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Investment thesis

Hemisphere Media Group (NASDAQ:HMTV) should benefit from the growing U.S. Hispanic population with its dominant market position and quality assets. HMTV would make an excellent acquisition target for larger competitors Univision or Telemundo.

Company overview

HMTV is the parent company of Cinelatino, WAPA Holdings and Azteca Acquisition Corporation (a special purpose acquisition company formed in July 2011) following a series of mergers completed in April 2013.

Cinelatino is a U.S. Spanish-language cable movie network with subscribers across the U.S., Latin America and Canada.

WAPA Television is a broadcast network in Puerto Rico and WAPA America is a U.S. cable network. WAPA also operates a sports television network (WAPA 2 Deportes) and a news and entertainment website (WAPA.TV).

Valuation

The 12.7x multiple appears high in isolation but must be taken in context. The expected triple-digit EPS growth (2014 EPS estimate of $0.49 compared to $0.20 in 2013), high EBITDA margin of ~46% and strong EBITDA growth (see charts below) deserves a high multiple.


Management said in the most recent earnings release that it is "confident that through our management expertise we can continue to find underperforming assets in our space that can become market leaders." This roll-up acquisition strategy (funded by rising cash flow and a recent refinancing) should eventually place HMTV on the radar of its larger competitors such as Univision and Telemundo, who might be willing to pay a high multiple given the quality assets. For example, in June 2006 a consortium of private-equity investors acquired Univision Communications for $13.7 billion or ~16.4x EBITDA.

WAPA and Cinelatino are quality assets that deserve a high multiple

Cinelatino is the No. 2 Spanish-language cable television network in the U.S. with ~12 million subscribers and has the largest subscriber base of any Spanish-language cable television movie network due to its focus on premium, contemporary movies (compared to older and lower budget movies on competing movie channels).

Cinelatino can offer subscribers three value-added features by distributing programming to the U.S. and Latin America via two distinct feeds. First, it provides the first window for U.S. subscribers within weeks of a theatrical release. This is a competitive advantage over English-language premium movie channels such as HBO and Showtime that have a much later distribution window (e.g. a year after release). Second, it offers exclusive first-run television series. Third, it can acquire titles for the U.S. even if the title is unavailable in Latin America.

Additional growth drivers include:

  • A growing number of pay-TV subscribers in Latin America, excluding Brazil (e.g. expected to rise at a 7% CAGR from 2011 to 2016) as well as increased market penetration (e.g. currently distributed to only 21% of total pay-TV subscribers).
  • Monetization of digital rights, especially of recently launched original programming. Cinelatino should not make the mistake U.S. content providers made several years ago when they licensed content to Netflix for virtually nothing as it was simply "found money" to them. Cinelatino realizes the value of its quality content and should price it accordingly.
  • Cinelatino is seeking to introduce advertising on its U.S. feed as it is currently commercial-free.

Bottom line: Long-term distribution agreements provide steady cash flow while the monetization of digital rights and the introduction of advertising represent two significant and overlooked growth catalysts.

Source: SEC filing

WAPA

WAPA Television is the No. 1 broadcast network in Puerto Rico (the second-largest Hispanic television market in the U.S. behind L.A.) for the fourth consecutive year with a prime channel position, the most local news and entertainment programming and recent upgrade to HD. Its market share rose in each of the past three years. Moreover, WAPA can effectively compete against telenovelas aired by competitors as it is the only significant buyer of Hollywood blockbuster movies and U.S. television series in Puerto Rico. The fact that WAPA grew its market share while many of the big four networks lost market share is further proof of its quality programming and loyal viewers.

Source: SEC filing

WAPA America is one of the most broadly distributed Spanish-language cable television networks in the U.S. with over 5 million subscribers. WAPA 2 Deportes is the leading sports network in Puerto Rico and frequently out-rates all U.S. networks including ESPN, TNT and TBS.

WAPA.TV is the No.1 television network website in Puerto Rico with over 13 million monthly page views while the mobile version has over 900,000 monthly visits.

Additional growth drivers include:

  • A low cable and satellite penetration rate of 52% (compared to a higher rate in the U.S.) provides the opportunity to grow even without an increase in the total number of subscribers.
  • Licensing digital rights of original programming. See Cinelatino note re licensing.
  • Distributing content on mobile devices. This represents a relatively untapped and significant revenue opportunity that can increase subscriber loyalty as they would be able to consume content on more than one device (e.g. television and smartphone).

Bottom line: A dominant market position should drive higher revenue across all three segments (advertising, subscriber, retransmission).

Growing U.S. Hispanic population should drive higher demand

HMTV is positioned to benefit from the booming U.S. Hispanic population as one of the few pure-play Hispanic TV and cable broadcasters.

According to the U.S. Census Bureau, the U.S. Hispanic population (the second-largest Hispanic economy in the world after Mexico) rose 50% to 53 million from 2000 to 2012, and is expected to grow to 64 million by 2020. Moreover, more than half of the total U.S. population growth from 2000 to 2010 is due to an increase in the Hispanic population.

U.S. Hispanic television households rose 21% to 14.1 million from 2006 to 2012 (or 7x the overall U.S. television household growth rate) and are expected to grow another 9% to 15.4 million in 2014. Hispanic pay-TV subscribers rose 35% to 11.9 million from 2006 to 2012 (or 5x the overall U.S. subscriber growth rate).

U.S. Hispanic cable network advertising revenue rose at a 18% CAGR from 2006 to 2011 (or 3x the overall U.S. cable advertising growth rate) and is expected to rise at a 13% CAGR through 2014.

Bottom line: HMTV is at the intersection of three secular trends: a rising Hispanic population, increasing Hispanic pay-TV subscription growth and higher advertising rates.

Furthermore, HMTV should be able to extract favorable distribution arrangements with pay-TV providers and higher advertising rates for three main reasons.

First, its higher quality programming deserves a premium compared to marginal programming for obvious reasons. (This marginal programming only exists because of a lack of an "a la carte" option for cable or satellite subscriptions, which would for all intents and purposes eliminate every channel except for about 10. This will not change anytime soon as content owners and distributors have no desire to shoot themselves in the head by giving subscribers the option of only paying for 10 channels instead of 200.)

Second, pay-TV distributors need Hispanic programming as this demographic is no longer a minority in terms of viewers. For example, recently a Spanish-language television station had the most viewers for the first time in the coveted 18-49 age demographic. Moreover, U.S. Hispanics represent over 16% of the U.S. population but only 5% of the aggregate media spend targets U.S. Hispanics. As advertisers "overcompensate" in the coming years in order to reach this growing and valuable demographic, HMTV should be able to charge premium rates.

Third, Univision and Telemundo said viewers watch more programming in real time (as opposed to several days later using an ad-skipping DVR). Specifically, Univision said more than 90% of viewing of Spanish-language shows is done in real time compared to ~65% for the English-language networks. It is reasonable to assume HMTV assets have similar characteristics. These real time viewer numbers are similar to those enjoyed by sports networks (on an anecdotal basis) and deserve a premium as advertisers are increasingly reluctant to pay the same rates (much less higher) without proof their ads are not being skipped. Moreover, the reason the major sports leagues are able to command such exorbitant televisions rights is because advertisers know almost no one records a football game on Sunday and watches it on a Thursday.

*This marginal programming only exists because of a lack of an "a la carte" option for cable or satellite subscriptions, which would for all intents and purposes eliminate every channel except for about 10. This will not change anytime soon as content owners and distributors have no desire to shoot themselves in the head by giving subscribers the option of only paying for 10 channels instead of 200.

Risks

Industry consolidation. The consolidation among cable and satellite providers gives them greater purchasing power, which may result in lower increases during renewal of distribution agreements (or the start of new ones).

Dependent on advertising/subscription revenue. Weak economic growth, especially in Puerto Rico, could result in lower advertising and subscription revenue for WAPA and Cinelatino.

Programming costs. WAPA and Cinelatino enter into long-term programming contracts for movies, television series and sports and would be negatively affected by any significant increases in costs upon renewal or a loss of programming rights.

Digital threats/competition. WAPA and Cinelatino face increasing competition from digital media including Hulu, Netflix, Apple TV and Amazon Prime as well as from other channels. Furthermore, DVRs that allow users to skip ads may negatively affect advertising rates. There is indirect competition for advertising dollars from magazines, newspapers, radio and other digital media. Lower audience ratings for any reason (e.g. decline in viewers, change in ratings methodology) may result in lower advertising and subscription revenue.

Staggered board/dual class structure. The dual class structure (Class B shares have 10 votes each while Class A shares only have one) and staggered board prevent a hostile takeover.

Conclusion

The target price of $13.55 is based on a 15x multiple, which is reasonable given the reasons mentioned above.

A stop loss should be placed at the recent support area around $11.25 or 4.3% below. The time frame is one year.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Source: Hemisphere Media Group Is An Attractive And Pure-play Spanish-language TV And Cable Content Provider