SINCLAIR BROADCAST GP -CL A SBGI
August 16, 2015 - 10:38am EST by
JSTC
2015 2016
Price: 28.36 EPS 1.60 3.00
Shares Out. (in M): 95 P/E 12.4 12.4
Market Cap (in $M): 2,720 P/FCF 5.7 5.7
Net Debt (in $M): 3,825 EBIT 419 643
TEV ($): 6,545 TEV/EBIT 12.7 12.7

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Description

In 2012-13, the TV broadcasters were great stocks to own.  I was last involved in late '13 with LIN (VIC writeup yielded a ~70% return in three months: link here), but became cautious on the space after exiting that position (in Nov-13) and have been uninvolved for the past two years.  Various risks that became more acute throughout 2014 have since largely been put to rest.  Now, I believe that Sinclair Broadcast Group (“SBGI” or the “Company”) is emerging as an exceptional opportunity going into 2016 and could turn out to be a double over the next 12-18 months

SBGI's stock has essentially gone nowhere for two years, and as a result, has become progressively cheaper as pending acquisitions have since closed and retrans has continued to drive the top-line higher organically.  At an 18% FCF yield before growth investments (16% net of growth investments) and having underperformed broadcast peers, SBGI is cheap on both an absolute and relative basis.  Furthermore, this valuation reflects no value attributed to 'excess' spectrum that doesn't generate EBITDA.  I have historically only given SBGI credit for its spectrum as upside optionality, but recent developments suggest that this value could be monetized imminently.  On its last earnings call (8/5), mgmt announced the results of its analysis estimating that SBGI could monetize $2bn worth of spectrum (equivalent to ~75% of SBGI's market cap) while giving up only 3% of its broadcast cash flow (BCF).  Finally while still early days, 2016 is shaping up to be a record-breaking political year, which is very likely to exceed 2012's peak levels and Street's estimates.  SBGI’s core business is undervalued and should trade at a low-DD% FCF yield (50-65% upside), and the value of SBGI’s spectrum to be realized in the incentive auction offers an incremental 40-50% upside – making SBGI a potential double over the next 12-18 months.  

THESIS

Upside: Based on 9x (11% yield) the mid-point of mgmt’s FCF per share guidance and assuming $2bn of spectrum value before taxes (based on mgmt’s estimate), SBGI has upside of over 100% in the next 12 months.  Here, I have estimated that monetized spectrum is taxed at a 30-40% cash rate – this may turn out to be conservative.  I discuss these assumptions more fully herein.

   

Valuation: SBGI currently trades at ~8x average 2015/16 EBITDA and a FCF yield 16% (18% excluding investment in growth).  What other sector in the entire market trades at a high-teens % FCF yield, where revenue and cash flow are growing?  Even if I ignore the spectrum opportunity, ignore a political-driven beat in 2016, and assume mgmt is going to sit on its hands for the next several years, the FCF yield alone is sufficient to achieve a 20%-handle annual return.  Like other broadcasters, SBGI runs with a decent amount of leverage (just below 5x) given cheap debt, robust cash flow, and asset coverage.  While cash flow will be primarily directed toward the (i) dividend, (ii) opportunistic share buybacks, (iii) and tuck-in acquisitions, debt pay-downs offer another accretive use of cash where appropriate.  



Relative Valuation: SBGI trades cheap to its pure-play peers, with GTN and NXST trading at a premium of >1x EBITDA and 400-500bps of adjusted FCF yield.  While SBGI’s opportunity for M&A is less material than its smaller peers given the FCC’s 40% of households cap, SBGI benefits from size and scale that give it leverage in retrans negotiations and geographic diversity of revenue.  In addition, SBGI has made investments in content and the new ATSC 3.0 digital broadcast standard, which are included in expenses/capex but not yet reflected in SBGI’s revenue for purposes of mgmt's FCF guidance.  Finally, SBGI is best positioned to capitalize on its spectrum value, given the flexibility inherent in its multi-station markets.  The below table is based on Street’s consensus estimates and mgmt’s guidance: 



Spectrum: I have historically not attributed additional value to SBGI or any of the broadcasters for spectrum due to the many variables and uncertainty surrounding the auction, as well as a general apathy historically communicated by mgmt teams regarding participation.  It was also previously unclear how much BCF (station-level EBITDA) broadcasters would lose if they were forced to shutter stations in markets where they sold their spectrum.  However, recent developments suggest that a near-term monetization of SBGI's spectrum is possible, and we can now quantify the upside more concretely.  During its earnings call on 8/5, mgmt indicated it could sell $2bn worth of its spectrum while only giving up ~3% of its BCF.  Based on subsequent discussions with mgmt, I have come to believe that they have every intention of offering the full $2bn worth of spectrum in the auction.  While mgmt has historically voiced that it had no intention of participating in the spectrum auctions, its stance has shifted over the past year as new information regarding rules and indicative valuations have been released by the FCC.  The FCC has published presentations prepared by Greenhill which provide an overview of the auction process and potential valuations for spectrum by the market (see here: October 2014 Slides, and February 2015 Slides).  Mgmt indicated that with the additional disclosure, it was able to conduct a station-by-station analysis to evaluate the merits of participating in the auction.  As the largest owner of duo-, tri-, and quad-opolies of any broadcast affiliate, SBGI is uniquely positioned to reshuffle station licenses and free up excess spectrum without sacrificing the lost EBITDA that would result from shuttering stations.  Based on the Greenhill analysis, mgmt estimated the value of this excess spectrum at $2bn.  There are still questions as to what the ultimate opportunity from the auction will be – it will depend on telco demand for spectrum in SBGI’s markets and what price they will pay – but what is clear is that management is prepared to supply the FCC with a substantial chunk of spectrum to be auctioned.  The amount realized by SBGI might be more or less than $2bn, but the stock is pricing in $0 value for the spectrum and any amount monetized will be very meaningful upside to the stock, with its market cap of just $2.7bn.  

2016 Political: SBGI benefits from a meaningful boost to revenue during political years, and especially during presidential election years like 2016.  It’s still early, but indications suggest 2016 could be an even bigger political year than the records set by the 2012 election cycle.

http://blogs.wsj.com/washwire/2015/07/15/what-to-watch-in-presidential-campaigns-quarterly-filings/

http://news.yahoo.com/bushs-2016-campaign-says-raises-11-4-million-173713664--election.html

https://next.ft.com/859941fa-23f4-11e5-9c4e-a775d2b173ca 

Retrans: Growth in retransmission revenue has been one of the most important and overlooked evolutions in the broadcaster business model.  This growing stream of retrans revenue is far more stable and predictable than advertising revenues, which ebb and flow with the economic environment.  SBGI’s retrans picture looks highly favorable, and mgmt has indicated that its net retrans will grow at a “teens %” rate in coming years.  With the recent renewal of the Company’s CBS and CW affiliation agreements, SBGI has 75% of its MVPD subscriber base up for renewal over the next twelve months, while only 10% of their network subs still need to be renewed.  This puts the Company in a great net retrans position currently, with good visibility on its reverse retrans costs going forward.  The growing composition of retrans in SBGI’s topline de-risks the business model and argues for a higher than historical valuation multiple for the group. 

Recent Volatility:  Fears around “cord cutting” catalyzed by Disney’s commentary on its earnings call earlier this month regarding sub losses at ESPN led to exceptional volatility in the media sector, to which SBGI was not immune.  This volatility offers an outstanding opportunity to buy SBGI, given over-blown fears in response to issues which are not new and only mildly relevant to the broadcasters.  The sell-off illustrates a fundamental misunderstanding on the part of market participants regarding the retrans ecosystem, and the affiliates' place in it.  First, the broadcasters’ mgmt teams are all indicating they don’t see any material loss of subs.  While some consumers choose to cut costs by switching to “skinny bundles”, which exclude ESPN and other cable channels, it has no impact on the broadcasters.  Local broadcast channels are the core of any bundle, and they are never cut.  Second, while there is a secular trend towards cord cutting amongst millennials longer term, it has been a very slow decline. Nationwide subs have been essentially flat for the past five years, and any decline in the near-term is estimated to be in the ~1-2% range, annually. This is not a mass exodus away from bundles.  Lastly, net retrans is growing at a teens rate annually, so sub losses would have to accelerate meaningfully in order to really be felt by the affiliates. We’re talking about the loss of a relatively small amount of growth in retrans, which itself comprises a minority of total revenue (albeit high margin revenue).  Rabbit ears are and have always been an alternative to accessing local stations without cable.  Ultimately, cord cutting risk is fully priced in at a mid/high-teens% FCF yield, and has been massively overblown in the market recently. 

BUSINESS OVERVIEW

SBGI is the largest TV broadcaster, with 161 stations in 79 markets.  Its stations reach 38% of US households, just below the FCC’s 39% cap.  SBGI’s size affords it scale, reach, and diversification far beyond its peers.  Its revenue composition includes 30% syndicated content, 30% local news, 28% network, 8% local sports, and 4% paid programming.  Its network affiliations are also well balanced with 26% ABC, 20% CBS, 27% Fox, 9% NBC and 18% other.  Geographically, no market makes up more than 5% of revenue for SBGI, with the politically important Washington D.C. market being its largest.  This scale and diversity gives SBGI negotiating power with vendors, networks, and MVPDs.  It also allows SBGI to deliver an all-in-one offering when selling to political campaigns and other advertisers seeking to blanket a local, state or regional audience.   



The core of SBGI’s content is its local news.  The data supports that local news remains highly relevant to viewers, and the networks and MVPDs recognize its value proposition.  For commercial advertisers, local news delivers a large audience in key demographics; and for political advertisers, it delivers informed viewers who are likely to be involved at election time.  Beyond news, SBGI purchases syndicated programming such as game shows (Wheel of Fortune, Jeopardy, etc.), sitcoms (Big Bang Theory, etc.), reality (Judge Judy, etc.), and talk (Ellen, Dr. Phil, etc.).  As a result of SBGI’s scale, it gets a first-look at new shows and lower programming costs per station.  Finally, SBGI airs local sports and develops original programming.  Its original programming focuses on low-cost, unscripted productions.  

While the TV broadcast model historically relied primarily on broadcast advertising revenue, sold to local businesses and national advertising agencies.  Digital and retrans have been important growth drivers in recent years.  SBGI’s digital strategy includes investment in station websites, personalized mobile apps, and the development of technology to more efficiently and effectively deliver ads over various mobile platforms.  These investments and SBGI’s station reach has made its digital platform one of the most visited news (#13) and political (#2) platforms on the web.  Unique visitors have grown to almost 40mm from less than 5mm in 2012, and this translates into digital revenue growth in the high-teens %. 

Finally, retransmission revenue has been one of the most important evolutions in the broadcaster business model.  Starting several years ago, the broadcasters recognized that they were being underpaid by MVPDs (cable and satellite providers) for their content and began pushing for per-sub rates closer to that of major cable channels.  Given the popularity of local news and network programming, the MVPDs were compelled by market forces to increase per-sub rates paid to broadcast affiliates.  Though much progress has been made by broadcasters in growing their share of the MVPD’s programming fees, there remains a substantial disconnect between rates ($) and ratings (viewership), as illustrated in the table below.  The major broadcast networks to which SBGI’s stations are affiliated generate 2-3x the viewership, while receiving programming fees roughly in-line with far inferior cable channels and well behind ESPN at $7.44 per sub. 



SBGI’s retrans picture looks highly favorable, and mgmt has indicated its net retrans will grow at a “teens %” rate in coming years.  With the recent renewal of the Company’s CBS and CW affiliation agreements, SBGI has 75% of its MVPD subscriber base up for renewal over the next twelve months, while only 10% of their network subs still need to be renewed.  This means SBGI is in a very favorable net retrans position, as its reverse retrans costs are already contractually locked-in while retrans revenue will be imminently boosted as expiring contracts renew at higher rates.  Retrans revenue is more stable and predictable than advertising spend, which ebbs and flows with economic cycles.  The growing composition of retrans in the topline of broadcasters de-risks the business model and argues for a higher than historical valuation multiple for the group. 

SPECTRUM OPPORTUNITY

I have historically not attributed additional value to SBGI or any of the broadcasters for spectrum given the many variables and uncertainty surrounding the auction, as well as a general apathy communicated by mgmt teams regarding participation.  It was also previously unclear how much BCF (station-level EBITDA) broadcasters would lose as a result of selling spectrum.  But in speaking with SBGI mgmt, it is now clear to me that their posture toward the auction has become far more constructive, as a result of new disclosure on the rules, process, and potential valuation.  Mgmt sees the opportunity to monetize ‘excess’ spectrum, which currently generates no BCF for the business.

During its earnings call on 8/5, mgmt indicated it could sell $2bn worth of its spectrum while only giving up ~3% of its BCF, and I believe mgmt has every intention of offering the full $2bn worth of this spectrum in the auction.  The FCC has published presentations prepared by Greenhill which provide an overview of the auction process and potential valuations for spectrum, by geographic market (see here: October 2014 Slides, and February 2015 Slides).  Mgmt indicated that with the additional disclosure, it was able to conduct a station-by-station analysis to evaluate the merits of participating in the auction.  As the largest owner of duo-, tri-, and quad-opolies (2-, 3-, or 4- stations in one market) of any broadcast affiliate, SBGI is uniquely positioned to reshuffle station licenses and free up excess spectrum without sacrificing the lost EBITDA that would result from shuttering stations.  Based on the Greenhill analysis, mgmt estimated the value of this excess spectrum at $2bn.  There are still questions as to what the ultimate opportunity from the auction will be – it will depend on telco demand for spectrum in SBGI’s markets and what price they will pay – but what is clear is that management is prepared to supply the FCC with a substantial chunk of spectrum to be auctioned.  The amount realized by SBGI might be more or less than $2bn, but the stock is pricing-in $0 value for the spectrum.  Any amount monetized will be very meaningful upside to the stock, with its market cap of just $2.7bn.  

 

SBGI 2Q’15 call (8/5): “We continue to evaluate spectrum auction opportunities; and based on the Greenhill median prices, believe there could be opportunities for us to relinquish licenses with an aggregate value of approximately $2 billion at a cost of less than 3% of our current BCF and still participate in the potential business models that come with ATSC 3.0… that $2 billion is based on the median Greenhill values… we could obviously sell more than that; it would have a greater BCF impact. That number is kind of our best guess right now of an optimal outcome…. We went market by market, station-by-station, but the big assumption is that the Greenhill median values are the ultimate auction outcome… I do think there is a market perception that we won't – we don't want to participate. So that's one of the reasons we put that statement in the earnings release here or call today, just to give some people a little bit more specifics around what the upside is for Sinclair, which is about $2 billion with a minimal impact on BCF. And what has changed recently is just more rules, and specifics have come out around the auction and have enabled us to help quantify for you all what could be the potential and help solidify our optimal strategy. At the end of the day, we're here to maximize shareholder value and the auction is a means to do that. And we're weighing all those alternatives. So we'll know, as was stated by David, that the actual outcome is uncertain pending a lot of variables in the auction. But when you do the math and you look to maximize value, there could be some substantial opportunities for Sinclair.”

Reactions from other broadcasters to the auctions are mixed, and appear influenced by station exposures (large market vs small market), existence of duopoly markets, and other factors.  NXST remains constructive but highlights their small-market focus limits the monetization potential…

 

NXST Barcap Conference (6/12): “We think that there are spectrum opportunities in the near-term for the company. We'll see how that plays out. Really beginning in 2016, our general thesis is that the spectrum opportunity and the spectrum demand is largely a top 20 market phenomenon. We have two stations in the top 20 markets. We have another handful of stations that are on the edges or adjacent to top 20 markets. So the opportunity for us, we believe, is probably most in focus in those seven or eight markets, and we'll be evaluating that as the spectrum auction approaches early next year. And we believe that it will take place in 2016.”

 

NXST 2Q’15 call (8/6): “Obviously, we will look at it and if we are able to sell spectrum assets at a premium to what those assets are worth as operating businesses, as good fiduciaries we would do that, if it's a significant premium… So our position on the auction hasn't changed… We believe that the best use of our spectrum would be some sort of a recurring revenue model or leasing model rather than a one-time return on capital liquidation event. And our bias is still toward operating businesses rather than selling businesses.”

GTN has an outsized composition of #1 or #2 stations in their markets, and has expressed limited interest in the auction.  In most cases, selling spectrum would put GTN out of business in those markets (unlike SBGI which has substantially more flexibility through license sharing and other arrangements)…

 

GTN 2Q’15 (8/5): “There's been a lot of controversy on the impact of the repacking and everything that's happening with the FCC. I think that's very company-specific. That is something that we have publicly said that it was extremely unlikely that Gray will participate in, because our stations make a lot of money. They've got tremendous cash flow and they have an enormously important role in their individual communities.”

MEG is open to participating in the auction…

MEG 2Q’15: “Finally, the FCC announced it would begin the spectrum auction at the end of the first quarter 2016. As outlined during our Investor Day, Media General is positioned well to consider several spectrum monetization opportunities in projected high demand markets. We are big believers in the broadcast business and its future, but we also have done much work in this area to refine our strategy and consider potential auction opportunities.”

On August 6th, the FCC voted to approve bidding procedures for the auction, and they have tentatively set a March 29, 2016 date to begin the auction.  Fed Chair Tom Wheeler is determined to substantially complete the auction while he is in office, before the 2016 presidential election.  For that to happen, the auction needs to begin sometime in the spring of next year.  While there are still variables that could impact the process and ultimate timing of the auction, there is good reason to believe the auction could go off in the next twelve months.

There are two steps to the auction process: (i) a reverse auction involving broadcasters who own spectrum, and (ii) a forward auction involving telcos wishing to purchase spectrum.  In step one, broadcasters opt into the auction and declare a “walk away” price at which they are willing to sell their spectrum.  The FCC aggregates these “offers” to compile a market-by-market database of spectrum for sale.  In step two, the telcos bid for spectrum in the markets they demand.  Based on aggregate demand from the telcos and the price they are willing to pay, more or less spectrum will be sold in each market.  The spread between where broadcasters are willing to offer spectrum and the bid at which the telcos are willing to purchase spectrum becomes the FCC’s “commission.”  This amount will be remitted to the US Treasury. 

RECENT HISTORY

It’s informative to retrace recent history for the broadcast stocks, given the volatility they have experienced and their evolving business model.  Leading up to the 2008/09 recession, rosy economic projections and private equity interest drove valuations well into double-digits for EBITDA multiples.  In the recession, these highly levered and cyclical stocks got hammered.  Valuations remained extremely low (FCF yields wide of 20%) well into 2012, even as advertising recovered, and the stable and growing retrans portion of the business comprised an ever-increasing percentage of revenue.  There were accretive acquisitions, but the stocks just weren’t rewarded for them.  As the market rallied out of the 2012 summer downturn and earnings beat on higher than expected political revenue, valuation multiples began to expand somewhat, but it really wasn’t until 2013 that the market recognized the massively accretive consolidation going on in the space and re-rated the entire sector higher.  By the end of 2013, some stocks were trading into the high-SD/low-DD% range for FCF yields.  As a result of a series of negative headlines in early 2014, the sector was volatile but ultimately went nowhere in 2014. 

These negative headlines during 2014 included: (i) the FCC apparently taking a tougher stance regarding consolidation and the approval of announced deals, (ii) the FCC targeting broadcasters JSA (joint service agreements) for breakup, (iii) the threat of Aereo being validated by the Supreme Court, and (iv) the threat of networks stomping all over affiliates in reverse-retrans negotiations after CBS’ high profile move to replace LIN with Tribune on its Indianapolis station.  But since last year all of these risks have been greatly reduced or eliminated totally: (i) bills have progressed in Washington to grandfather JSAs, (ii) all pending deals have been approved by the FCC, including SBGI’s large acquisition of Albritton, (iii) Aereo was effectively shut down when the Supreme Court ruled it was violating the rights of broadcasters, and (iv) affiliation agreements signed in late 2014 and 2015-YTD have put to rest concerns that affiliates would get squeezed by the networks. 

RISKS

The broadcast stocks have proven susceptible to headline risks, as illustrated by the derivative impact on the space from Disney’s recent commentary regarding ESPN’s sub losses (see DIS earnings call from 8/4).  However, I think the risk picture feels as mitigated as it has been in a long time, and see the read-through from ESPN’s fundamental weakness to SBGI as negligible.  Ultimately, I think a teens% FCF yield for this business over-discounts these risks (many of which I see as minor), and I address each of them below.

Reverse Retrans: Retransmission consent payments (or “retrans”) are payments made by MVPDs (cable and satellite companies) to SBGI for the right to air its stations to cable customers.  Local stations, with their local news and primetime network content, are the most highly rated channels in the cable bundle.  Given consumer demand for these stations in the bundle, MVPDs must negotiate carriage with the affiliates, and like other cable channels (TNT, TBS, ESPN, etc.) SBGI demands payment for this carriage.  The networks (ABC, NBC, CBS, etc.), in-turn want a share of these retrans payments given the valuable primetime content that they supply to the affiliates.  These affiliate fees are often called “reverse retrans.” 

 



Over the past few years, there has been concern that that SBGI and other affiliates were at a disadvantage in negotiations with the networks (ABC, NBC, CBS, etc.), and that this dynamic would result in a disproportionate/excessive share of retrans being paid to the networks as reverse retrans.  This risk was most acutely in-focus in September of last year, when CBS gave its Indianapolis affiliation to Tribune (TRCO) after failing to reach an affiliation agreement with LIN (which has since been acquired by MEG).  Les Moonves, the CEO of CBS, is a very vocal and public figure who often likes to air private negotiations in the public arena.  His public commentary around the move further fueled fears in the market that all affiliates were at risk.  However since then, I believe these risks have been largely put to rest.  Affiliation agreements inked late last year and YTD’15 have gone off without any of the drama of the Indianapolis affair, and broadcast affiliates (including SBGI) are guiding to teens net retrans (that is, retrans less reverse retrans) for the foreseeable future. 

 

SBGI recently renewed affiliation agreements with both CBS and CW.  The CBS agreement was a 5-year, forward agreement – most of SBGI’s stations don’t even expire with CBS until 2016.  The long-term and forward nature of these agreements illustrates that the network/affiliate relationship remains respectful and symbiotic.  The networks recognize the value of local news, require daytime programming which the affiliates provide, and respect the scale and reach that SBGI boasts as the largest TV broadcast affiliate.  With these renewals, SBGI has 75% of its MVPD subscriber base up for renewal over the next twelve months, while only 10% of their network subs still need to be renewed.  This results in a very favorable net retrans position for the Company.  The growing composition of retrans in SBGI’s topline de-risks the business model and argues for a higher than historical valuation multiple for the group. 

Cord Cutting: “Cord cutting”, or the replacing of cable packages for an a la carte selection of over-the-top (“OTT”) media alternatives such as Netflix, is a subject that was brought into acute focus by Disney’s commentary on its earnings call earlier this month regarding sub losses at ESPN.  This commentary, in the context of weakness at other diversified and cable media companies, sent the entire media sector into a tailspin.  The broadcasters were caught up in this volatility despite reporting strong 2Q performance and providing constructive commentary for the remainder of the year.  This sell-off in broadcasters illustrates a fundamental misunderstanding on the part of market participants regarding the retrans ecosystem, and the affiliates' place in it.   First, the broadcasters' mgmt teams are all indicating that they don’t see any material loss of subs.  While some consumers choose to cut costs by switching to “skinny bundles,” which exclude ESPN and other cable channels, it has no impact on the broadcasters.  Local broadcast channels are the core of any bundle, and they are never cut... 

 

SBGI 2Q call (8/5): “We're not seeing any disruption. I think what you're hearing on ESPN is they're hitting a ceiling in terms of their revenue potential. And so now they have to start rationalizing their costs. But so far, that is not a problem for us in terms of our sub counts, as we're still on the most widely distributed tiers on all of our MVPDs, where that's not in case for ESPN.”

 

NXST 2Q call (8/6): “Well, I think, first of all, it's important to differentiate that we are not a cable network and that I believe that we are and will continue to be a part of every skinny bundle, as evidenced by the comments made by Apple and Sony and Sling just over the last week here. We have pretty perfect information on our sub count as we get paid on those sub counts every month. And we have seen no material degradation in our sub counts literally over the past year. And so I don't believe that the sky is falling. I like our chances in the skinny bundle because that means we have fewer competitors on the dial… we're in a slightly different business than national cable and I believe that we will be on every skinny bundle package going forward. I'm not sure you can say the same for ESPN or Viacom or Discovery networks. Those will be the choices of the MVPDs.”

The data confirms that consumers value their local news and network content, and it continues to be highly relevant.  So, while skinny bundles directly target the high cost of ESPN stations (i.e., Grandma doesn’t want to pay for Sports Center), SBGI and the broadcast networks are left unscathed.  Second, while there is a secular trend towards cord cutting amongst millennials longer term, we’re talking about a very slow decline that has been massively overblown.  Nationwide subs have been essentially flat for the past five years, and any decline in the near-term is estimated to be in the ~1-2% range, annually.  This is not a mass exodus away from bundles. 

Lastly, net retrans is growing at a teens% rate annually, so sub losses would have to accelerate meaningfully in order to be really felt by the affiliates. We’re talking about the risk of loss of a relatively small amount of growth in retrans, which itself comprises a minority of total revenue (albeit high margin revenue).  Rabbit ears are and have always been an alternative to accessing local stations without cable, but the bottom line is that cord cutting risk is fully priced in at a mid/high-teens% FCF yield, and has been massively overblown in the market recently.  Not to mention, there’s a more bullish side of cord cutting for the broadcasters as ratings decline for cable channels that get cut out by skinny bundles.  Fewer channels in the cable bundle means fewer advertising impressions; fewer impressions means advertisers chasing less inventory, which should drive advertising rates higher for the broadcasters.

JSAs: Joint service agreements (or “JSAs”) are contracts between same-market broadcasters which authorize a one station to sell ad time for the other station in exchange for a fee.  These JSAs allow news operations to exist where they otherwise could not, by reducing costs for small stations.  In early 2014, the market became focused on the FCC’s push to abolish JSAs.  By mid-year, the FCC implemented a rule to disallow JSAs, but provided a two-year period within which to comply.  JSAs comprise only a few % of SBGI’s revenue, but ultimately they probably will not even have to comply.  There is a bipartisan-backed bill moving through the House that would grandfather existing JSA arrangements.  The bill is the counterpart to the bipartisan Senate bill introduced in May and passed by the commerce committee in June.    

New Tech: Aereo, a new technology company that sought to retransmit broadcast signals to mobile devices, was an often cited risk to the broadcast model in 2013/14.  Last year, the Supreme Court ruled that Aereo was violating broadcasters’ copyrights, and shut the business down.  Apple TV or other OTT devices/apps will grow in popularity in the future, but those devices will need to pay the broadcasters retrans just like the existing MVPDs.   

Advertising Spend: The most valid concern regarding SBGI is just the economic environment, as a significant piece of the business is leveraged to advertising spend.  While national advertising has been a little soft over the past year, local advertising (which comprises >80% of non-political broadcast revenue, including retrans) has been strong.  National is only a small portion (<20%) of SBGI’s business.  2Q earnings were strong overall for SBGI and other broadcasters, and they were constructive on the forward outlook. 

CONCLUSION

SBGI operates in a complex industry, not without risks; but a misunderstanding of these risks has caused the market to meaningfully over-discount the Company’s robust cash flow stream (yielding 18% ex-growth investment).  The headline risks that have caused volatility over the past couple years are largely behind SBGI, and recent fear-induced selling has created an outstanding opportunity to own the stock going into a 2016, a presiential year.  Furthermore, SBGI's stock currently prices in zero value for its 'excess' spectrum, which could be monetized for ~$2bn based on mgmt's estimates.  SBGI’s core business is undervalued and should trade at a low-DD% FCF yield (50-65% upside), and the value of SBGI’s spectrum to be realized in the incentive auction offers an incremental 40-50% upside – making SBGI a potential double over the next 12-18 months.  

 

 

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.

Catalyst

Spectrum Incentive Auction in 2Q'16

Political cycle in 2H'16

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