|Shares Out. (in M):||81||P/E||8.3x||8.3x|
|Market Cap (in $M):||1,054||P/FCF||4.7x||4.7x|
|Net Debt (in $M):||2,113||EBIT||326||326|
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Business overview: Sinclair is a local television broadcast company that earns revenue from advertising, retransmission consent fees paid by cable and satellite companies, and digital advertising
Current trading: despite a positive industry outlook and highly accretive recent acquisitions, the company trades at a 21% normalized free cash flow yield
Investment thesis: high free cash flow yield, low single-digit organic revenue growth, sticky local advertising base, new revenue streams (retrans and digital) not fully appreciated by the market
Additional catalysts: the market does not fully appreciate the free cash flow contribution of approximately $1.1bn of acquisitions completed in the last 12 months. Despite guidance from the company, consensus EBITDA in 2014 is still significantly below where the company has guided for pro forma EBITDA in 2012
Price target: ~12% normalized free cash flow yield implies $23 share price
Sinclair Broadcast Group (“SBGI”) is the largest independent television broadcasting company in the U.S. The company owns or operates 84 stations in 46 markets, reaching 27% of the American population. SBGI’s television portfolio includes 22 FOX, 20 MTN, 15 CW, 11 ABC, 11 CBS, 3 NBC, 1 Azteca and 1 independent. In addition to television broadcasting, SBGI also has an assortment of other businesses, including an alarm monitoring business, a commercial sign fabricator and various real estate ventures.
As of Q3 2012, revenue by affiliates was the following (excl. the Newport acquisition):
Fox – 36%
ABC – 20%
CBS – 18%
MTN – 14%
CW – 10%
IND – 1%
NBC – 1%
The company generates revenue through three primary channels: advertising, retransmission fees and digital marketing. Approximately 70% of advertising revenue is derived locally, and in the 46 markets where SBGI operates, the company takes approximately 20% of the local ad share. Local markets are a primary focus of the company, as advertising buys are more relationship-driven and stable, unlike national advertising purchases, which are more commodity based. Due to broadcasters’ regional monopoly status (via the affiliate arrangement with the network and an FCC license), broadcast companies have deep economic moats. SBGI in particular has a strong operational track record, posting an average ROIC over the last five years of 33.4% and broadcast cash flow (“BCF”), defined as broadcast EBITDA before corporate allocation, margins of ~45% with minimum maintenance capex required (<$300k per station in a typical year).
Television Broadcast Industry Background
Commercial television broadcasting companies operate regional TV stations that are often affiliated with a major network (NBC, CBS, ABC or Fox). The major networks own most of the television stations in the top 10 designated market areas (“DMAs”), but rely on affiliates to broadcast content in smaller markets. Although only about 11 million television households (out of ~114 million) depend solely on over-the-air signal, all television households have access to local network channels through their cable and satellite services (multichannel video programming distributors or “MVPDs”). Although the broadcast industry is mature, it is far from a state of terminal decline. According to a recently published FCC document, nearly 78% of Americans say that on a typical day they get news from their local broadcast station (either directly over-the-air, or through MVPDs) – more than from newspapers, the internet or the radio. In addition, the three major broadcast networks’ nationwide evening newscasts draw 22 million viewers, five times the number of primetime viewers for the three major cable news networks (CNN, Fox News Channel, and MSNBC). Furthermore, 96 of the top 100 TV shows in the 2011-2012 season originated on broadcast television. Despite the rise of internet advertising, local TV advertising’s share of the total advertising spend has remained relatively constant through time (~10%) and more importantly, studies continue to indicate that television is by far the most effective advertising medium for raising new product awareness. Although with the rise of MVPDs and their non-network program offerings there is increased competition for local ad share, broadcast television networks remain the only ad medium viewable in 100% of television households (whereas the MVPDs can only air advertisements to their subscribers). This creates a significant competitive advantage for the network affiliates, especially with regards to political advertising. Industry analysts have long proclaimed the downfall of television advertising. Most notably, McKinsey released a study in 2006 that claimed by 2010 TV advertising would be only one-third as effective as it was in 1990. Although the financial crisis significantly reduced advertising budgets in 2009-2010, the television Armageddon scenario envisioned by various media analysts has yet to occur. AT Kearny recently published a research piece on precisely this topic: “Contrary to the fears of many, the Internet – and social media, in particular - hasn’t yet cannibalized TV advertising. In fact, it may even be improving the TV experience for viewers and advertisers alike.” The report also estimated that television’s share of the overall ad market rose 3% between 2006-2010 while the gains in Internet advertising have come largely at the expense of print.
Since the great recession, there have been three major industry developments, described below, that have created a step-change in television broadcaster profitability: retransmission revenue, duopolies, and digital revenue.
Retransmission (“retrans”) fees represent the compensation paid by MVPDs to local broadcast television stations for the right to carry their content as part of the MVPD’s program offering. As recently as five years ago, MVPDs did not compensate networks or affiliates for retransmitting their content. It was generally assumed that carrying local broadcast content for free and allowing the networks and affiliates to show advertising was fair compensation. The historical dynamic changed as increased competition between MVPDs allowed local broadcast stations to begin demanding a subscriber fee, similar to cable channels. In 2009, the last year that SBGI broke retrans revenue out separately, the company earned approximately $97mm in retrans fees and expected that to grow to ~$106mm in 2010. Retrans revenue, similar to royalty revenue, is highly attractive as there are no costs associated with it. In addition, total industry retrans revenue is still growing rapidly. Somewhat mitigating this windfall, however, is the fact that most broadcast companies are being forced to share some of this revenue with the networks, as Fox, NBC, etc. are beginning to demand a share of this increasingly large pie. Nevertheless, most broadcast company management teams are optimistic that retrans revenue will continue to be a major profit driver for the industry. While MVPDs pay approximately $33 billion per year for content that they air on their platform, network broadcasts, which bring in 35-40% of the audience share, receive less than 10% of the total (~$2.4bn in 2012). SNL Kagan recently updated their long-term industry retransmission forecast and project that by 2018, total retran fees will surpass $6bn, representing ~13% of total affiliate fees paid by MVPDs. SNL Kagan’s estimate assumes an average fee per subscriber of slightly less than $1.00 per month, while each MVPD would be responsible for aggregate retrans fees of $4.86 per subscriber. This does not seem unreasonable when considering the audience share that networks draw. To put this estimate in perspective, SNL projects that the current average retrans fee per subscriber is ~$0.47 per month (similar to what SBGI likely earns). In comparison, ESPN currently earns ~$4.75, TNT earns ~$1.20, and Disney earns ~$1.00 per sub per month. As mentioned above, the most significant factor mitigating this windfall to TV broadcasters is that the networks are increasingly demanding a share of the retrans fees (called “reverse compensation” or “reverse retrans”). SBGI started to pay Fox a reverse retrans fee in 2011 and management has stated that reverse retrans may eventually approach 50% of total retrans revenue. Although in the short term, management expects some mismatches (i.e., network affiliation agreements being renewed before MVPD contracts are renewed) that cause temporary declines in retrans profit (retran revenue – reverse retrans), they are confident that over the next few years retrans profits will grow significantly. In addition, there have been recent proposals by the networks to negotiate on behalf of the affiliates for higher retrans fees. In exchange, the networks would expect a higher percentage of the proceeds. Local television broadcasters do, however, have leverage in the retrans negotiations via their production of local news, widely considered ‘must-have’ content. SBGI produces the local news in 75% of its markets. Although there may be some near-term pressure on retrans profit over the next 12 months, it will likely not be material. Additionally, with the help of networks’ negotiating leverage, the retrans revenue stream is poised to grow significantly over the next decade.
The television broadcast industry is heavily regulated by the FCC. Until the mid-1980s, a single company could only own five television stations. Thus, the major networks owned stations in the nation’s largest markets and were forced to run their programming through affiliates in the other markets. In the 1980s-1990s, regulations were gradually loosened to eventually allow a single owner to operate stations that reach up to 39% of the country’s population. However, the same company cannot own two of the top four stations in a given market.
In many of SBGI’s markets, the company operates multiple stations. Although in some cases, this is permitted by the FCC, SBGI and other broadcast companies (most notably Nexstar) have been accused of sidestepping the legislation by establishing shared services agreements and local marketing agreements with stations owned by shell companies, thus effectively controlling them. Despite the criticism, ‘duopolies,’ as these arrangements are called, have resulted in significant cost savings, as redundant production, sales and overhead expenses can be eliminated. Nexstar, perhaps the industry’s most vocal proponent of the duopoly model, claims that broadcast cash flow margins in duopoly markets are approximately 500bps higher than non-duopoly markets. Although the FCC has begun to scrutinize this relatively recent industry development, broadcasters insist that without duopolies many stations in small markets would be unable to compete effectively and would likely go off-air.
Online advertising has increasingly become a focus for television broadcasters as companies sell ads on local news channel websites as well as mobile apps (i.e., weather and traffic). A recent study by Borrell Associates found that local advertising grew 38% in 2011 and that local TV captured a larger share (11.8% in 2011 compared to 10.5% in 2010). Digital’s importance is also increasing for television broadcasters, making up 6.9% of industry revenue in 2010 compared to 3.7% in 2007. SBGI does not break out digital revenue, but it is reasonable to assume that the revenue contribution from digital is in-line with its peers.
Free Cash Flow Accretive Recent Acquisitions
SBGI has completed five acquisitions over the last 12 months that have expanded the number of stations by ~44% and will significantly increase free cash flow. All of the acquisitions are being funded internally through cash on hand and new debt issuance. It is important to note that all of SBGI’s acquisitions are asset purchases and the resulting D&A (i.e., goodwill amortization) is fully-deductible for tax purposes.
|Four Points||7||$ 200||$ 31||6.5x|
|Total||23||$ 1,052||$ 156||6.7x|
|**Note: Assume $5mm of additional corporate overhead to be conservative.|
Illustrative Transaction Returns
The summary below gauges the value creation of the announced transactions with an illustrative ‘even-odd’ free cash flow calculation. Due to the cyclicality of political advertising, broadcaster earnings are typically much stronger in even years (~15-20% higher). As a result, it is common to analyze broadcast businesses on an even-odd average basis (i.e. ’11-‘12E).
SBGI’s current valuation implies a very high free cash flow yield. Using management’s pro forma figures, as well as some reasonable estimates for D&A and pro forma interest expense, we can calculate a normalized ‘even-odd’ year free cash flow for the company.
Price per share assuming 15% normalized FCF yield - $18.30 (41% premium to current)
Private Market Valuation
In the past 18 months, over $2bn of TV assets have been sold at multiples ranging from 8.5x to 11x BCF. Nevertheless, public valuations continue to trade 3 to 5 multiple points below this range. See below a take-private valuation analysis assuming a BCF multiple at the bottom of the precedent transaction comp range.
BCF even-odd year average: $459mm (pro forma for acquisitions, assumes 2011 BCF is representative ‘odd’ year, 2012 representative ‘even’ year)
Assumed multiple - 8.5x
Implied TEV – $3,902mm
Less: estimated net debt at Dec. ‘12 – $2,113mm (per company presentation)
Implied equity valuation: $1,789mm / $22.00 per share (70% premium to current)
This analysis excludes the value of SBGI’s other investments (i.e., the alarm monitoring business, real estate ventures, etc.). As of 9/30/12, the book value of the non-broadcast division was $279mm. Applying a 30% discount to the book value adds $2.40 of additional equity value per share. This valuation does not seem unreasonable given that the company has recently monetized several real estate assets for gains (average annualized return of ~22%) and was recently offered $50mm for the alarm monitoring business.
Implied equity valuation – $1,985mm / $24.40 per share (88% premium to current)
Normalized even-odd FCF yield – 11.2%
TEV / Normalized even-odd EBITDA – 9.2x
Normalized even-odd P/E – 15.6x
Over the past five years, valuation multiples have come down substantially for television broadcast companies, despite improving industry fundamentals in the form of higher digital and retrans revenue. Before the financial crisis, SBGI traded in a range between 9.0-11.5x EBITDA, which was in the middle of the comparable company range. Today, SBGI trades at 7.1x even-odd PF EBITDA, approximately in the middle of the range for its peers. In addition, the company pays a quarterly dividend of $0.15, representing approximately a 4.6% annualized yield at SBGI’s current price.
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