On the Hunt for Bargains
If you have been following my articles lately you will find that I am attracted to media businesses. I have focused a large amount of my efforts analyzing the companies that are involved in the more "traditional" forms of media for value opportunities - as the bulk of Wall Street effort has been redirected to online content. Through traditional forms of media are suffering a loss of market share to the internet, I believe that there are considerable bright spots and cases of bargain valuation.
One form of media that has fallen out of favor is traditional Radio Broadcasting. I believe that the sector offers lush hunting grounds for value - as the companies are small, obscure and trade at attractive valuations. One major reason these companies are less popular is the advent of the internet. Despite the fact that internet and satellite radio alternatives have made significant inroads, there remains a significant source of business to be had.
In this article I will discuss a small radio broadcaster that I believe exhibits strong qualities that have gone unappreciated by the market as interest in the radio space has shifted away from terrestrial and towards the "trendier" internet and satellite options. The company is Entercom (NYSE:ETM).
What Entercom Does
Entercom owns a portfolio of more than one hundred local radio stations that provide various types of broadcast content including but not limited to: Classical, Rock, Adult Contemporary and Sports. The company also enjoys national distribution - serving 23 regional markets across the United States. The company has also been making acquisitions - recently acquiring KBLX-FM, based in Berkeley, California. The company also streams its stations through the internet. The company generates the majority of its revenue through the sale of advertising space on its channels.
The Numbers on Entercom
Currently priced at $9.23 per share against $7.37 of book value and a market capitalization of approximately $345 million, the company is tiny. Though it is priced above book, it is only trading at a modest premium of 1.25 to book, in contrast to a P/B ratio of 7 and 56 for Sirius XM and Pandora, respectively. Though Entercom does carry a large amount of debt - something typical to businesses operating in the broadcast space, the company generates a robust amount of Free Cash Flow, at approximately $50 million, a FCF multiple of 7x when measured against its current market capitalization, a very appealing number especially when viewed against both comparable terrestrial radio peers and non-terrestrial alternatives. The company also has a moderate P/E ratio of 14.1.
Insider ownership in the company is also high - currently standing at 44%. Entercom is also second generation family business, something that I believe will help incentivize the stewardship of shareholder capital.
The stock is also currently has a short ratio higher than 10%, a ratio which I believe that this is unjustified given the strength of the company's balance sheet, its high insider ownership, cheap valuation relative to underlying assets and robust free cash flow. I believe this high short ratio is a sign of market pessimism and as such I would believe a squeeze to be likely should the company produce favorable results or experience a catalyst in the near term.
The company currently pays no dividend but I will discuss this fact and my opinions on this matter at length later in this article.
Warren Buffett's Wisdom: The Conceptual Strength of Local Media
Local newspapers are one of Warren Buffett's best loved assets and they remain so even after the sweeping changes the broader industry has witnessed over the past several decades. While it is undeniable that many digital sources have supplanted traditional forms of print based news, Buffett has gained considerable attention for investing in small, local papers over the past several years. His rationale is that the market for local news and local advertising will always remain robust, particularly if it's a de facto monopoly in a "one newspaper town." Specialized publications are also likewise valuable resources - and boast attractive margins due to their specific nature and devout reader base.
I will attempt to extend this metaphor one degree further, to local radio stations. In a similar vein, local radio stations provide individuals with an attractive advertising proposition - as they have a captive audience and are able to direct their advertising dollars in a geographically relevant and focused manner, in contrast to other advertising venues such as the internet.
There is also a form of significant entrenched brand recognition at work here - engendered from years of listening. You can probably remember the names of several radio stations and their frequencies off the top of your head as you are reading this after years of hearing their commercial jingles being repeated. I know I sure can.
Potential Catalysts: Ripe For Consolidation
The broadcast television sector is currently undergoing a large amount of consolidations through mergers due to low interest rates enabling favorable financing terms and the potential of elimination of operating redundancies through the economies of scale. I believe that there are significant parallels in the terrestrial radio business as well - given the changes to the industry and the economies of scale.
I believe that Entercom's robust cash flow can be deployed into purchasing other radio companies or simply acquiring more station assets as the company has an established track record of this behavior - with a recent acquisition in 2012. I also believe that should Entercom run out of assets that would be profitable to acquire, there is another catalyst on the horizon for investors that has the potential to be incredibly rewarding...
Catalyst Two: Reinstating The Dividend Could Mean Big Money
When examining the history of the company, a few things become immediately apparent: The company has declined significantly from its IPO in 1999, over 70% and despite this decline the company once paid a robust dividend.
Much of this decline, in my mind, is due to timing. As the hype generated by satellite and internet radio increased, investors grew increasingly pessimistic about the future prospects of radio companies. While I do degree that this new technology has reduced the value proposition of these companies, I do not believe that it has totally eliminated it.
In 2006, after several years of share price declines, the company instituted a quarterly dividend - yielding over 4%. However, this could not have come at a worse time, considering the deterioration of ad spending during the financial crisis - which caused the dividend of the company to be reduced from 38 cents a share to 10 cents a share - finally being halted in 2008, with the common of the company trading below a dollar at one point.
As interest rates dropped and advertising spending recovered, shares of Entercom have rebounded significantly from their (ludicrous, unbelievably cheap) all time lows. In addition, the company's robust free cash flow indicates to me that the company could resume paying a dividend on its shares - given the high insider ownership of the company and the behavior of another broadcaster, Salem Communications Corporation (NASDAQ:SALM) - which resumed and has since increased its dividend since the financial crisis. Salem Communications, since resuming its dividend in 2012, has appreciated over 200%.
Were Entercom to pursue the same course of action - I believe that it's share prices would increase significantly in price - with a .10 cent quarterly dividend giving the company a yield of over 4% to investors purchasing their shares at current levels.
I also believe that should the company resume paying a dividend - investors would bid up the price of the company significantly due to the demand for yield in this low rate environment. In addition, mandated index and ETF purchases could cause share price to significantly appreciate in the near term, combined with a low float caused by high insider ownership and significant short interest - a squeeze could likely occur via panic covering.
Ben Graham discussed at length the danger of bidding up shares of a company after a dividend increase has been announced - viewing it as the acme of irrationality to pay a higher price for shares after such an announcement, as investors late to the party forego the benefits of a higher dividend by paying a correspondingly higher price for shares. In contrast, investors who are already invested will benefit substantially from this irrational behavior not only through dividends but through higher share prices.
Despite the fact that I believe there are significant bright spots to be had in the traditional broadcasting sector - it is important to understand that the company will have to adapt to an increasingly digital world going forward. Though expanding its content offerings online does provide a way to stay relevant, it is important to understand that other alternatives including XM, Pandora and iTunes may become increasingly competitive.
Media companies are also particularly vulnerable to a decline in the broader economy due to their high debt loads and their dependence upon selling ad space. If there is another protracted downturn in the economy I believe that Entercom, like all companies dependent upon advertising, will suffer - however I believe that the company is in a much better position having weathered the financial crisis of 2008.
Another risk to be aware of is structural - as the company is both thinly traded and of small capitalization. The establishment or liquidation of a larger position in the company could produce significant appreciation in share price that could be disconnected from the operating record of the company.
One of the most important tools in a Value Investor's arsenal is the willingness to seek out unpopular or obscure areas of the market and to profit from them. Terrestrial Radio provides one such fertile hunting ground. Given the highly sought after new entrants into the Radio marketplace, the stalwarts of the sector have gone ignored and unloved despite weathering the stresses of the financial crisis.
I believe that Entercom represents a compelling purchase for investors at current levels. The company, in my mind, is trading at much more rational valuations to its peers in the Satellite or Internet Radio sector - currently offered at a modest premium to book value. The company also has high levels of insider ownership and robust free cash flow yield which could be diverted into either accretive acquisitions or into a dividend which stand to benefit shareholders enormously.
Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in ETM over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.