Since merging with CBS Radio, shares of Entercom Communication (ETM) have been steadily falling, mainly due to the amount of debt raised to close the merger.
Management is excited about some growth segments, raising the company’s overall risk, which at the same time doesn’t get along with current debt ratios.
The company has limited cash flows, but needs to keep paying dividends and reducing its debt.
Watch ETM for the management’s narrative to turn more realistic.
Since merging with CBS Radio, shares of Entercom Communication (ETM) have been steadily falling, mainly due to the amount of debt raised to close the merger. If you have been following the radio space, you may know that Cumulus Media (CMLS) and iHeartRadio (IHRT) went bankrupt because of excessive amounts of debt, as a result of highly leveraged M&A activity.
Off course, ETM didn’t file for Chapter 11 or had a level of debt as high as those of its peers, but it has another problem. The management, now with more than 230 stations under its care and national reach, started to dream about the future of radio (or audio as the company calls it now), and acquired a couple of podcasting businesses (badly received by the market), and reinvested in digital audio (i.e. Radio.com). The problem with this is the rise in the company’s overall risk, given the amount of debt on its balance sheet.
As the management is enthusiastic about future growth, and shareholders, with fresh memories of the failures of its peers, are fearful of going bankrupt, a conflict of interests arises between the former and the latter. And when such conflicts happen, share prices are the victims, as is the case with ETM, which is down about 70% from its pre-merger highs of early 2017.
But that’s not all. Since Q2 2016, ETM had been paying an attractive dividend that reached $0.36 per share (+7% yield at current prices), before been cut to $0.08 (1.56% yield) in Q3 2019. The management announced this cut after the stock had fallen by more than 35% on its Q2 2019 earnings release, saying that the extra cash would be used in debt repayment and stock buybacks.
The goal was to calm investors and save the stock price to continue its free fall.
In my view, the management realized (finally) that the market wasn’t interested in buying podcasting businesses when there is such a debt burden to repay, and was rather into using some free cash flow to reduce the latter. I’m comfortable with the idea of an investor-conscious management, but an indecisive one is unbearable.
I think that managers shouldn’t let investors (or other market participants) tell them what to do with their businesses, unless they’re doing an awful job, which I consider not to be the case with ETM and its successful integration with the radio division of CBS. Then, there is no reason for ETM to change its strategy overnight to please the market, nor even to reduce its dividend by roughly 80%. I see the latter as a fatal mistake and a lag on future valuations (more on this later).
Limited Free Cash Flow, But Three Conflicting Ways To Invest It
In this environment, where the company has cut its dividend, the stock is impressively cheap, and investors are screaming for debt reduction, the management is against the wall. Let me explain.
During the first nine months of 2019, ETM generated operating cash flows of roughly $100 million, and I expect a full-year figure close to $150 million, due to strong revenue seasonality in Q4 2019. So, in a best-case scenario, ETM could generate $150-200 million in run-rate operating cash flow, and would have three main ways to invest/spend it: dividends, stock repurchases, and debt repayment.
I have to say that, in my opinion, the dividend cut was completely wrong (as I mentioned above). In a world where dividend/income investing is gaining so much attention and investors’ appealing, cutting a dividend will weigh on future valuation multiples.
A stock that has a reputation of cutting its dividend in rough times, won’t have the appeal (dividend yield/earnings multiple) of one that has been growing (or keeping) its dividend over the years, even in recessions and bad times. Hence, this management behavior makes you think twice before investing in ETM.
Indeed, the main reason to buy ETM shares for the long term is the dividend. Right now is a value move (even though it has a lot of debt) because of the price. But, what else has ETM to offer?
I expect revenue growth to range 1-2% per year, and earnings to perform in tandem, when merger synergies are realized. Also, radio is not an industry with many growth opportunities – other than digital radio, which I only expect to grab share from traditional (analogue) outlets, and not to abnormally expand the industry as a whole.
So, ETM equals dividend, and without a significant yield, or a constantly growing rate, the stock is worthless (figuratively), there’s no appeal.
As I mentioned above, keeping and growing the dividend is mandatory, but not buying the stock at these prices is a sin.
Right now, buying back its own stock is one of the wisest decisions for ETM. Let’s put it this way, the shares are trading at less than five times forward earnings, and are worth half their book value. From most perspectives, the stock is attractive.
Therefore, stopping the buyback program to favor any other use of funds, at a time when the stock is at historical lows, and is deeply undervalued and misunderstood by the market, would be a terrible decision.
With a duty to pay a dividend, and a stock so attractive, paying down debt with an interest rate of ~5.5% seems inconvenient. Although reducing it would strengthen the balance sheet and augment the overall appealing of the stock.
Having said that, I think that the management should take debt repayment as its last choice. As of September 30, ETM has a debt load of ~$1.7 billion, and its main debt ratios are as follows:
Net debt/EBITDA (forward FY2019): 5.1x
EBIT/Interest expense (forward FY2019): 2.5x
Operating cash flow/Interest expense (forward FY2019): ~1.4x
The above readings are not the best for slow growers, but are not alarming on their selves. It all comes down to how volatile is the operating cash flow over the years.
The tables below show the three categories of cash flows for ETM from 2009 to 2013, and from 2014 to 2018 (both from right to left), respectively.
Over 10 years, operating cash flows have varied from $73.9 million to $102.2 million (and 2019’s figure might get to >$150 million). Excluding post acquisition years, it has come from the same $73.9 million in 2009 to $72 million in 2016. The trend is quite stable to my eyes. The only year with a significant drawdown was 2017, and it was due to the CBS merger. Off course, with such an amount of debt, I don’t expect ETM to perform significant M&A activity for some time.
If future cash flows were to perform as in the past, there were no problem with keeping the debt (or reducing it slight year after year). But, as I mentioned before, investments in growth like podcasting and digital radio may prove to be cash-flow demanding, adding more risk to the company’s operations.
So, future cash flows are uncertain, given the aggressive attitude of the management, so the company is in the need to pay down debt, or get more defensive, concerning risky and growth investments.
No wonder why the market has been upset by recent podcasting acquisitions from ETM and its overall adventurous attitude. With such a limited amount of cash flows, and a duty to pay dividends and repay its debt, the company should avoid risk at all costs.
I must say that ETM’s debt on its own is not that bad, the problem is that the management is adding risk by being aggressive with growth investments.
The bottom line here is, ETM has to restore its prior dividend, that’s a must, then improve debt ratios, or reduce overall risk, by limiting the exposure to aggressive investments.
Right now, my recommendation is to WATCH the management over the financial results. Its narrative over the last few quarters has been optimistic, and tends to drive your eyes to the company’s growth segments like podcasting, audio search, digital radio, etc., instead of its lack of substantial cash flows to face dividends, buybacks and debt repayments, all at the same time.
Just stay on the sidelines until the management lands on earth and recognizes its issues and what’s the “value” it can really create for shareholders (you know, dividends). I’ll leave you with some words from the CEO during the last earnings call:
“… our stock is trading at what we believe is a significant discount to value. As of yesterday’s close ($3.69), the free cash flow yield over 30%. We do not control our share price. But we do believe there is a disconnect relative to the strength of our business and our platforms and assets and the opportunities we see for growth and value creation. We are excited about the future and look forward to continuing to work hard to realize significant value for our shareholders.”
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within 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.