How Much is Spanish Broadcasting Worth?

Spanish Broadcasting System, Inc. (NDAQ: SBSA) directors are starting to feel the heat after a large shareholder criticized the company’s stock performance and governance while promising to take action if things do not improve, according to a Schedule 13D filing with the SEC. Discovery Group, which owns a 9.8 percent stake, sent a letter to the board expressing grave concerns regarding the severe and steady erosion of shareholder value that has occurred since the company went public eight years ago. Management has also been unresponsive to these concerns and countless opportunities to reverse these trends. However, the activist hedge fund believes there is still hope as shares trade substantially lower than their intrinsic value. So, is this a good time to get in SBSA on the coattails of an activist hedge fund?

Spanish Broadcasting IPOed in 1999 at $20 per share, but the stock now trades at just $1.60. Discovery Group attributes this dramatic decline to (1) weak operating performance as measured by essentially no growth in operating income, (2) significant sums of money spent on acquisitions that provided no incremental value to the company, and (3) the utter loss of management’s credibility with the investment community. In the end, the value of the company was about $1.5 billion when it IPOed while today the market cap stands at just $500 million with $375 million in debt. Operating income also failed to increase, standing at $32 million when the company IPOed compared to $38 million in 2007. And finally, the company spent $934 million on acquisitions while the company’s value dropped $1 billion.

Discovery Group met with Spanish Broadcasting officials several times during the past two years to discuss the decline in shareholder value and the challenges the company faces to restore a fair valuation given its small size, weak governance, disappointing operating results, unrestrained M&A spending, lack of credibility with institutional investors, and general proclivity towards running the company as if it were privately held. The activist hedge fund also met with several industry players who insist that the company’s premier properties, market leadership position, attractive geographic markets and promising media genre would make it a desirable and valuable target in the ongoing industry consolidation. However, it is generally understood in the industry that the company will not consider any transaction that requires him to relinquish any degree of control and questions its ability to cooperate with any partnership with strategic suitors or private investors.

Just how bad is it? Well, here’s a synopsis of one scenario presented by the Discovery Group in their letter:

We now know this claim to be justified because we have direct knowledge of an important public media company (“XYZ”) that is interested in a potential transaction that could yield a substantial premium to the current SBSA stock price, yet Mr. Alarcon refuses to engage in an evaluation of this opportunity. During a meeting with Mr. Alarcon in December 2007 members of our firm presented the rationale for a combination with XYZ, to which SBSA would bring great strategic value and substantial, immediate cost synergies. Mr. Alarcon concurred with the analysis and suggested that we get the reaction of XYZ’s management to the idea. Our team met in January 2008 with XYZ’s Chairman/Chief Executive Officer and its Chief Financial Officer. We communicated to Mr. Alarcon that the XYZ officials were very enthused about the possible combination and wish to engage in a further dialogue directly with Mr. Alarcon. Mr. Alarcon is also in possession of detailed materials prepared by Discovery that outline a proposed structure for this transaction which yields a premium in excess of 100% to SBSA shareholders. Suddenly and without explanation, Mr. Alarcon refuses to discuss this opportunity. While Mr. Alarcon’s change in posture is consistent with his industry reputation, it is surprising nonetheless. Mr. Alarcon’s resistance in this case cannot be attributed to valuation because the proposed structure gives him the option to either remain invested or liquidate his shares. Rather, it appears that Mr. Alarcon fears a loss of control. That fear is interfering with Mr. Alarcon’s ability to act in the interest of all shareholders.

Discovery Group is now increasing its pressure on Spanish Broadcasting to unlock value by threatening to replace board members if it does not immediately retain an investment bank to investigate three specific alternatives:

1. A Going-Private Transaction. “If Mr. Alarcon insists on retaining all voting control and all management authority, it seems rather obvious that there is no purpose to SBSA remaining public. Given the current stock price and the vast availability of private equity capital, we believe that a transaction can be structured that provides an acceptable premium to shareholders. Any qualified investment banking firm can introduce Mr. Alarcon to numerous private equity firms, many with media expertise. We have spoken to several of these potential financial partners that would be interested so long as Mr. Alarcon is willing to provide them with adequate financial oversight and controls. As testament to the feasibility of this option, Univision was taken private in April 2007 by a consortium of industry-leading private equity firms; Madison Dearborn Partners, Providence Equity Partners, Texas Pacific Group, Thomas H. Lee Partners, and Sabon Capital Group. Currently, Clear Channel Communications is close to completing a similar deal with Bain Capital Partners and Thomas H. Lee Partners. Cumulus Media is working on an announced going-private transaction with Merrill Lynch Global Private Equity.”
2. A Sale to a Strategic Party. “Industry consolidation is now seen as part of the solution to the long-term secular decline in radio advertising. By combining platforms, companies seek to gain competitive advantage and reduce costs. SBSA has a unique franchise in Hispanic radio that is a highly-desirable addition to any broad media platform. The asset values of SBSA licenses and stations far exceed the current share price. While the current management team has not been able to harvest the value of SBSA’s assets and industry position, a strategic suitor would reward shareholders immediately for the opportunity to maximize the potential of this business. As we have explained, we have direct knowledge of parties interested in a strategic combination with SBSA.”
3. Remain Public But Adopt Modern Corporate Governance Standards. “It is highly unlikely that a comprehensive evaluation of all alternatives would result in a decision to remain public, if measured in terms of the best interests of public shareholders. Regardless, while the Company is public, the Directors must find the courage to invoke the governance changes needed to reassure the capital markets that they takes their stewardship responsibilities seriously. The Board must dismantle the antiquated A/B common equity class structure, which only serves to entrench Mr. Alarcon and embolden his self-serving agenda. Importantly, the jointly held positions of Chairman and Chief Executive Officer must be split in order to bring more accountability to bear on the management team. Mr. Alarcon’s track record running SBSA since it became public makes abundantly clear the need for a change in operating management. Lastly, the Board must undertake a director search to add truly independent directors that will serve the interests of public shareholders.”

In the end, this is great news for shareholders and may be a situation worth watching for other investors as the Discovery Group continues to put on the pressure. It will be interesting to see how the company responds in the coming months…

Disclosure: none