A few weeks ago I’ve mentioned on my blog how dirt cheap Entercom (ETM) is. Back then it traded for around $6.30 per share; since then, the price has continued its march downward to $4.80. Your loyal writer bought it all the way down, at $6.36, $5.60, $4.97 and $5.10.
In this post I’d like to review the stock and tell its story.
ETM - A short business card
ETM operates over 100 radio stations in 23 markets. The major source of revenue for ETM is "spot commercials" - these radio commercials that we all know from listening to commercial radio stations. During recent times, ETM expanded its network and it has now Internet broadcasting services and radio stations websites.
Media market and Radio market
Radio may sound boring at first. Well, It is. But nevertheless, it is one of the most effective ways of reaching to your local audience and one of the most cost-effective ways to do so. Radio advertising is cheap relative to other media and much more focused. The effectiveness of radio can be seen in very simple ways - in a newspaper, you can just flip pages and ignore the commercials. But when you listen to your favorite radio show and it is interrupted for a few commercials, many people just “listen them off.” Another example would be that people can listen to radio while driving, while other media cannot be used - newspapers, magazines, and even some billboard ads. For instance, about a month ago, while driving in my car and listening to a radio show that I like, I found out that a new super-market is opening in my area and I decided that I will check it out next time I'll need groceries.
ETM’s revenue comes mostly from local commercials. About 20% of its revenue comes from (U.S.) national advertisers. The advertising firms are very diverse. For instance, see this chart of nationwide advertisers (for the entire radio industry).
I like the Buffett connection and if we look on a chart of cross-industry wide section:
The top advertisers are actually local governments and other public services, like child adoption, military recruitment, etc.
These graphs are from July 2011, but they can give you an idea what does the ads market looks like.
It’s also nice to see that my favorite bank is on the top of the radio advertisers list, showing how effective it is and how it is aimed to serve its community (but let's save that for a post about Wells Fargo). Using a radio ad you can reach a very specific type of listeners.
Radio, like many other businesses, is tightly linked to the economy. When the economy contracts, less money is left to spend on advertising. Nevertheless, radio advertising shows resilience. The reason is that while there is less money left for advertising, cash-strapped companies turn to a cheap advertising media, like radio, thus offsetting some of the decline in revenue. Another cause for radio advertising resilience is elections. One might think that elections happen once in 4 years, but in the U.S. there are other types of elections – for example, state and local elections. Elections give a boost to radio revenue, especially local elections, and they are independent from the economy.
Another demonstration of radio’s advertising resilience is the passing decade – 2000-2010. In this decade, many advertising media went through transformations and declining demand as the media market expanded and created new fields – like Internet advertising, electronic newspapers, electronic billboards, even spam email, but market size stayed almost constant. As Buffett once said – 600 million eyeballs and 24 hours a day is all that you have (U.S. media market). Even though advertising market conditions deteriorated in the last decade, newspapers went bust and revenues declined, radio market share remained relatively constant (slides 9-11). I think the reason is that there are times in the day in which you can only listen to radio and nothing else can replace it – for instance in your car while driving to work.
Industry consolidation and the source of "Goodwill" on many companies balance sheets
Radio business is a media business. In the media business one must grow all the time, buying competitors to eliminate them from the market or to prevent a competitor from getting the upper hand. During the early 2000′s and prior, as part of industry-wide consolidation, many radio companies bought radio stations at very high rates. Sometimes the rates were exorbitant. As radio equipment is cheap, the premium price paid over the equipment price was written on these companies' books as goodwill. This goodwill is still there to this day, a relic of a rich past where everybody bought everybody at any price. On the other side of the balance sheet, radio companies built a mountain of debt to finance those buyouts.
For every non-economic move, “pay day” eventually comes. The recent market turmoil caused radio revenue to decline, resulting in a shrinking cashflow to serve a huge debt-pile. On top of that, banks that were once happy to lend to everyone, became overly strict and now lent money at very high rates, if at all. Not only that, banks rates became higher and lending became tighter to compensate for banks' bad behaviour in the past, covenants are more harsh. This caused many companies to slash dividends, which in turn contributed to a decline in stock prices, thus eliminating equity issue as a tool for companies to get cash. All these placed radio companies between the nail and the hammer – their cash flow weakened and the cost of maintaining their debt pile increased.
Another side effect of the industry wide dwindling revenue and cash-flow was huge goodwill writedowns that caused these companies to look like major losers, although these writedowns are basically non-cash values that have nothing to do with the current line of business. Some people asked me how I can invest in a company that lost $900 million in 2009 when its equity is around $200 million, my answer was that it lost this money during the boom years of 2000's by making non-economical acquisitions and not in 2009. In 2009 it actually showed resilience and turned in a nice profit.
ETM is different
As anticipated, many of the very leveraged radio companies went bankrupt, for instance – Regent communications, Citadel communications, and others. Others just declined in price and fight to survive. But there are also radio companies that acted more prudently and conservatively and maintained a relatively strong balance sheet and strong cashflow throughout the period. An example is ETM.
As you can see from the table, the company was hit by the financial crisis in 2008-2009 but not as much as one would expect. Actually it exhibited resilience and could easily continue and support its debt.
The acquisition frenzy of the 2000's and prior is clearly noticeable in the table. These acquisitions clearly did not increase revenue or cash-flow per share significantly. This goes to show that these were not brilliant decisions by company's management as they consumed a lot of cash in non-economical expeditions.
Nevertheless, the company is cheap. It generates a rather steady cash-flow of over 2$ per share in the last decade, and the stock is traded around 5$ these days. Over the last 3.5 years no stations were acquired and cashflow per share did not decrease materially. If in some day they will decide to distribute only 50% of the cash flow to shareholders, the dividend yield would be a tremendous 20%. During 2006 and 2007, right before the financial crisis, the company did distribute a dividend of $1.52 per share, or a whopping 30% yield on the price today.
The investment case
Given the history of bad financial calls management had done in the last decade, why do I like this company?
First, the company is not only dirt cheap, it is also being de-facto controlled by the bank. One of the good outcomes of the financial crisis is the tightening of debt conditions. Before the financial crisis, if you had 2 legs and a nose you could get a decent loan. Now, even credit worthy companies work hard to get credit. ETM is no exception.
The bank set a strict covenant on the loan and ETM is hovering above the covenant. They are not close to breaching it, but they are too close to it. This prevents them from going wild like in the good ol' days and starting a shopping frenzy that gets the company nowhere. Now, if they have some spare cash, they must think hard before spending it on buying stations. The good thing is that even if they will continue doing stupid acquisitions, they cannot spend huge sums as before, only small amounts in order for them not to breach the covenants.
Second, the Field family holds almost 9% of the company, so they have some skin in the game. David Field is the company’s CEO. He also has lots of RSU’s that can increase his holding in the company substantially (and dilute others). Nevertheless, dilution is painful but not as problematic as the company is very cheap as it is – about 1 million shares addition, less than 3%. Moreover, since most of his compensation is in company’s stock, he has a clear interest to raise the share price. A possible instrument for it can be buyback / dividend.
Third, lately, the Fields and other directors in the company started buying shares at the open market. Last time they did so was at August 2010, when the price was also around $5 per share, and since then the share visited prices as high as 13$ per share. An important difference between today and August 2010 is that back then they bought much more than today – 228,500 shares on August 2010 comparing to only 30,000 shares up till today.
Fourth, next year is a presidential election year, a period that is known for its good treats to radio companies that enjoy a potent demand for airtime by politicians, at about a 1-2% increase in revenue.
Finally, at the end of 2011, the company should finish deploying new technologies to its stations and expenses should drop into 2012, which will strengthen cash flow even further.
A close obstacle coming from the debt side will be the need to refinance the credit facility that matures at the end of June 2012. In my opinion, the question is not “IF” they will succeed to refinance it but under what terms. I assume their interest rate will pick up but not significantly. Currently they pay around 20 million dollars of interest annually, a little over 3.4%. Even if interest doubles (and I doubt it will) we are still looking at a company that generates an operating cash-flow of above $75 million per year, or about $1.8-$1.9 cash flow per share, or a multiple of 3. This is insanely low.
Another risk would be a "double dip." A prolonged recessionary environment can kill the company, but with EBITDA to interest coverage of about 5 and considering the already difficult environment, this looks far away to me. Moreover, as I already mentioned earlier, the company showed great resilience during 2008-2009.
Time works in benefit of the company
In the meantime, the company does what it did best over the last 4 years – repay its debts. Since 2007, the debt pile has decreased dramatically. As the debt diminishes, so does interest that needs to be paid. That in turn will increase operating cash flow. Risk has also decreased dramatically from 2008 in the form of lower debt. In fact, ETM's EV back in 2008 was about $860 million with share price $0.67 ($833 million LT debt + $25.6 million equity), now ETM's EV is around $810 million ($625 million LT debt + $203 million equity) with share price around $5. In other words, now ETM can be bought cheaper than in 2008, and with less risk!
It is possible that in the foreseeable future the company will resume paying dividends. If it does, it can serve as a strong catalyst and the stock might run to a more reasonable pricing levels that can be as high as $12-$13 per share (x6 FCF) and if economy improves, even $20 per share is not a unthinkable (x6 FCF before the financial crisis).