An Important Deadline Is Coming Up
If you have been following my articles, you have noticed my work about a special situation unfolding for Crown Media Holdings (NASDAQ:CRWN), the owner of the Hallmark Channel in July. Several months ago I discussed an opportunity to exploit what I believed was an undervalued situation that could best be defined as "quasi-arbitrage." Investors, including myself, who purchased shares in July have reaped a very healthy annualized return. Most importantly, this return came with what I believe was almost no risk due to the intricacies involved with the deal.
In this article, I will discuss the background of the situation for new readers and how the terms of this deal have since evolved since my first article. While investors have sacrificed some forms of upside since July, I believe that investors now enjoy a much higher degree of certainty in predicting future deal activity including major potential catalysts likely to occur after the New Year.
What Crown Media Holdings Does
Crown Media provides family oriented content including syndicated and original movies as well as special programming events and television shows. Crown Media also provides paid subscriptions to its movie channel and online content - generating a dependable stream of cash flow independent of ad sales, an area of business which is vulnerable to uncertainty during periods of economic difficulty. I believe that Crown Media operates in a highly desirable position within the industry as the move to streaming over the past several years has increased the value of companies that produce or retain the rights on content.
The Background To the Special Situation
Given the fact that the company operates the Hallmark Channel, one would expect there to be significant involvement from Hallmark Cards, the large privately held company of greeting-card renown. They would be right.
Hallmark's initial involvement with Crown Media took the form of licensing the Hallmark trademark and providing debt financing to the company. As the financial crisis intensified and the financial position of Crown Holdings became progressively tenuous - Hallmark Cards converted its debt to equity and helped Crown Media obtain additional debt financing. While this move did save the company, previous holders of the company's equity saw their positions diluted by more than 90% - and Hallmark becoming the effective owner of the company (with a 90.3% ownership).
After signing a "standstill" agreement in 2010, Hallmark recently disclosed it will reach the end of its mandated period of dormancy, causing the shares of Crown Media surge earlier this year. Though the remaining 9.7% of shares remain outstanding and available to the public, it is clear from the overwhelming majority of ownership that Hallmark is the dominant force behind the company and will control the fate of the Crown Media going forward.
Expiration of the Standstill Provides Guidance: Explaining The Wait Til 2014
In my previous article, I speculated that the best possible outcome for minority shareholders of Crown Media was any form of deal activity prior to 2014 - as there was a stipulation in the standstill agreement with Hallmark that provided minority shareholders with a $0.50 per share premium on any type of activity. With approximately 35 million outstanding shares available to the public, this would have represented a $17.5 million dollar payment that Hallmark would have been obligated to furnish to shareholders. This premium provided in conjunction with protection afforded in corporate law by "appraisal" and the fact that shareholders in the company have their interest aligned with Hallmark, as Hallmark is the largest shareholder in Crown, furnished a very significant margin of safety and significant upside. In a little over one month, the obligations of Hallmark to pay minority shareholders will expire - saving the company $17.5 million dollars and providing attentive investors with a timetable on potential activity, likely to occur during the first half of 2014.
Examination of Three Possible Scenarios
1. The Possibility of a Sale To A Third Party
I believe that this represents the best possible outcome for minority shareholders of Crown Media - given the fact that their interests are aligned with Hallmark in achieving the highest possible price for the company.
For investors that have been paying attention, the broadcasting sector has experienced a significant amount of merger and acquisition activity over the past year. Sinclair Broadcasting (NASDAQ:SBGI) has been acquiring a large amount of assets, including Fisher Communications. In addition, the Belo Corporation (NYSE:BLC) has been acquired by Gannett (NYSE:GCI). These acquisitions are logical, as large amounts of redundancy (and thus cost savings) can be realized when one network buys another - if they are able to overcome regulatory hurdles.
When announced, Belo Corporation's PE post merger was 14 compared to Crown's current P/E ratio of 10. Crown also has less debt and has higher free cash flow than BLC, further confirming my belief that this is a very attractive asset that will likely be in high demand. Taking an average of the past two quarters of BLC's free cash flow (113M and 94.86M) we can arrive at an average FCF of $103 million, dividing this number into the $1.43 Billion dollar purchase prices provides us with a FCF multiple of approximately 14x for comparable merger activity. Multiplying 14 by Crown Media's FCF of $140 million yields a market capitalization of approximately $1.9 billion, or when divided by the total outstanding shares a price of $5.4. Writing the price down to $5 is currently 58% higher than current market prices, with the stock most recently trading at $3.16 per share.
Given the popularity of content-driven programming, there are many potential suitors for Crown Media including Disney (NYSE:DIS), CBS (NYSE:CBS) and Scripps Networks (NYSE:SNI). The two largest companies I have mentioned - Disney and CBS will be able to easily purchase Crown Media however given their immense size there could only be a marginal impact on their profits. Scripps Networks however is of a size that is "just right" in my opinion - as the company's market capitalization is approximately $11 Billion and the company has an emphasis on "lifestyle" programming - owning assets including the Food Network, the DIY Network and the Travel Channel. I believe the addition of the Hallmark Channel to the portfolio of Scripps Networks is both a logical and meaningful acquisition.
2. The Possibility of a Short Form Merger
Another likely possibility is that Crown Media will be taken private by Hallmark and absorbed into the company through a process known as a short-form merger. Given the fact that Hallmark has cleared the requisite hurdle of 90% ownership, the company will be able to easily affect a merger given the small size of the outstanding equity in the company. Due to a provision in corporate law known as appraisal and the costly process of discovery during shareholder lawsuits - I believe that Hallmark will offer a significant premium on its outstanding shares in order to avoid unnecessary expenditures.
While I do not expect shareholders will receive a return as high as what could be achieved should the company be sold to a third party, I believe that given how probable this event is and the attractiveness of its alternatives the situation can best be described as a "heads you win big, tails you win." The announcement of a short-form also opens up the possibility of engaging in pure arbitrage, as I believe it is very possible that a higher bid could be issued by Hallmark as a method of fending off shareholders lawsuits or another entrant could appear during the standard "go-shop" period.
3. Remaining a Standalone Entity
Since its restructuring in 2010, Crown Media has turned a profit every year and generates a robust amount of free cash flow relative to its market capitalization. The company is also expanding its presence into the internet and subscription based content in addition to developing new shows and films. I believe that should the company remain a standalone entity, investors will also benefit given the robust free cash flow generated by the company which could be used to pay down debt and even potentially be distributed as a dividend.
While I do not believe that this outcome will lead to a large one time catalyst, I am of the opinion that investors will be, at worst, "stuck" with a good business operating in a highly desirable space. I am also of the opinion that given the attractiveness of the alternatives (a sale to a third party or a short form) that this outcome, though desirable for long term shareholders, is unlikely to occur when measured against the other alternatives.
I hope that from reading this article that it is apparent Crown Media is "in-play." With the standstill agreement set to expire at the end of next month and previous deal activity in the broadcasting sector as a guide to the future - I believe that special situations investors are well served to take note of this situation given both the attractive risk v reward proposition.
While this deal is not for everyone, given the small amount of outstanding equity not owned by Hallmark, for individuals and investors managing small funds I believe that Crown Media is an excellent business to own in 2014.
Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in CRWN 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.