Introduction: Southern Cross Media Group is a radio, TV station, and digital platform operator in Australia. The company operates 99 radio stations and 94 TV signals that reach 95% of the country’s population. Radio advertising accounts for about three quarters of its revenue. It trades on the Australian Stock Exchange under the symbol SXL. Southern Cross generates 100% of its revenue in Australia, so all dollar amounts in this report are in Australian dollars. The IR site of the parent company, Southern Cross Austereo (SCA), can be found here: https://www.southerncrossaustereo.com.au/investors/

Notes:

·         With its share price below $0.20, Southern Cross executed a 1-for-10 reverse stock split in November 2020. All the numbers in this report have been adjusted for the split. There are currently about 262 million shares outstanding.

·         Southern Cross reports its financials twice per year and uses a June-ending fiscal year. The company will report its FY22 1^st-half results on Feb. 24.

Summary: As an advertising-dependent business, Southern Cross (also referred to as SCA) was greatly impacted by the pandemic. Its revenue dropped 18% in FY20 and another 2% in FY21. While I believe Australia’s advertising market is recovering and Southern Cross’ balance sheet is in better shape than ever, its share price is no higher than it was at the height of the pandemic in May 2020. Thus, I think the stock is cheap, trading at current-year metrics of a P/E of 10, 1x sales, and an EV/EBITDA of about 4.6. Prior to the crisis, Southern Cross traded at about 2.3x sales, and other Australian media firms currently show mid-teen P/Es on 2023 EPS. My target price is $3.80, implying upside of more than 100%, based on an EV/Sales of 1.8x, or an 18x P/E on FY23 EPS.

Abridged History: Like many media companies, Southern Cross came together through a bewildering series of mergers, acquisitions, and divestitures. Macquarie Bank created Macquarie Media Group in 2004 to acquire radio stations. In 2005, after a series of acquisitions, it became publicly listed, but with a complicated ownership structure. Two years later, Macquarie Media acquired TV and radio station owner Southern Cross Media for $1.35 billion. In 2009, following large losses during the financial crisis, the company was restructured as a single public entity, and it adopted the Southern Cross name. In 2011, Southern Cross launched a $714 million takeover bid for rival radio station owner Austereo Group, and a merger was consummated. Today, Southern Cross Austereo (SCA) is one of the largest media companies in Australia. However, from an investment perspective, it has been a disaster: Split-adjusted, its share price has fallen from $26 in late-2006 to under $2 today. Indeed, over the past 15 years, Southern Cross has generated a woeful -5% annual return to investors.

The Pandemic / Ad Market

Southern Cross was not in great shape when the pandemic hit. At the end of calendar 2019, the firm had $329 million in short- and long-term debt and only $16 million in cash. So, in March 2020, the firm voluntarily halted trading on its free-falling stock for two weeks to give management some time to come up with a plan. In early-April, the firm announced cost cutting initiatives, capex reductions, a suspension of the dividend, a $50 million revolver drawdown, a renegotiation of its debt covenants and, most significantly, an equity raise of $169 million. The equity deal, which consisted of new shares and rights, was completed at (split-adjusted) $0.90 per share, a 45.5% discount to the pre-halt close (and far below pre-pandemic levels). The deal increased the shares outstanding by more than 150%. Despite the huge dilution, the stock recovered from just over $1 in early April 2020 to $2.70 just a few weeks later, but the gain didn’t hold. Since then, the stock has generally traded in the range of $1.60-$2.40. At $1.80, it is currently at the low end of this range.

According to its most recent report, Southern Cross’ revenues from top-10 advertising categories (including retail, auto dealers, home furnishings) were down 16.6% in 2H FY21 vs. 2H FY19, but up 13.0% in 2H FY21 vs. 2H FY20. However, I think there was a stronger turnaround in the second half of calendar 2021 (Southern Cross’ 1H FY22, not yet reported) despite lockdowns in some areas. On its FY21 year-end earnings call, Southern Cross’ management mentioned 20% ad sales growth in July and August, with double-digit percentage growth in 9 of the top-10 ad categories (retail being the laggard). The top-10 advertising categories represent about 60% of Southern Cross’ total ad revenue. The firm noted that supply chain issues in the auto sector have affected auto-related advertising. Some categories that have been directly impacted by the pandemic, such as live entertainment, travel, and movies, continue to suffer larger impacts, but these categories are relatively small. Of note, Australia has a federal election coming up in May which should boost political ad spending.

Southern Cross received significant government support during the pandemic. As in the U.S. and other countries, the Aussie government provided grants to businesses to prevent mass layoffs. Under its JobKeeper program, Southern Cross received $37.1 million, of which $5.2 million was recognized in FY20 and $31.9 million was recognized in FY21. The firm also received $10.3 million from a fund to support news organizations. In FY21, these two grants reduced Southern Cross’ employee expenses by $40.5 million. Thus, without these extraordinary grants, Southern Cross’ FY21 EBITDA would have been $85.4 million rather than the reported $125.9 million. I estimate the company’s FY22 EBITDA at $114.1 million, meaning that I expect its EBITDA to decline year-over-year on a reported basis but increase 34% excluding last year’s extraordinary grants.

Southern Cross claims that it cut “non-revenue-related” (overhead) by $31 million in FY21 as compared with FY20, but this is misleading as it includes some impact from the grants. Nevertheless, I do believe it has reduced its staff expenses as compared with its pre-pandemic levels. In my model, Southern Cross’ employee expenses are $151.2 million in FY22, down from $205.5 million in (pre-pandemic) FY19, a 26% reduction.

In early-2021, Australia passed a law which requires online news aggregators like Google and Facebook to pay local news providers for links to their content. Google and Facebook, fearing similar laws in other countries, both fought the law before it was passed, but eventually relented. SCA has since announced an agreement with Google News Showcase to pay for SCA’s news content. While the terms have not been disclosed, SCA’s management has said the deal is not material. SCA intends to sign a similar deal with Facebook but, according to media reports, Facebook has resisted signing such deals thus far.

Segments: Southern Cross operates in two segments: television and audio (radio/streaming). Of the two, audio is much more important. For FY22, I forecast audio will generate 75% of the company’s revenue and 79% of its EBITDA.

TV

Southern Cross owns TV stations in regional markets (outside of the major cities). It is one of three broadcasters in Australia licensed to operate in these markets. As in the U.S., these stations act as affiliates for national broadcasters and are dependent on their programming and ratings. Southern Cross also produces local content, such as news programs. Australia has 5 major TV networks. In order of ratings, they are: Seven West, Nine Network, Network 10, ABC TV, and SBS. Prior to 2016, most of Southern Cross’ stations were affiliates of Network 10, while Nine was carried by stations owned by WIN Corporation. In 2016, after a legal dispute between Nine and WIN, Nine signed a 5-year, $500 million contract with Southern Cross that covered its stations in regional Queensland, southern New South Wales, and regional Victoria (basically, the East Coast of Australia). These stations produce most of the company’s TV revenue. The firm has other stations that are Seven West affiliates, including the leading station in Tasmania. The switch from Network 10 to Nine was an upgrade (Nine’s ratings are roughly 10% higher), but the terms were unfavorable as ad revenue between Southern Cross and Nine was roughly split 50/50. After it was dropped by Nine, WIN picked up Network 10, so Southern Cross and WIN effectively traded affiliations. The deal between Southern Cross and Nine was set to expire on 6/30/21. In February 2021, Southern Cross’ management told investors that a renewal was imminent. Instead, Nine announced in March 2021 that would go back to WIN, where it believes it has greater reach. Southern Cross’ share price dropped 12% on the day of the news. In interviews, Southern Cross’ CEO Grant Blackley claimed to have been “blindsided” by the move.

After the loss of the Nine affiliation, Southern Cross signed a deal with Network 10 (where Blackley, incidentally, spent most of his pre-SCA career) in June 2021. So, in effect, the situation is back to where it was prior to 2016. There have been several negative reports in the Australian media on how much revenue Southern Cross is set to lose by the change (as 10’s ratings are lower). On November 1, the company put out a press release denying one of these reports. While the change is likely to lower revenue, Southern Cross has said that it will be EPS-neutral to the company because the revenue split with 10 is more favorable than it was with Nine. I estimate that Network 10’s share of the ad revenue is 30%-35%, less than the 50% or so paid to Nine. Southern Cross has estimated that its revenue-related expenses will drop $23 million-$24 million from FY21.

One concern is that the deal with Network 10 is only for two years (ends 6/30/23). Southern Cross probably signed a short-term deal in anticipation that the ad market will be back to normal by the time it ends, allowing it to strike a better deal. Also, Southern Cross’ affiliate deal with Seven West expires at the end of this June, which creates some uncertainty.

Apart from the affiliate issues, Southern Cross’ TV operations have been troubled. The company claims that its power ratio (ad revenue compared with audience share) is greater than 1.0 (1.11 last year) and leads the market. Its audience share generally ranged between 33.5%-36% over the past three years. However, like traditional TV broadcasters everywhere, it has been affected by Netflix, YouTube, Facebook, TikTok, etc., as streaming channels and new platforms steal share. In FY19, Southern Cross recorded an impairment to intangibles of $226.9 million (down to $0) related to its regional TV operations, an acknowledgement that traditional TV ad revenue is permanently lower. Then, in FY20, its TV revenue dropped 18% due to the COVID-19 crisis. Advertising has slowly recovered as the effects of the virus have declined and government stimulus has boosted the economy. In general, national TV ad spending has recovered faster than local spending as small- and medium-sized businesses continue to be adversely affected by sporadic lockdowns. In my estimates, I assume Southern Cross’ TV revenue drops 21% (about $36 million) in FY22 due to the affiliation change and some ongoing COVID-19 effects. However, I estimate its FY22 TV EBITDA will be a healthy $30.0 million. Although lower than the $38.1 million achieved in FY21 (which included JobKeeper grants), it would be higher than the $25.2 million generated in FY19 (pre-pandemic). As ad spending recovers, I believe Southern Cross can generate more EBITDA from TV due to the more favorable split with Network 10, cost cuts during the pandemic, and outsourcing of some functions that used to be part of TV’s cost base.

There’s only so much that Southern Cross can do compete with streaming channels and other threats. As digital advertising has gained, TV advertising has fallen to just over 20% of Australia’s total ad market from more than 35% over the past 15 years or so. In mid-2021, Southern Cross launched a new 24-hour news network on the East Coast called SkyNews Australia. It has also launched a sales initiative called “Boomtown” to encourage national advertisers to allocate more ad spending to regional markets outside of Australia’s major cities, which it claims has benefitted both TV and radio advertising.

There were reports in July 2021 that a group of investors with media experience was working on financing to buy Southern Cross’ TV assets. However, CEO Grant Blackley seemed to suggest on the FY22 earnings call that the TV stations are not for sale, and no deal has come to fruition. However, given the company’s focus on radio, it would not be a huge surprise if the TV stations are sold someday.  

Audio

Southern Cross generates most of its revenue and EBITDA from its radio stations. Its 99 stations have 7.2 million listeners. SCA has roughly 40% share of the regional market in Australia and 30% share in the major cities, making it the largest radio broadcaster in the country. Radio ad spending in Australia was in a long-term uptrend prior to the pandemic, accounting for about 8% of ad spending in the country. However, as everywhere else, terrestrial radio in Australia is threatened by digital providers like Spotify, Apple Music, podcasts, etc., and non-traditional devices like cellphones and smart speakers. SCA has said that, by 2024, 80% of Australians will be listeners of digital audio programming.

Southern Cross claims that it is now a “digital-first” company such that it is increasingly programming to draw listeners to its streaming services over its traditional radio stations Historically, its streaming has mainly consisted of its own radio content. To expand its streaming, the firm launched a streaming service called LiSTNR in February 2021. The free app covers live radio, music, recorded programming, podcasts, and news. There are also some premium podcasts and live sports. To support LiSTNR, Southern Cross increased digital audio spending by about $7 million in FY21. At the end of FY21, the firm reported that it had 4.5 million listeners across digital platforms. Aided by the launch of LiSTNR, Southern Cross reported $15.4 million in digital revenue in FY21, a 40% increase from the $11.0 million produced in the previous year. For FY22, the firm expects digital revenue to rise 75%-100% as it operates LiSTNR for the entire year and enhances its other streaming offerings. Even so, as digital revenue will account for less than 10% of its FY22 revenue, SCA will be dependent on traditional radio for the foreseeable future.

Southern Cross’ radio stations have the largest number of listeners in 25-54 age group. Its two metro radio brands are Triple M (targeted at men aged 25-54) and Hit Network (targeted at women aged 30-54). These two networks generate about 40% of Southern Cross’ total revenue (with regional radio and TV accounting for the rest). Triple M Network is the #1 network for men aged 25-54 and the #2 radio network overall in Australia. Triple M’s streaming audience grew 55% in FY21, and its podcast downloads increased 34%.

Southern Cross’ radio revenue dropped 5.5% in FY21, with the biggest drop among the major markets in Melbourne, where there were prolonged lockdowns. The performance was stronger in other cities that suffered fewer virus-related effects, with some showing gains over FY20. As for the regional stations, they were slowed by lockdowns and economic turmoil. In normal times (not in a pandemic), regional radio advertising generates relatively stable revenue from local businesses that cannot afford to spend as much on TV or digital ads. As in its TV operations, the firm has cut operating costs in radio.

Cash Generation/Balance Sheet

Southern Cross’ balance sheet is in much better shape than it was before the pandemic. Using the $169 million raised in 2020 and cash generated by operations, the firm repaid $275 million in debt in FY21. At the end of FY21, the firm had $75.4 million in cash and equivalents and long-term debt of $127.2 million, resulting in net debt of only $52.6 million. The outstanding debt consists of a bank loan at a variable interest rate (1.28% in FY21) that matures on January 8, 2023. At the end of FY21, Southern Cross’ reported leverage ratio was only 0.4, down from about 2.3 at the onset of the pandemic. Including capital lease obligations of $113 million, its total debt was $240.2 million at the end of FY21, down from $323.5 million at the end of FY19.

The lower level of debt (obviously) means that Southern Cross’ interest expenses are declining. In FY21, the firm’s net interest expenses (which includes bank interest, capital lease payments, etc.) fell to $21.9 million from $27.2 million in FY22. I forecast net interest expenses will decline further to $16.7 million and $9.7 million in FY22 and FY23, respectively.

I calculate Southern Cross’ free cash flow to equity at about $83 million in FY21. This amount was boosted by the government grants and unusually low capex of $14 million, so its FCFE will probably drop by about 50% in FY22. Capex is likely to be around $35 million in FY22 due to an IT upgrade, deferred spending, and a one-time move to a smaller headquarters, but the company has said annual capex will moderate to about $18 million-$20 million beginning in FY23. Based on current projections, Southern Cross should probably produce about $300 million in FCFE over the next 5 years, which is significant for a company with an EV of about $525 million.

SCA paid two dividends totaling (split-adjusted) $0.055 in FY19 but suspended them at the onset of the pandemic. As its results have since improved and its balance sheet is healthy, the firm paid a dividend of $0.05/share on October 1^st. If annualized at $0.10/share, its current dividend yield is 5.5%. SCA’s management has said that it intends to pay out about 70% of its earnings as dividends, which could mean that its annual dividend will be up to $0.20/share within a few years.

Income Statement

SCA’s revenue has declined due to the pandemic and will probably not recover to pre-pandemic levels due to the TV affiliation change and weakness in traditional advertising. Partially offsetting this issue, SCA shares less ad revenue with Network 10 and has permanently reduced operating expenses in both its segments. Thus, I estimate its FY22 EBITDA margin at 21.1%, only slightly below the 22.3% achieved in FY19.

Amounts in AUD 1000s

Balance Sheet

SCA’s balance sheet is in much better shape than it was before the pandemic after issuing equity and paying down debt. Admittedly, most of its assets are intangibles.

Amounts in AUD 1000s

Debt and Other Obligations

SCA was facing an approaching debt repayment of more than $300 million when the pandemic hit, but its debt situation is far less critical now.

Amounts in AUD 1000s

Cash Flow Statement

SCA’s cash flows were boosted by government grants in both FY20 and FY21. However, it still would have generated operating cash flow and FCF without them. Based on my earnings projections, SCA should produce about $70 million and $80 million in operating cash flow in FY22 and FY23, respectively. The firm paid $59.9 million in dividends in FY19 before suspending them during the pandemic. If earnings grow as anticipated, it could get back to this level in a few years.

Amounts in AUD 1000s

Historical Ratios

SCA’s ROIC’s are unimpressive (mid-single digits) and probably below its WACC. The company has a history of value destruction. Fortunately, its leverage ratios are much improved.

Segment Financials

Audio (radio and streaming) is Southern Cross’ major source of revenue and EBITDA. I estimate audio will generate 75% and 79% of its FY22 revenue and EBITDA, respectively. TV revenue is going to be lower due to the affiliate switch, but expenses are lower as well.

Amounts in AUD millions

Revenue by Type

National TV advertising has recovered faster than SCA’s other sources of revenue. Local ad spending as been slowed by the effects of the pandemic on smaller businesses. This has had a large impact on SCA due to its ownership of radio and TV stations outside Australia’s major metro areas.

Amounts in AUD millions

Valuation

Although peers like Seven West and Nine Entertainment have seen their stock prices recover to pre-pandemic levels, Southern Cross has not. At an EV of $525 million for a company with about $540 million in revenue, I think SCA is inexpensive. Historically, it has traded just above 2x sales, which is where Nine trades now. SCA also traded at an average EV/EBITDA of about 8.4 in the five years prior to pandemic. Using 1.8x sales and an EV/EBITDA of 8.4, I get a price target of $3.80, 110% upside from the current price.

Risks:

·         TV losing share to Netflix, other streaming channels

·         Radio threatened by digital audio and non-radio devices

·         Competition from new media is driving up production and licensing costs and competition for talent

·         Pandemic hasn’t ended yet, ad spending hasn’t fully recovered

·         Fewer people driving to work (and listening to the radio)

·         TV affiliate switch

·         History of poor capital allocation and returns

Reasons to buy:

·         Stock is cheap, trades at a discount to its own historical metrics and those of peers

·         Improved balance sheet

·         Ad spending recovery as pandemic fades, especially in radio; upcoming federal election should help

·         Dividend reinstatement

·         Possible sale of TV or other assets

·         Significant cost cuts

·         Leading radio operator in Australia, big presence in regional TV as well

·         Digital revenue rising, new LiSTNR app

Conclusion

Southern Cross is probably not a buy-and-hold-forever stock given its history of value destruction and the competitive threats from digital media on its traditional advertising model. Yet, I think we may be at the point of maximum pessimism and the stock is cheap. I think the risk/reward is favorable, with potential upside of more than 100%.

Legal Disclaimer: This research report expresses my research opinions, which I have based upon certain facts, all of which are based upon publicly available information. Any investment involves substantial risks, including complete loss of capital. Any forecasts or estimates are for illustrative purpose only and should not be taken as limitations of the maximum possible loss or gain. Any information contained in this report may include forward-looking statements, expectations, and projections. You should assume these types of statements, expectations, and projections may turn out to be incorrect. This is not investment advice, nor should it be construed as such. You should do your own research and due diligence before making any investment decision with respect to securities covered herein. The author has a position in this stock and may trade this stock.