Entravision Communications Corporation NYSE:EVC
July 28, 2017 - 1:11pm EST by
wichita
2017 2018
Price: 6.50 EPS 0 0
Shares Out. (in M): 90 P/E 0 0
Market Cap (in $M): 587 P/FCF 0 0
Net Debt (in $M): 225 EBIT 0 0
TEV ($): 812 TEV/EBIT 0 0

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Description

STRATEGY – BUY ENTRAVISION COMMUNICATION (NYSE:EVC) BELOW $6.50 PER SHARE

Summary

Entravision Communications Corporation (NYSE:EVC, “the Company”, or “Entravision”), a media company targeting Hispanics in the United States and Mexico, presents a timely special situation. On April 13, 2017, the FCC finalized the “incentive auction” for broadcast spectrum, which resulted in anticipated proceeds of approximately $264 million for the Company. The proceeds reflect the FCC’s acceptance of one or more bids placed by EVC during the auction to modify and/or relinquish spectrum usage rights for some of the Company’s television stations. Company Management does not expect that the modification/relinquishment of the spectrum usage rights will result in material changes in its operations or results. The proceeds are expected to be received in the second half of 2017.  Management has indicated it will use a portion of the proceeds to reduce debt (targeting debt-to-EBITDA ~2.0-3.0x) while retaining the cash balance for possible future acquisitions and shareholder returns.  As of March 31, 2017, total debt was $291.9 million, cash was $69 million, and trailing 12-month consolidated adjusted EBITDA was $69.2 million. The 2013 Credit Facility contains a total net leverage ratio financial covenant if the revolving credit facility is drawn. As defined in the credit agreement, the total net leverage ratio (net of up to $20 million of unrestricted cash) was 3.9x.

EVC will initially pay no taxes on the receipt of the $264 million as proceeds will be funneled into an intermediary to qualify for 1031 status (additionally, as of December 31, 2016, the Company had federal and state NOLs of approximately $309 million and $203 million, respectively, available to offset future taxable income). Thus, once the cash is received in 2H'17, EVC will effectively have ~$30-40 million in net cash (including a $32.5 million payment related to the relocation of WJAL-TV and any free cashflow generated from 2Q’17-4Q’17). At a stock price of $6.50 per share, the total enterprise value would be ~$550 million. Given the meaningful NOLs and reduced tax rate, free cash flow has averaged $45-50 million (although we see this value declining in the core business given headwinds in radio advertising and more recently digital).

The primary risk to the thesis is that management makes a foolish acquisition or misallocates the cash.  Given the Company’s prior history of material impairment charges related to an overzealous acquisition strategy from the early 2000s, this concern is legitimate. However, given our conversations with management, we believe the likelihood of their repeating the last binge is low. The Company has indicated a focus on buying “tuck in” assets in predominantly fast-growing and high-density U.S. Hispanic markets where it currently has capacity, and 1 or 2 other markets it has not entered. Our sense is that they are primarily buying stations and smaller digital revenue companies (i.e., Pulpo and Headway Digital for a combined $30 million). We also believe that the frenzy around some of the Hispanic oriented assets has declined and multiples are more rational. There are currently a handful of small and overleveraged companies from which EVC may be able are to pickoff assets (i.e., Spanish Broadcasting System Inc. OTCMKTS:SBSAA). Further, on July 21, EVC announced its intention to acquire Stations KMIR-TV, the NBC affiliate, and KPSE-LD, the MyNetworkTV affiliate, serving Palm Springs, California, for $21 million (6.5x expected blended 2016-2017 pro forma broadcast cash flow, including synergies). The acquisition will be immediately free cash flow accretive due to the tax efficient 1031 election structure.  Said differently, EVC will acquire $3.2 million in after-tax free cashflow (or a 15% yield), and public investors will capitalize those cash flows at an 8-10% yield.

We use some conservative assumptions to value the existing core business before putting to work the remaining cash available after debt paydown for M&A or other shareholder return. We assume stabilization in the radio segment and GDP/inflationary level growth in TV. EBITDA Margins continue to approach the 10-year average historical levels. Accounting for the lowered interest expense from the reduced debt balance, stock based compensation, and NOLs, we value the core existing business at $6.70-7.20 per share (comprised of cash per share of $2.20 plus $4.50-5.00 per share in no-growth free cash flow). Next, instead of just adding the cash per share, we add an estimate of the acquired free cash flow using a 6.5x purchase multiple for the remaining $200 million in proceeds. Using a 12.5x FCF multiple (8% yield) suggests an intrinsic value of $9-10 per share or 50% above current levels. 

Brief Company History

Headquartered in Santa Monica, California, the Company was formed in 1996 and IPO’d in 2000. During this early period, the Company undertook an aggressive acquisition strategy spending $1.1 billion on purchases from 1997-2000.  To finance these acquisitions, the Company issued almost $400 million in debt cumulatively over the same period and raised $814 million in net proceeds through the IPO to cover the balance. 46.4 million Class A shares were sold to the public at a price of at a price of $16.50 per share, and 6.5 million Class A shares were sold directly to Univision at a price of $15.47 per share. Additionally, at the time of the IPO, Univision exchanged its $120 million subordinated note into 22 million shares of Class C stock.  In connection with Univision’s merger with Hispanic Broadcasting Corporation in September 2003, Univision (i) entered into an agreement with the U.S. Department of Justice, pursuant to which Univision’s percentage ownership of the Company would not exceed 10% by March 26, 2009; and (ii) exchanged all of owned shares of Class A and Class C stock for 369,266 shares of Series U preferred stock.  The Series U preferred stock was converted into 37 million shares of new Class U common on July 1, 2004.   As of April 2017, Univision owned approximately 10% of the Company on a fully-converted basis through 9.4 million Class U shares which have limited voting rights.

Starting in fiscal 2006 through 2010, Entravision began taking several impairment charges related to their prior acquisitions ($887 million in total), primarily in the radio segments and associated FCC licenses due to increased competition and a general slowing of growth in the radio and television industries.

Company Overview (See 10-K)

Entravision is a media company targeting Hispanics in the United States and certain border markets of Mexico across media channels and advertising platforms. Entravision’s portfolio encompasses integrated marketing and media solutions, comprised of television, radio and digital properties and data analytics services. EVC reports in three segments based upon the type of advertising medium: television broadcasting, radio broadcasting and digital media.

Net revenues for the year ended December 31, 2016 were approximately $258.5 million. Of this amount, the television segment accounted for 62%, the radio segment accounted for 29%, and the digital media segment accounted for 9%, of total revenue.

Historical Revenues by Segments (%)

 

Segment Operating Margin Before Tax (%)

 

 

The Company owns and/or operates 54 primary television stations located primarily in California, Colorado, Connecticut, Florida, Kansas, Massachusetts, Nevada, New Mexico, Texas and Washington, D.C. The television operations comprise the largest affiliate group of both the top-ranked Univision television network and Univision’s UniMás network, with television stations in 20 of the nation’s top 50 U.S. Hispanic markets. Univision’s primary network is the most watched television network (English- or Spanish-language) among U.S. Hispanic households during primetime.

The Company also owns and operates 49 radio stations in 18 U.S. markets, one of the largest groups of primarily Spanish-language radio stations in the United States. The radio stations consist of 38 FM and 11 AM stations located in Arizona, California, Colorado, Florida, Nevada, New Mexico and Texas. Additionally, the Company operates Entravision Solutions as a national sales representation division, through which it sells advertisements and syndicates radio programming to more than 300 stations across the United States.

Finally, Entravision provides digital advertising solutions that allow advertisers to reach online Hispanic audiences in the United States and Mexico. The Company operates a proprietary technology and data platform that delivers digital advertising in various advertising formats to allow advertisers to reach Hispanic audiences across a wide range of Internet-connected devices on both Company and partner owned/operated digital media sites.           

Positives

Growing U.S. Hispanic Population

Entravision owns and/or operates media properties in 14 of the 20 highest-density U.S. Hispanic markets.  Hispanics are one of the fastest-growing segments of the U.S. population and, by current U.S. Census Bureau estimates, now the largest minority group in the United States. As of 2016, more than 56 million Hispanics live in the United States, accounting for nearly 18% of the total U.S. population (increasing from 35.3 million in 2000 when this group made up 13% of the total population).    

United States Population Estimates, 2000-2015

The overall Hispanic population is growing at eight times the rate of the non-Hispanic population and is expected to grow to 68 million, or approximately 20% of the total U.S. population, by 2021, and over 77 million U.S. Hispanics, representing nearly 22% of the total U.S. population by 2030. Approximately 51% of the total future growth in the U.S. population through 2021 is expected to come from the Hispanic community. Based on the 2010 census, 75%, of Hispanics lived in eight states with Hispanic populations of one million or more (California, Texas, Florida, New York, Illinois, Arizona, New Jersey, and Colorado).

The U.S. Hispanic population is projected to have accounted for total consumer expenditures of over $758 billion in 2016. With an average of $71,000 in 2016, Hispanic household income is growing at a faster rate than Non-Hispanic household income and is projected to reach an aggregate of $1.2 trillion in 2021. In addition, U.S. Hispanics are expected to account for 40% of employment growth in the U.S. from 2015 to 2020.

Entravision management believes that the demographic profile of the U.S. Hispanic audience makes it attractive to advertisers. The larger average size and younger median age of Hispanic households (averaging 3.4 persons and 30.5 years of age as compared to the U.S. non-Hispanic averages of 2.4 persons and 43.2 years of age) lead Hispanics to spend more per household in many categories of goods and services. Although the average U.S. Hispanic household has less disposable income than the average U.S. household, the average U.S. Hispanic household spends 8% more per year than the average U.S. non-Hispanic household on food at home, 41% more on restaurants, 58% more on children’s clothing, 45% more on footwear, 35% more on soaps, detergents and other cleaning products and 20% more on cellular phone services. The Company expects Hispanics to continue to account for a disproportionate share of growth in spending nationwide in many consumer categories as the U.S. Hispanic population and its disposable income continue to grow.

Approximately 78% of Hispanics age five and over in the United States speak some Spanish, while approximately 64% of U.S. Hispanics are bilingual and 33% are Spanish dominant. Over $7.8 billion of total advertising expenditures in the United States were placed with Spanish-language media in 2015, of which approximately 85% was placed with Spanish-language television and radio advertising.

Experienced & Aligned Management

Walter Ulloa, aged 68, has been Entravision’s Chairman and Chief Executive Officer since the Company’s inception in 1996. From 1989 to 1996, Ulloa was also involved in the development, management or ownership of EVC’s predecessor entities. From 1976 to 1989, he worked at KMEX-TV, Los Angeles, California, as Operations Manager, Production Manager, News Director, Local Sales Manager and an Account Executive. Ulloa owns 13% of Entravision shares on a fully-converted basis, primarily through the Class Bs. At current prices, the shares are worth approximately $75-80 million.

The Class A and Class B have similar rights and privileges, except that the Class B is entitled to ten votes per share as compared to one vote per share for the Class A. Each share of Class B common stock is convertible at the holder’s option into one share of Class A stock.

Univision, through the Class U shares, owns approximately 10% of the Company on a fully-converted basis, for a total value of approximately $60-65 million. Please see section on “Brief Company History” for a discussion of the historic ownership and evolution.  The Class U shares have limited voting rights and do not include the right to elect directors. However, so long as Univision holds a certain number of shares, the Company may not (without the consent of Univision), merge, consolidate or enter into another business combination, dissolve or liquidate or dispose of any interest in any Federal Communications Commission license for any of the Univision-affiliated television stations. Each share of Class U is automatically convertible into one share of the Class A stock (subject to adjustment for stock splits, dividends or combinations) in connection with any transfer to a third party that is not an affiliate of Univision. 

Entravision Beneficial Ownership Summary

Substantially all of Entravision’s television stations are Univision- or UniMás-affiliated television stations.  The network affiliation agreements with Univision gives certain Entravision owned stations the exclusive right to broadcast Univision’s primary network and UniMás network programming in their respective markets. These long-term affiliation agreements each expire in 2021, and can be renewed for multiple, successive two-year terms at Univision’s option (subject to EVC’s consent).

Under the Univision network affiliation agreement, Entravision has the right to sell approximately six minutes per hour of the available advertising time on Univision’s primary network, subject to adjustment by Univision, but in no event less than four minutes. Under the UniMás network affiliation agreement, Entravision has right to sell approximately four and a half minutes per hour of the available advertising time on the UniMás network (subject to adjustment from time to time by Univision). Under the network affiliation agreements, Univision acts as Entravision’s exclusive third-party sales representative for the sale of national advertising on the Univision- and UniMás-affiliate television stations. The Company pays certain sales representation fees to Univision relating to these advertising sales. Additionally, Entravision generates revenue under two marketing and sales agreements with Univision, which give the Company the right through 2021 to manage the marketing and sales operations of Univision-owned UniMás and Univision affiliates in six markets – Albuquerque, Boston, Denver, Orlando, Tampa and Washington, D.C.

Finally, Paul Zevnik, the “lead independent” director (aged 66), is a partner at the law firm of Morgan, Lewis & Bockius, LLP. Zevnik was involved in the development, management and ownership of Entravision’s predecessor entities from 1989 to 1996, and served as Secretary from the Company’s inception in 1996 until October 2003.

Receipt of $264 million in cash, Tax-Free

On April 13, 2017, the FCC finalized the “incentive auction” for broadcast spectrum, which resulted in anticipated proceeds of approximately $264 million for the Company. 

FCC Broadcast Television Spectrum Incentive Auction Winning Bids

The anticipated proceeds reflect the FCC’s acceptance of one or more bids placed by the Company during the auction to modify and/or relinquish spectrum usage rights for certain of the Company’s television stations. Company Management does not expect that the modification/relinquishment of the spectrum usage rights will result in material changes in its operations or results. The proceeds of the incentive auction are expected to be received in the second half of 2017.  Management has indicated it will use a portion of the proceeds to reduce debt (targeting 2.0-3.0x debt-to-EBITDA) while retaining the balance for possible future acquisitions and shareholder returns.  As of March 31, 2017, total debt was $291.9 million, cash was $69 million, and trailing 12-month consolidated adjusted EBITDA was $69.2 million. The 2013 Credit Facility contains a total net leverage ratio financial covenant if the revolving credit facility is drawn. As defined in the credit agreement, the total net leverage ratio (net of up to $20 million of unrestricted cash) was 3.9x. Thus, assuming 2.5x leverage on $70 million of EBITDA implies new total target debt of $175 million ($118 million repayment), leaving ~$214 million of cash for acquisitions and return of capital to shareholders.

EVC will initially pay no taxes on the receipt of the $264 million as proceeds will be funneled into an intermediary to qualify for 1031 status (additionally, as of December 31, 2016, the Company had federal and state net operating loss carryforwards of approximately $309 million and $203 million, respectively, available to offset future taxable income).

On July 21, EVC announced its intention to acquire Stations KMIR-TV, the NBC affiliate, and KPSE-LD, the MyNetworkTV affiliate, serving Palm Springs, California, for $21 million (6.5x expected blended 2016-2017 pro forma broadcast cash flow including synergies). The acquisition will be immediately free cash flow accretive due to the tax efficient 1031 election structure.  Said differently, EVC will acquire $3.2 million in after-tax free cashflow (or a 15% yield), and public investors will capitalize those cash flows at an 8-10% yield.  

Negatives

Questionable Prior Acquisition Decisions

The primary risk to thesis is that management makes a foolish acquisition or misallocates the cash.  Given the Company’s prior history of material impairment charges related to an overzealous acquisition strategy from the early 2000s, this concern is legitimate.

As discussed, during the early 2000s, this the Company undertook an aggressive acquisition strategy spending $1.1 billion on purchases from 1997-2000.  To finance these acquisitions, the Company issued almost $400 million in debt cumulatively over the same period and raised $814 million in net proceeds through the IPO to cover the balance. Starting in fiscal 2006 through 2010, Entravision began taking several impairment charges related to their prior acquisitions ($887 million in total), primarily in the radio segments and associated FCC licenses due to increased competition and a general slowing of growth in the radio and television industries. Specifically, the $610.5 million charge in 2008 consisted of a $133.5 million impairment of goodwill in the radio segment, a $413.0 million impairment of the radio FCC licenses, a $59.1 million impairment of the television FCC licenses and a $4.9 million impairment of the television syndicated programming contracts. The impairment charge of $189.7 million for in 2006 was a result of a $156.2 million impairment of goodwill in the radio segment and a $33.5 million impairment of the radio FCC licenses.

Given our conversations with management, we believe the likelihood of their repeating the last binge is low. The Company has indicated a focus on buying “tuck in” assets in predominantly fast-growing and high-density U.S. Hispanic markets where it currently has capacity and 1 or 2 other markets it has not entered. No major acquisitions have been completed since 2002, and the Company has largely executed on the strategy articulated (see note on Palm Springs stations above).

Entravision’s Historical M&A Activity

Recent acquisition targets Pulpo Media and Headway Digital have centered around growing Entravision’s digital revenues segment.  Pulpo is a provider of digital advertising services and solutions focused on Hispanics in the U.S. and Mexico. EVC purchased Pulpo in order to acquire an additional digital media platform to enhance its offerings to the U.S. Hispanic market. The transaction was funded from the cash on hand, for $15.0 million, net of cash acquired of $0.7 million, and $1.4 million contingent consideration.  The Q1 2017 earnings were somewhat concerning, however, in that Pulpo, on a stand-alone basis, posted negative low double-digit revenue growth.  Management commented that although the local business for Pulpo is strong (positive double-digit growth), national business is struggling.  The national demand is increasing for video, a product that EVC has been scrambling to produce, and unable to meet efficiently due to lack of inventory. That said, management believes Headway will be a strong compliment to the existing Pulpo business which will help drive growth in future quarters.

Headway Digital is a provider of digital marketing solutions primarily in the United States, Mexico and Latin America.  The transaction, also funded from Entravision’s cash on hand, includes an initial payment of approximately $12 million and up to $34.5 million in contingent earn-out payments based upon the achievement of certain performance benchmarks. Management believes the addition of this mobile programmatic data and performance digital marketing company will further enhance EVC’s digital capabilities to target audiences and consumers while supporting the EVC’s  goal to expand the contribution of digital operations to 20% of total revenue by 2018. As a note, on the 2017 Q1 conference call management stated that, “Pulpo and Headway revenue in Q2 of last year combined was approximately $12.2 million.”  2016 full year digital revenues (primarily Pulpo) was $23.1 million and operating margins recently turned to positive 4% in 2016 from -11% in 2014.

Our research suggests that the frenzy around some of the Hispanic oriented assets has declined and multiples are more rational. There are currently a handful of small and overleveraged companies from which EVC may be able are to pickoff assets (i.e., Spanish Broadcasting System Inc. OTCMKTS:SBSAA). Finally, we note that due to the 1031 election, management has 6 months to execute on closing those deal. Due to the time constraints, it’s also possible management feels pressure to execute on a less than ideal choice, although early indications suggest otherwise.

Compensation Structure

We see the current compensation structure as potentially worrisome given the M&A back drop created from the infusion of cash.  Total compensation for named executive officers is composed of (i) Base salary; (ii) Cash Bonus; (iii) Equity incentive compensation; and (iv) other standard benefits (i.e., automobile allowance, medical and life insurance premiums).  The salaries strike us as a little rich: $1 million for Ulloa and $500,000 each for the Chief Financial Officer (Chris Young), Chief Operating Officer (Jeff Liberman), and Chief Revenue Officer (Mario Carrera). The cash bonus component is discretionary. For example, factors considered in these bonuses include: (i) the performance and specific accomplishments of each NEO during the past year; (ii) the Company’s overall performance during the past year; and (iii) general competitive considerations, including retention purposes. Determination of the cash bonuses is based on the CEO recommendation and does not engage in specific benchmarking. We also note that Ulloa had requested that the Committee refrain from granting any bonus to him in 2009 and 2011 (following periods of weak performance), and the full amount of the bonus which he was eligible to receive in 2010, 2012 and 2013. 

Similarly to the cash bonus, for the Company does not use any pre-determined formula in determining the amount of equity incentive grants that are granted to executive officers.  It bases the grant amount on considerations such as the level of experience and individual performance of each executive officer, the number of stock options or restricted stock units granted to such executive officer in previous grants, and general retention/competitive considerations. Again, the Committee relies substantially on the CEO to recommend which individuals should receive equity incentive grants and the amounts of such grants.

Finally, in addition, certain key employees, receive additional performance-based restricted stock units (“PSUs”), which can be earned in an amount equal to 0% to 200% of their restricted stock unit grant, with vesting as follows: (A) upon the Company's achievement of performance goals based on certain revenue and consolidated adjusted EBITDA goals for the next fiscal year, and (B) provided the recipient is employed by the Company based on a multi-year vesting schedule.  On the one hand, we are concerned about adjusted-EBITDA/revenue metrics alone as targets, especially for an acquisitive Company. On the other hand; at least it is an objective measure. That said, our worry for revenue and “adjusted” anything targets is that the fastest way to meet them is to continuously acquire new businesses (whether it actually benefits shareholders). Hence, we would prefer to see return-based metrics as the criteria (i.e., ROIC).  Also, using “adjusted” anything is worrisome in that the metric typically excludes non-cash impairment charges and amortization/impairments of intangible assets.  This structure incentivizes management to acquire other businesses because they won't be penalized by future write-downs resulting from their overzealous expansion. 

Earnings Outlook

Entravision generates revenue primarily from (i) sales of national and local advertising time on television stations and radio stations; (ii) digital media platforms; and (iii) retransmission consent agreements that are entered into with Multichannel Video Programming Distributors (“MVPDs”).  Advertising revenue is generally higher during presidential election years (2016, 2020, etc.) resulting from significant political advertising and, to a lesser degree, Congressional off-year election years (2018, 2022, etc.). The Company recognizes advertising revenue when commercials are broadcast and when display or other digital advertisements record impressions on the websites of third party publishers.

Local and national advertising contributed ~81% of the revenue generated from the television operations in 2016 (42% of total TV revenues from local, 39% from national, and the remaining 19% from retransmission consent revenue). Substantially all the revenue generated from the radio operations is derived from local (62%) and national advertising (38%). In total, approximately 44% of revenues are from local advertising, 35% are from national advertising, and the remaining is 21% is a combination of digital revenues and retransmissions consent revenues.  Due to the cyclical nature of advertising, EVC’s revenues were hit particularly hard during the financial crisis (down almost 20% YoY in 2009). Since 2011, revenues have grown at a 4.5% CAGR, been roughly flat over the last 10 years, and grown at close to inflation (1.7%) since 2003.  We think growth of 2% for revenues for TV and Radio is a reasonable projection.  Management is targeting a 20% YoY growth (primarily M&A related to Headway, not organic) in 2018 for the digital segment which we expect to help mitigate declines in other segments.  

Entravision’s Financial Segment Analysis

Operating Margins have meaningfully declined from a high of 26% pre-crisis to 19% at year-end 2016.  Although TV segment margins have actually improved over this time frame (growing from mid-30s to 41%), the radio segment margins have essentially collapsed.  We assume at some point these margins have to stabilize for this business to remain a core asset as management has indicated radio provides synergies and cash flow enhancement opportunities with Television that remain valuable to the Company.

Assuming 2.5x leverage on $70 million of EBITDA implies new total target debt of $175 million ($118 million repayment), leaving ~$214 million of cash for acquisitions and return of capital to shareholders. We also note that on April 20, 2017 management moved one of its television stations, WJAL, from Hagerstown (population 900,000) to Washington, D.C. (population of over 8 million). WJAL is now broadcast on a shared channel in perpetuity of another full power station in D.C. in exchange for a payment by EVC of $32.5 million.  Accounting for the Free Cash Flow generated in the remainder of 2017, we expect Entravision at to have roughly $175 million in debt, and at least $200 million in cash.

Valuation

On average, EVC comparable companies trade for of 8-10% free cash flow yield.