘only’ down 4%. They further indicated that these underlying trends had not improved in 2Q, echoing other channel checks I have made into the local broadcast ad market. This top-line performance is particularly alarming, given macro indicators for local economic activity are the strongest they have been in years; thus suggesting that something secular is at play here. This is further supported by the fact that outdoor advertising trends (LAMR is 80% local) have diverged from broadcast and are accelerating YTD. Lastly, the risk of cyclically/secularly challenged core is especially acute in radio, given the lack of meaningful digital/retrans/other revenue sources to mitigate declines. Whereas TV operators are <50% exposed to core, radio exposure to core is near 100%. Street is forecasting sequential improvement in revenue and margin trends each of the next three quarters. Further, they assume topline growth in 2019 and 17% EBITDA growth. Even assuming this rosy scenario, ETM would still be trading at 9x 2019 EBITDA, well above better positioned TV operators.
Balance Sheet:In order to acquire CBS Radio, a business nearly 3x the size of legacy ETM, the Company incurred an incremental $1.4bn of notes and term debt taking leverage to ~4x. However, EBITDA declines and underperformance versus expectations means leverage today stands at 6.3x 2018 EBITDA, and at 5.4x 2019 EBITDA (if we assume Street’s 2019 numbers can be achieved, which I do not). Even with this extended level of leverage, ETM’s FCF yield is only 10.5% 2018 and 12.9% 2019, which compares unfavorably to TV broadcasters yielding mid/high-teens% with less leverage.
CBS Radio: The acquisition of CBS Radio was effectuated through a split-off of CBS to participating CBS shareholders, with ETM shareholders owning ~28% of the pro-forma float. CBS’ stations operate in top DMAs and expanded ETM’s footprint into 23 of the top 25 DMAs. Mgmt and the market viewed CBS Radio as a neglected segment of the larger enterprise, with room for signficant improvement. While there is still time for mgmt to prove this thesis correct, the early fact pattern has not been supportive. I would further note, that while the “orphan business segment” thesis has worked out well in many situations historically, we can’t take for granted that the business was poorly managed under CBS ownership. A similar thesis existed for CBS Outdoor (now Outfront Media, NYSE:OUT), but OUT has consistently underperformed its peer LAMR since the split-off. It is quite possible that headwinds facing CBS Radio’s performance under CBS ownership had more to do with its large market exposure and secular changes in the advertising landscape than it did with mis-management by Les Moonves’ team. Many industry participants have questioned ETM mgmt’s thesis that it can employ the same playbook on CBS Radio that it has used effectively with its legacy portfolio. The jury is still out, but I strongly believe the market is failing to appropriately discount execution and other risks facing this turnaround.
USTN: One of the excuses offered by mgmt for 1Q underperformance was lost revenue associated with United States Traffic Network (“USTN”), a vendor to ETM that provides short duration advertising network services (e.g., sponsored traffic reports) and purchases ad spots from ETM to be resold by USTN to advertisers. In its 10K, ETM indicated that USTN represented <2% of the PF Company’s revenue in 2017. Fast forward to 1Q, and mgmt indicated that as a result of distress facing ETM, it could not recognize $12mm of revenue (~4% of revenue) in the quarter. Further, ETM has written off receivables from USTN in exchange for a note and equity interest in USTN. On the 1Q call, mgmt indicated that: “for the full year, our traffic advertising revenues will fall about $15 million short of what we previously expected for 2018, which translates into about 1% reduction in our revenues year-over-year although this shortfall could be greater if USTN is unable to successfully execute its restructuring plans and we are unable to replace these revenues through our own sales efforts.” Mgmt is telling investors that the ‘worst case scenario’ related to USTN revenue losses this year is $30mm, which would be a ~2% drag to growth. However, this situation remains fluid and uncertain, particularly given broader challenges and bankruptcies throughout the radio industry. The presumption of replacing a material customer in this soft ad environment is by no means a given.
Conclusion: ETM has rebounded from post-1Q earnings lows (~$6.50/sh) and now trades above $8/sh. The fact pattern since earnings season has only grown worse, as hopes for 2Q improvement in core have failed to materialize across the industry. I see continued poor trends and executional issues in 2Q as a catalyst for the short, when ETM reports next week or early August (last year they reported 7/28). From a valuation perspective, ETM should be trading at a discount to TV broadcast, sub-$4/sh or >50% downside. If radio core trends do not stabilize soon, ETM’s leverage will become a more serious threat to its solvency, and ETM could follow the path of so many of its peers (Clear Channel, Cumulus, etc.), into bankruptcy/restructuring.
DISCLAIMER: DO NOT RELY ON THE INFORMATION SET FORTH IN THIS WRITE-UP AS THE BASIS UPON WHICH YOU MAKE AN INVESTMENT DECISION - PLEASE DO YOUR OWN WORK. THE AUTHOR AND HIS FAMILY, FRIENDS, EMPLOYER, AND/OR FUNDS IN WHICH HE IS INVESTED MAY HOLD POSITIONS IN AND/OR TRADE, FROM TIME TO TIME, ANY OF THE SECURITIES MENTIONED IN THIS WRITE-UP. THIS WRITE-UP DOES NOT PURPORT TO BE COMPLETE ON THE TOPICS ADDRESSED, AND THE AUTHOR TAKES NO RESPONSIBILITY TO UPDATE THIS WRITE-UP IN THE FUTURE.
I do not hold a position with the issuer such as employment, directorship, or consultancy. I and/or others I advise hold a material investment in the issuer's securities.
2Q earnings miss Downward revisions to Street's numbers