Media General (NYSE:MEG) reported another difficult quarter on October 19. Once again, management turned in a pathetic top line, mitigating the damage solely by heavy cost cutting. Nonetheless, MEG’s operating results achieved the main goal of avoiding a violation of its Total Debt/LTM covenant, with Total Debt/LTM EBITDA at 6.6x, well below the 8.0x covenant level.
Based on historical trends, it appears that MEG has made it through what will likely be its worst quarter in the next year which could present an opportunity for an attractive return from current prices. However, before getting into the potential positive attributes of MEG, there a number of considerable negatives to review.
Poor Revenue: MEG’s topline in Q3 was laughable. Estimates were for $151MM and MEG reported a total of $145MM. Q3 2010 revenue included $163MM in revenue of which about $11MM was due to political ($10MM) and BP marketing related to the Gulf of Mexico oil spill ($1MM).
Even when excluding those revenues, MEG’s Q3 2011 was still down 6% compared to Q3 2010. This matters because Q4 2011 has a 0.25x step-down from the Q3 2011 covenant whereby MEG’s Total Debt/LTM EBITDA must be under 7.75x. While Q4 is typically MEG’s strongest quarter, the revenue degradation is concerning if this trend persists in Q4.
Management & Governance: There’s no doubt at all that MEG management is one of the worst to ever run a company. The management suite consists of grossly overpaid executives who appear to have little to no experience in actual media and broadcast operations and the results demonstrate this.
Several years ago, MEG management purchased DealTaker.com and Blackdot in an attempt to enter the online advertising space. Despite warnings from significant shareholders at the time that MEG should steer clear of this space, MEG management used shareholder capital to acquire these businesses which are now rapidly declining.
In 2010 these businesses were at least cash flow positive, but in 2011 they are a cash burn for MEG. Even worse is that management is maintaining consultants to assess how to counteract changes in Google’s algorithm which is what has been a primary cause for the division’s underperformance. Given management’s track record, it would not surprise me to see that the consultants are able to address this just months before Google alters its algorithm once again.
Management also fiddled a robust summer for debt financings away, leaving MEG in a challenging position regarding its debt refinancing needs. MEG has roughly $365MM in bank debt due in April 2013 and MEG would want to refinance this ahead of its Q1 2012 10-Q to avoid a “Going Concern” (“GC”) opinion from its auditors. A GC would not change the day to day operations at MEG but could result in a breach of MEG’s debt covenants and/or lead to downgrades of the company’s debt which would raise the cost of financing for MEG.
MEG management is also self-serving. On the Q3 call, two Gabelli analysts including founder Mario Gabelli, asked about management’s view on valuation multiples regarding recent broadcast television station transactions. Management appeared to not have a strong grasp on what the multiples were based on (LTM EBITDA, two year average EBITDA, EBITDA less CapEx, etc.).
Nonetheless it appeared that management clearly thought that MEG deserved a higher valuation based on the higher end of broadcast television transactions commanded in recent transactions. However, despite this, when asked if management would entertain a break up of the company, management clearly indicated a preference to maintaining the status quo, citing the strong regional synergies MEG possessed across publishing, broadcasting, and digital platforms.
Keep in mind that the publishing division continues to experience revenue declines in the 9% range and the digital strategy is a complete farce at this point.
MEG’s governance is another area of frustration. It’s an absolute joke that MEG’s Chairman and scion of the founding Bryan family has quietly watched as CEO Marshall Morton and his team have been on a generally nonstop course to obliterate the company.
According to MEG’s latest proxy J. Stewart Bryan III owns 85% of MEG’s controlling Class B shares and owns or serves as fiduciary of 568,475 Class A shares. Just two years ago the value of those class A shares were nearly $5MM but as of now are worth less than $1MM. When Bryan III retired as MEG’s CEO in 2005, those shares were worth nearly $30MM. The rest of the Board consists of apparent “fiduciaries” who are happy to plunder $116,000 annually from shareholders and absolve management from operational and financing blunders.
Despite poor current fundamentals and an incompetent management team, there actually are some attractive qualities to MEG. With a market capitalization below $100MM, the current poor fundamentals, financing risks, and atrocious management team are close to priced in. If one can get beyond that (which is difficult), the risk/reward for MEG is highly compelling.
Potentially More Expense Breathing Room in Q4: MEG management appears to be leaving a several million dollars in wiggle room for total expenses in Q4. Management has said that 2011 total expenses should come in around $585MM. Total expenses in Q3 2011 were $139MM bringing 9 Month expenses to $440MM. This leaves $145MM to accrue in Q4.
However, Q3 2011 expenses were down nearly 9% compared to Q3 2010. Employee compensation and D&A will likely remain flat in Q4 2011 while Production and SG&A costs could experience a slight increase given the seasonal uptick in revenue. This could result in total operating costs of $140-$145MM.
Achieving the lower bound of that range could be crucial because MEG needs to achieve roughly $82-85MM in EBITDA for YE 2011 to remain in compliance with its 7.75x Net Debt/EBITDA covenant. This means MEG needs about $24MM in EBIT for Q4 which would translate into $164MM – $169MM in Q4 revenue which should be achievable.
2012: Management is clearly hoping for 2012 to bail them out of the current situation but historical data indicates that 2012 could be the remedy equity investors and bond holders need. While I am not incorporating significant political ad dollars in Q4 2011, the South Carolina and Florida Republican Primaries will be held in January 2012 which could very well lead to ad spending ahead of the actual date. Early February will also bring Super Bowl 46, which is held on NBC, impacting a significant number of MEG’s broadcast television stations. Super Bowl 45 and 44 were carried by Fox and CBS, respectively. Super Bowl 43 was the last Super Bowl broadcast on NBC and it generated $3.2MM in ad dollars for MEG. I think $2MM is a conservative estimate for MEG’s ad dollars related to Super Bowl 46.
We also know that the 2010 Winter Olympics generated roughly $7.5MM in ad dollars while the 2008 Summer Olympics generated about $13MM in ad dollars. Even with a difficult global recession, the 2012 Summer Olympics should still yield ad dollars close to the 2008 Summer Olympics given the comparability of economic climates in 2008 and 2012.
In 2010, MEG’s political broadcast revenues alone (not including publishing and digital ads related to political ads) totaled $42MM. This was a significant amount for a non Presidential election year and 2012 is expected to be a highly contested race. Assuming $50MM in total political ad spending for MEG across all platforms is quite conservative, particularly given MEG’s presence in key battleground states of Florida,Virginia, and Ohio. In a previous post I discussed MEG having a historically “sticky” EV/EBITDA valuation of 6.8x.
Assuming MEG can maintain expenses close to 2011 levels which is likely given the need to refinance their bank debt and wanting to show the company as streamlined as possible, MEG could generate $125MM in EBITDA and $75MM in EBIT. Another consideration is that MEG’s interest expense should be about $55MM in 2012 and that MEG is not expected to be a cash tax payer in 2012 (or 2011). This would result in EPS of $0.86. A conservative 4.0x P/E would yield a share price in the mid $4s while using MEG’s historical EV/EBITDA multiple against $125MM in EBITDA would yield a share price in the mid $8s.
However, this price is based on what are conservative topline estimates. As Exhibit I shows, Q4 2011 estimates are on the low side and 2012 revenue assumes continued declines in the Publishing and Digital segment. The strong growth estimate in 2012 is largely due to $10MM in Summer Olympic ad dollars (ad dollars for 2008 Summer Olympics were $13MM), $2MM in Super Bowl 46 ad dollars (MEG had $1MM in Super Bowl ad dollars in a non-NBC broadcast year and $3.2MM in the last NBC broadcast Super Bowl), and $50MM in total political ad dollars (MEG recognized $42MM in political ad dollars tied to just its Broadcast division in 2010). And despite these seemingly achievable figures, MEG is trading at 20%-33% of what could be a reasonable valuation based on these estimates.
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EXHIBIT I: 2011 & 2012 PROJECTIONS
Given the tremendous operating margin in the Broadcast division, slight increases in the topline can lead to massive growth in operating income. Exhibit II presents a scenario analysis on what can happen if things actually go a bit better for MEG with respect to the 2012 cycle events.
I anticipate further declines in Publishing and Digital relative to 2011 and build up 2012 Broadcasting revenues based on varying expectations of Political, Summer Olympics, and Super Bowl ad spending. I then scale both the P/E and EV/EBITDA multiple based on the performance of MEG in 2012. Generally the better a business performs, the higher the multiple assigned to it.
EXHIBIT II: VALUATION SENSITIVITY ANALYSIS
Valuation: MEG’s current share price in context to Exhibit II clearly illustrates that the market is heavily weighing MEG’s refinancing issue, near-term operational challenges, and expectations of a rather tepid 2012.
Or better said, it appears that the market is pricing in close to the worst case scenario. MEG’s current price incorporates a discount due to refinancing uncertainty and management’s track record of underperformance. What makes the company appealing is that MEG doesn’t really need competent management to do well in 2012. There is a large advertising pipeline in 2012 due to a number of events already discussed in this post. MEG has prime “real estate” in the form of top ranked broadcast television stations in key states. As Exhibit II demonstrates, even middling outperformance beyond relatively modest expectations could lead to explosive share price performance.
Another avenue for value creation could be if Mario Gabelli works with Chairman Bryan III to force a break up of MEG. Clearly, Q3 conference call remarks by MEG management illustrate that it is fully entrenched and self-serving. MEG management probably is aware that they are unlikely to find a situation comparable to the current one where they can command $6MM+ in annual compensation while leveling a company so will balk at nearly any offer that leads to them out of a job. Appealing to Bryan III’s legacy and salvaging what’s left of it could be one successful avenue.
MEG’s assets have significant value on a standalone (platform) basis. In fact, a break up valuation can lead to a valuation range over $6. In the past year MEG management finally began reporting operating data by platform in addition to the convoluted geographic presentation MEG provides. Exhibit III presents that data along with a Sum of the Parts Valuation.
EXHIBIT III: MEG SUM OF PARTS VALUATION
What is clear is that MEG’s Broadcast division alone can be reasonably valued at near $3-10 (yes $10)/share net of MEG’s total debt including pensions. Recent transactions in the broadcast television station support this valuation. Just two weeks ago E.W. Scripps (“SSP”) paid $212MM to acquire McGraw-Hill’s (“MHP”) television division. MHP’s broadcast stations consisted of just four full-power ABC affiliates stations in Indianapolis, Denver, Bakersfield, and San Diego.
Another recent deal was the acquisition of Four Points by Sinclair Broadcast Group (“SBGI”) for $200MM. While the deal multiple was not available, the acquisition included seven stations of which just two were major affiliates (CBS) and the rest second tier broadcasters such as MyNetwork and CW. MEG’s 18 broadcast stations are primarily big time affiliates in attractive markets so a multiple in the range of SSP’s acquisition of MHP’s television stations is reasonable.
The rumored multiple for MHP on a sale basis was 9-10x EBITDA but broadcast television stations have sold for near 12+x in the past. In addition, MEG’s Broadcast division boasts #1 or #2 ranked stations in their respective regions. Keep in mind that Exhibit III uses a two year average EBITDA for MEG’s Broadcast division which averages an off-political and on-political year.
One could argue that the $88MM in 2 year average EBITDA from that division is understated because it includes just the first year of political elections in a post Citizens United world whereby the level of political ad spending could increase as more 501(c)(3) groups proliferate and deploy the capital they raise. In addition, 2011 has been a tepid, near recession year.
When considering these two factors, MEG’s two year average under slightly better circumstances could command a valuation near $10 for just the Broadcast division net of MEG’s pension and debt.
What should be noted is that certain potential strategic buyers could treat an acquisition of MEG’s broadcast division as an asset purchase for tax purposes. This can allow the acquirer to realize tax deductions that can reduce its effective acquisition price. Simply stated, while the valuation sellers obtain could be 9-10x EBITDA, the buyer could be paying much less when factoring in the tax considerations which could make striking a deal at these valuation levels more amenable to a prospective buyer.
MEG’s Print division may also have value to a strategic buyer at the right price. In the Sum of the Parts Valuation, I assign a 4.0x 2011 estimated EBITDA (or about 0.3x 2011E Sales) as a valuation multiple that could overcome the obvious secular decline of the newspaper division.
It’s important to note that the Print division is cash flow positive and the proposed multiple to achieve a sale could allow a competent strategic acquirer to recoup the capital invested to acquire the business in a relatively fast payback period.
MEG, for example, is still in the process of attempting to establish paywalls for a number of its newspapers. A newspaper company that has already implemented the appropriate infrastructure for paywalls could insert MEG’s regional newspapers into its own in-house system and immediately expand its ability to capture incremental revenue online to offset declining circulation and classified ad revenue. Small regional companies such as A.H. Belo (“AHC”) or Daily Journal Company (“DJCO”) boast strong balance sheets which could easily absorb MEG’s Print division and immediately expand their geographic reach and leverage their print platforms more effectively than MEG’s current management.
Lastly, MEG could sell its Digital division for 0.10x EV/2011 Estimated Revenue. Even if the Digital division was written off, the impact on MEG’s total valuation on a Sum of the Parts basis is immaterial.
Clarity on Refinancing: MEG management should be tarred and feathered for missing a very open window in the summer of 2011. This period offered the chance for more aggressive credits to finance themselves at highly attractive rates yet MEG management did absolutely nothing to take advantage of this opportunity. Since then, the European financial crisis has set in resulting in yields blowing out making refinancings for companies like MEG much more challenging. Nonetheless, it appears that the credit market is easing relative to just 4-6 weeks ago based on upcoming new issues.
Nonetheless, it appears that MEG will be locked into a Term Loan B refinancing versus its current low cost Term Loan A deal unless some major improvement in the financing markets occurs. That’s ok given the stock price drop largely reflects this and Moody’s appears to be doing what is typical of credit agencies and marking the bottom with its downgrade. The largest drop in MEG’s stock price in the past month was due to Moody’s downgrading MEG’s bonds from B2 to B3. While MEG has its warts, the cynic in me can’t help but laugh at Moody’s and most credit agencies generally being adept at signaling both tops and bottoms.
S&P also got in on the action, downgrading MEG’s debt to triple hooks (“CCC”) on October 26. Interestingly enough the stock was up over 40% on the day of this downgrade and the bonds also have been rallying. S&P is following the price action on the bonds so I suspect its rating downgrade will be a non-factor. MEG’s bonds have traded between $75 and $85 since Moody’s downgrade and that range is consistent with CCC bond ratings, at least in the low $80s and $70s so S&P is doing nothing except following the price action.
Despite the downgrades, the biggest factor will be how bond spreads broadly behave in the coming months. To that effect, corporate bond spreads have been compressing at the fastest pace since 2009 which is great news for MEG relative to its share price. To be clear, management’s inaction in the summer of 2011 may have cost MEG investors anywhere from $15MM-$30MM in total interest expense costs but what matters more at this point is certainty in terms of what MEG’s refinancing would look like.
Recent deals across industries suggest MEG will need to refinance its approximately $360MM in bank debt with a Term Loan B deal with a spread close to L+700 and likely with a LIBOR floor of 150 basis points. Further, those that structure the deal would probably force a fairly heavily original issue discount (“OID”) to bring the overall yield up to entice investors. It would not be surprising to see an OID leading to the deal sold at $96-97. This means all-in costs on this deal would equate to about 11-12%.
When factoring in the interest expense from MEG’s bonds, total interest would run in the high $70MM range. However, it appears that the market may have more than priced this into the stock and if the corporate bond market continues to improve, the outlook for MEG will improve that much more.
Overall, MEG continues to remain a high risk/high reward play. The management team is abysmal. Shareholders should realize that this team has cost investors significant value given their repeated blunders. The biggest blunder by far was missing a large refinancing window this summer. Historical data and comps demonstrates that MEG could have refinanced at L+400 on a Term Loan A basis and no upfront fee (same as a discount for Term Loan B). On a $360MM refinancing, this would have equated to less than $20MM in interest expense with total interest expense of about $55MM when accounting for the Senior Notes.
However, MEG management’s incompetence and inability to refinance when conditions were spectacular in the summer has led to a total interest expense likely to be near $80MM. Given that MEG is not a cash tax payer, that $25MM in interest expense that would have been saved would have gone straight to improving MEG’s capital structure.
With just 23MM shares outstanding, the $25MM could have added over $1 in per share value to MEG. Instead, swaths of employees will likely be gutted to offset these blunders while MEG’s management team pockets unconscionable compensation while leaving investors in the lurch.
Nonetheless, 2012 should present far stronger fundamentals for reasons described in this post that should override the ineptitude of MEG’s management team.
Disclosure: Author manages a hedge fund and managed accounts long MEG.