Media General (MEG) reported Q4 2011 earnings on Thursday, January 26 2012. The company actually performed well relative to expectations. But as is typical with Media General’s imbecilic management team, the company was able to steal defeat from the jaws of victory by citing concerns regarding its ability to remain within compliance of its covenants in 2012. As a result, Media General is going hat in hand to its lending group to ask for an extension and amendment of its current debt deal. Since S&P downgraded Media General’s debt in October 2011, the stock has increased from near $1.00 to $5.50 before Media General management squashed investors in the Q4 2011 call. The stock was due for a pullback given the aggressive run up into earnings but the main question longs and shorts must consider is: Is there anymore upside left in Media General? I think the answer is yes – Media General could still run up significantly from current levels.
Before discussing why Media General has potential upside, let’s first review what Media General observers already know. Media General management is perhaps the worst team ever assembled. This is a team that along with their “financial advisers” missed the biggest refinancing window in years in Q1 2011. A review of conference call transcripts during that period shows a lazy management team that felt comfortable that refinancing would be possible at any time and never focused on getting this accomplished. To be clear, CEO Marshall Morton cost Media General investors roughly $10-25MM through this incompetence, which led to the share price declining from well over $7 to roughly $1 over 2011. So any investor in Media General must immediately realize that Media General’s management is simply looters, transferring millions from investors, creditors, and employees while providing nothing but strategic and financial failure. The main problem is that the founding Bryan family controls the voting block. For whatever reason, J. Stewart Bryan III has seen no reason to change management, even as he has watched the value of his family’s stake in Media General decline from roughly $23MM to <$3MM in recent years. Bryan III is proving the Chinese proverb “Wealth does not pass three generations".
Going long Media General is partially an assumption that underlying business fundamentals overwhelm the incompetence of management while shorts assume that management will eventually find a way to destroy this company. I still believe the underlying fundamentals remain strong and that the credit issues presented by Media General can be addressed in a way that works for investors. When one reviews Q4 2011, it should be noted that Media General matched sell side expectations of revenue of $168MM while also exceeding the EPS estimate when adjusting for one-time items. With $27.7MM in adjusted operating income and $14.6MM in interest expense, Media General generated EBT of $13.1MM. The company recognized a non-cash $7MM tax expense leading to EPS of $0.27 compared to a $0.10 estimate. If Media General had successfully addressed credit issues in 2011, Media General stock could have skyrocketed off these results.
Instead, management warned that it would seek to amend its existing credit agreement because it could struggle to remain in compliance with its covenants in 2012. This would be a concern if a management team with credibility stated this, but Media General management has a laughable track record of predicting how Media General business will fare. In early 2011, Media General management reinstated a number of expenses and spoke boldly of an improving economy that would benefit the company, only to provide the pathetic “it’s the economy” excuse a few months later when results did not materialize. In fact, management’s concerns about remaining in compliance make me feel somewhat optimistic as it seems that even conservative forward projections indicate it would be difficult to breach covenants.
FY 2011 EBITDA figures should be the lowest EBITDA Media General recognizes for the next four quarters. This is because Q1 2011 was poor due to Florida and a drop off from the 2010 political revenues. In contrast to Q1 2011, Q1 2012 should be much much stronger. In fact, each quarter in 2012 should be considerably stronger than 2011, whereby EBITDA figures should match 2010 numbers and which should allow Media General to remain within its compliance levels. Table I presents Media General’s historical quarterly data from 2009 through 2012, using my own estimates for 2012 figures. I have been relatively close to Media General’s own realized estimates in 2011, generally hitting the operating profit number. For example, if one goes to my post in October and scrolls to Exhibit I, they would see that my Q4 estimate for Media General’s EBIT and EBITDA was$24MM and $36MM, respectively. This is pretty much what Media General achieved for Q4 2011, when accounting for the $6MM goodwill impairment charge in the quarter.
TABLE I: Media General HISTORICAL AND PROJECTED QUARTERLY FIGURES (Click to enlarge)
One area that Media General's management cited as a potential problem in terms of coming under its covenant levels is its Publishing segment. While I anticipate continued struggles in the Publishing segment, the challenges appear to be moderating. While the first three quarters of 2011 notched 9+% declines in Publishing, the Q4 decline was 6.6%. In contrast, in Q4 2010 the Publishing segment’s decline accelerated so this slight change in Q4 2011 is a welcome sign. It hardly means any gains from Publishing will accrue but it does suggest the drag on Media General’s business may be less acute. Nonetheless, management is now concerned about the Publishing segment, whereas during periods of faster declines they expressed no such concern.
Management also cited uncertainty in the economy and challenges specifically in Florida could cause problems. But I am skeptical, given that in 2011, management was optimistic about the economy and stated that they believed the downturn in Florida was past the company. Florida has a number of state-specific positives related to Media General in 2012 covered further below.
It’s been covered numerous times but 2012 will be the first Presidential election in a post-Citizens United world. In 2010, political ad dollars exceeded 2008 ad dollars, despite 2010 being a non-Presidential election year. According to AdWeek, total political spending hit $4.6B in 2010, exceeding the 2008 Presidential election by 8%. In 2012 the Republican party has been holding hotly-contested primaries with different winners in each state since primaries and caucuses commenced. Aside from the Publishing segment, Media General should have a very strong 2012 due to the political cycle. Media General has already racked up revenues that exceeded its expectations in Q1 2012 from South Carolina and Florida, with Florida’s primary still yet to be completed. Media General properties will benefit from Super Tuesday in March when primaries in Georgia, Ohio, and Virginia occur along with a primary following in Alabama later in Q1 2012. The Super Bowl will also take place in Q1 and reports indicate that Super Bowl Ads Sales set a record for NBC. This is why Q1 2012 EBITDA levels should improve markedly from Q1 2011 and allow Media General to remain within compliance, despite some covenant step downs.
In Q2 2012, primaries in Arkansas, North Carolina, and Rhode Island will benefit Media General along with an expected increase in Presidential level ad spending. Q3 2012 could also be a monster quarter for Media General. The London 2012 Summer Olympic Games will commence in late July, benefiting Media General’s NBC stations. Further, political ad dollars should begin to coalesce around the Republican Party’s Presidential candidate leading up to the Republican National Convention (“RNC”). The RNC will be held in Tampa, FL – the heart of Media General’s Florida division – in August 2012. This is a huge benefit to Media General and should yield significant positive business for its television and publishing segments in Florida. The Florida division was a major cash drag in 2011 but the Republican primary in FL, the RNC in Tampa, and the battleground status of the state should help make Florida a strong contributor to Media General in 2012.
In Q4 2012, the Democratic National Convention (“DNC”) will meet in Charlotte, NC, once again benefiting Media General’s various media properties. Media General owns two CBS stations and two NBC stations in NC which should benefit from DNC related ad spending. More importantly, Q2-Q4 should all start to increasingly incorporate heavier and heavier political spending, particularly in key battleground states. Using the 2008 election by state breakdown from Real Clear Politics demonstrates how well Media General’s properties are situated.
CHART I: 2008 TOSS UP STATES (SOURCE: REAL CLEAR POLITICS) (Click to enlarge)
Media General has operations in Florida, North Carolina, Georgia, Virginia, and Ohio, all of which should capture major political ad dollars. There is a very strong expectation that these states will remain big targets for political ad dollars, given the slight margin of victory in these states in 2008, along with the significant level of electoral votes attached to each state. Despite all of these positives, I have kept my estimates for 2012 pretty much inline with 2010. Table II uses the 2012 estimates along with Media General’s debt covenants to demonstrate how Media General can remain in compliance throughout 2012.
TABLE II: Media General DEBT/EBITDA RATIO 2012 PROJECTION (Click to enlarge)
In comparison to the last political cycle year in 2010, Media General will have the Summer Olympics vs the Winter Olympics, which should result in roughly double the Winter Olympic revenue, and an NBC broadcast Super Bowl compared to no NBC Super Bowl in 2010. Political revenues for the Presidential election and specific battleground states should be at least equal to 2010 political revenues. In comparison to 2010, there will be a potential drag of about $50MM from lost Publishing revenue, but this could be partially offset by retransmission revenue. More importantly, revenue through Media General’s Broadcast division yields much higher margins than Publishing so lost revenue on the Publishing side does not need to be fully recouped to make up for lost operating profit dollars. Conservative estimates of continued losses in Publishing and Digital and strong performance in Broadcast should still yield EBITDA levels that allow Media General to remain within compliance throughout 2012.
These conservative estimates should assuage some concern of Media General blowing through covenants. Since the earnings release, Media General stock has been in free fall and some reporting appears somewhat sensationalist regarding Media General’s covenants. The discussion above should help illustrate that Media General can generate solid EBITDA in 2012 as well as generate up to $40MM in free cash flow after interest expense, pension, and capex costs which will be used to reduce debt.
However, since management is uncomfortable with the covenant step downs, it is seeking relief from its bank group, which is lead by Bank of America (BAC). Media General has $363MM of bank debt which matures on March 2013 and is working with BofA to amend its agreement. The question is whether Media General can successfully amend its existing deal. I think Media General has a good chance to achieve this at a cost better than reflected by the recent stock price action. Management blew a huge chance to refinance at extremely attractive rates last summer. In doing so, management cost investors tens of millions of dollars. Media General’s $363MM is a Term Loan A, but its current credit profile has it buried in the high yield market. As a result, short sellers are foaming at the mouth and longs have dumped the stock in concern that Media General may have trouble in getting covenant relief. I’m a bit more optimistic, however.
Credit profiles matter but so do incentives. In the current market, bankers have a lot of incentive to avoid writing down debt. Media General’s Term Loan A puts its paper in the hands of typical banks with BofA serving as the lead bank. BofA and others in the lending group would likely prefer to extend rather than write down Media General’s debt. BofA probably also recognizes that credit markets could improve in terms of health, so an extension could give its borrower some more time whereby it could refinance out into a healthier market. That is, should a window like last spring’s emerge in the coming years. In structuring the right amendment and extension, BofA could generate up front cash fees, avoid any writedown of debt, have a higher yielding performing asset on its balance sheet, and ultimately, when credit markets thaw, be made whole when Media General refinances. In contrast, BofA could agree to not work with Media General and potentially have to deal with a significantly impaired asset on its books and incur significant internal costs in addressing the impaired asset. It appears that BofA and Media General have aligned incentives. This is also the same dynamic the rest of Media General’s banking group faces and it should be noted that amending the existing agreement will not require unanimous consent, another aspect that favors Media General.
Table III presents Media General’s current debt components along with a sensitivity analysis on a potential new deal with BofA and its impact on interest expense. What’s very clear is that the current deal for Media General is extremely attractive, priced at L+475 or effectively 5.25%. Recent financing transactions by companies such as Lin TV (TVL) suggest that Media General could obtain an extension that is a win-win for both Media General and BofA. Media General will likely push for a 3 year extension but my guess is that BofA would give them just about 2 years. The main challenge for Media General is its leverage covenants and it would probably seek a waiver for these. For BofA to agree to these covenants, it would likely price Media General at the very high end of the Term Loan A market which could range from L+600-700 with a LIBOR floor or 1+%. In addition, BofA would charge an upfront fee of 1%+ to do this deal. This could work out well for BofA’s bankers and in exchange, Media General could get a reset on its leverage covenants whereby BofA would potentially waive or set a very high leverage covenant for the near-term and then implement quarterly step downs.
TABLE III: Media General SENSITIVITY ANALYSIS TO NEW BAC DEAL
As with its prior schedule, Media General’s bank group recognized the cyclical nature of Media General’s business and as such allowed leverage covenants to expand based on non-political years. In Q3 2011, Media General was allowed to have a maximum leverage ratio of 8.0x compared to a maximum leverage ratio of 7.6x in Q3 2010. I would anticipate that BofA would implement a similar schedule, perhaps waiving covenants for Q2 and setting a leverage ratio of 6.5x and fixed charge ratio of 0.95x in Q3 2012, slowly bringing leverage levels down for 2012 before allowing them to rise in the off political 2013.
Table IV presents Media General’s 2012 quarterly estimates using a scenario whereby BofA extends Media General’s Term Loan under terms of L+700 with a 150 basis point LIBOR floor (the last row in Table III for Bank of America and Debt Sensitivities). While this would raise Media General’s interest expense by over 20%, it provides the company with the breathing room it feels it needs on a covenant basis and more importantly still allows Media General to be cash flow positive in 2012.
TABLE IV: Media General PROJECTIONS BASED ON NEW BAC DEAL
Q1 2012 would recognize interest expense under the existing term loan agreement while future quarters would increase due to the new deal. In either case, the additional covenant relief would likely remove the discount shares have currently experienced. BofA would probably also incorporate a schedule similar to the existing one that allows for covenant expansion in an off political year like 2013. This type of schedule would allow debt/ebitda ratios to reach levels near 8.0x and fixed charge ratios at roughly 0.95x, similar to the existing deal’s 2011 debt/ebitda ratios, and would allow Media General to be in the clear even with a return to 2011-like performance in 2013.
TABLE V: Media General SUMMARY 2012-2013 PROJECTIONS UNDER NEW BAC DEAL
BofA and its lending group do not want to recognize a severe writedown on Media General’s bank debt and by buying Media General some time to deal with some near-term issues, BofA avoids any severe writedowns and can also incur some additional fees, potentially as much as $5MM as shown in Table V for acquiescing to an extension. If a large refinancing window appears, Media General can then refinance out of the amended deal, taking out BofA and its lending group, whereby all parties win. While the terms in the above charts can fluctuate, the overall reasoning presented above will definitely be a part of BofA’s consideration when determining how to structure an extension and amendment. The benefit to Media General investors is evident in the reaction of a number of companies once a successful financing occurs.
In addition, while Marshall Morton and his team of cronies clearly are focused on lining their pockets, a larger shareholder such as [Mario] Gabelli could attempt to get more involved and suggest putting the entire company up for sale, or perhaps Bryan III might wake up and realize he could rather quickly double the value of his family’s share in Media General. As previously discussed, Media General’s Broadcast division alone could be valued at $855-950MM including total debt. This is based on using a four year average cash flow figure which would include one Presidential year, two off political years, and one Congressional year, averaging about an estimated $95MM. Recent comparables imply Media General could easily command a valuation multiple of 9.0-10.0x.
The New York Times Company (NYT) recently sold off its regional papers business suggesting there could be some value with Media General’s Publishing division in more capable hands. With about $28MM in platform cash flow, Media General’s Publishing unit could conservatively be valued at 2-4x this cash flow or $50MM-$100MM. Ignoring the Digital segment (DealTaker), breaking off the Broadcast and Publishing segment could total about $900MM-$950MM. If one netted out the existing net debt of $635MM and pension obligations of about $160MM, Media General shareholders would walk away with $7.00+ or 80% above current share prices.
The challenge is that management has demonstrated that its incentive is solely to continue to command undeserved, excessive compensation at the expense of shareholders. Given the M&A activity in Media General’s industry, I am somewhat skeptical that management has been willing to listen to potential suitors, despite management commentary that they are open to deals. Perhaps larger Media General shareholders could take the initiative in shopping the company if management proves unwilling or unrealistic in their valuation of Media General.
While a sale process could generate immediate value, the near term catalysts and incentives for both borrower and lender suggest an acceptable amendment/extension could materialize whereby Media General can achieve a valuation close to a break up value of $7-10. Media General has historically commanded a valuation of 6.8x EV/EBITDA. Even in October 2011, when Media General prices were near $1, this translated into about 6.8x EV/EBITDA with $23MM in equity value and about $650 of net debt. At the time, Media General’s pro forma LTM Q3 EBITDA was about $99MM. As with most cyclical companies, this valuation multiple “detaches” during cycle turns which is what occurred in Q4 2011. Participants start buying the stock knowing that the current quarter (which was Q4) would be the bottom in terms of operating profit. As a result, Media General is now valued at 7.9x EV/2011 pro forma EBITDA with that EBITDA figure being the cycle low/trough level. If history repeats, Media General will get back to the 6.8x multiple as EBITDA improves.
Assuming Media General gets to $125MM in EBITDA in 2012, I expect Media General to carry an enterprise value of $850MM which would result in an equity valuation of about $9.50 or so. However, under a new deal with BofA, the market could reduce the overall EV/EBITDA multiple Media General deserves as a higher level of interest expense would be paid out. If Media General commands an EV/EBITDA multiple of 6.25-6.50x as a result, Media General’s share price would still range from $6.50-$8.00. What would also be of use would be to compare the EV/Revenue multiples of highly levered traditional media companies such as Lee Enterprises (LEE) and the McClatchy Company (MNI). Both are worse assets than Media General and have significant leverage but trade around 1.4x EV/Sales. Using that multiple, Media General would command prices over $12.
The main challenge right now is waiting while management potentially bumbles and stumbles in its negotiations with BofA. The above discussion laid out a number of incentives BofA and its lending group have to work on a deal that works for Media General and performance by other levered old media entities post positive financing news suggests if Media General can secure a decent deal, the stock could continue to perform well as Media General captures significant upside from 2012′s political season without the overhang of credit issues. Media General is working to secure a deal before filing its 10K and with 42% of the stock sold short, the wait for potentially explosive good or bad news won’t be long.
Disclosure: Author manages a hedge fund and managed accounts are long MEG.