Media General: Warrant Conversion Could Mean Trouble

| About: Media General (MEG)

Media General (NYSE:MEG), "The Most Expensive TV Broadcast Stock," issued a press release on September 25th indicating that Berkshire Hathaway (NYSE:BRK.B) has converted its warrants into common shares. These warrants were received as an "equity kicker" to the term loan that Berkshire provided to MEG last May. The question is: why would Berkshire convert its warrants into common shares now? These warrants don't expire until May 2020 and have a strike price of $0.01 per share. There is only one logical reason Berkshire is converting its warrants - to sell the shares. It is highly unlikely that Berkshire is interested in maintaining an equity interest in this over-levered, "stub equity." Rather, it must be understood that these warrants represent "free money" awarded to Berkshire for lending to MEG, and now that they have been converted into common shares, Berkshire can work to monetize them through open market sales.

Berkshire received these 4.6mm penny warrants, convertible into ~17% of MEG's equity, as part of the May 2012 transaction whereby Berkshire provided MEG with a very expensive $400mm term loan. Equity kickers in the form of warrants are commonly included as part of the cost of debt when lenders are making levered loans to risky borrowers. The warrants allow the lender to participate in the upside of the equity without taking equity risk, because they don't pay anything for the warrants (i.e., strike price of $0.01). When the Berkshire transaction was announced, MEG's stock was trading at just over $3 per share - it has since traded to over $5 per share, up over 60%. Berkshire has made a huge incremental profit on its term loan through these penny warrants, and is now likely looking to monetize its gains.

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There is no other logical reason why Berkshire would convert its warrants now. MEG's equity is a "stub" equity behind over $800mm of debt and pension liabilities - that is leverage of ~10x 2-year average EBITDA. MEG trades at over 11x EBITDA, versus its better managed peers [Sinclair (SBGI), Belo (BLC), Lin TV (TVL), Nexstar (NXST), etc.] that trade at ~6.5-7.5x. MEG is not the kind of company that a value investor like Berkshire would seek to own. It must be understood that these warrants represent "free money" awarded to Berkshire for lending to MEG, and it is very unlikely that the conversion of these warrants reflects Berkshire's interest in maintaining an equity stake in the company. Rather, Berkshire is likely seeking to monetize these warrants through open market sales.

And for the same reasons that Berkshire would not seek to own MEG, no other strategic investor could acquire it either. It is impossible for another TV broadcast company trading at around 7x EBITDA to justify acquiring MEG for greater than 11x EBITDA, which is where the stock currently trades. Even if the strategic acquirer could cut out all of MEG's corporate overhead, MEG's valuation would still be almost 9x EBITDA.

MEG is over-levered, generates no cash flow, and is valued at a ~4x EBITDA premium to its peers. With these characteristics, what value can it offer to shareholders? And now, there is the strong potential for Berkshire, the second largest shareholder, to begin selling its shares, which could add meaningful downward pressure MEG's stock price.

Disclosure: I am short MEG. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: The author, his family, and funds the author manages and/or is associated with may or may not have a position in any of the securities mentioned in this write-up. Any of the aforementioned may trade in and out and around any of the securities mentioned without notifying you. Do your own diligence. Also note this write-up does not constitute any investment advice.

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