Business
Saga Communications (NASDAQ:SGA), founded in 1986 and headquartered in Michigan (US), is a radio broadcaster operating in 27 markets via its 79 FM and 34 AM company-owned radio stations and 77 metro signals. SGA is a strong local operator with top-end rankings in the markets that operates. SGA sold its remaining TV stations in 2017 and is now focused solely on radio broadcasting.
Operations
- 87% of revenues generated by local advertising. CEO prefers to work directly with local companies than be dependent upon intermediaries. That is only possible in local advertising market.
- Advertising revenues comes from auto dealerships, farming, medical and home improvement industries.
- Most advertising contracts are short-term in nature and run for a few weeks.
Management & Strategy
Ed Christian (Founder & CEO) is considered an industry expert and has grown SGA from 8 stations in 1986 to over 100 today. Mr Christian and Sam Bush (CFO) are significant shareholders. Mr Christian is the second largest shareholder but controls 60% of voting shares via Class B shares. CEO has voting control of SGA via super-voting Class B shares but he looks like he has treated shareholder well over company's history.
CEO tends to look SGA business as a brand development platform. Radio business is in a transformative phase but SGA will always play for the long ball. CEO is focusing on building more relationships with local businesses and working with them to build their brands and image through radio.
Financial Performance
Over the last 10 Years, SGA has kept its top line steady at c. $124m and its Gross Profit margin broadly steady at 26.4%. SG&A costs have popped after FY14, from an 5-year average of 6.2% of Sales to 9.3%. OpEx increase is attributed to a multi-year contract agreement to license historic Nielsen data in selected markets in conjunction with entering into licenses to receive Nielsen reports and services during future periods in those markets.
Apparently Nielsen has a lot of power in the radio industry and recently (Q3FY20) made a policy change under which it will no longer include the ratings for non subscribing stations in the summary data set that files the major buying systems used by agencies and advertisers. SGA is not a full-service client of Nielsen but nevertheless they pay for some kind of secondary services. According to management, such a policy change is a hot topic in the industry right now.
Nielsen surveys 2 different sets of markets. One is the diary market, which is, in my opinion, a highly automated way of surveying, where you're asking a responder to carry personally a diary for 7 days and contemporaneously fill out line-by- line what he listens to, what radio station, what time it starts, what time it ends. The other one is the PPM, which is the meters that are attached to people's belts and it warrants for up to 2 years for listening.
When they send this information out, radio stations subscribe "to the information" and the same with the people meter, they subscribe for the information. It then is also sold to the advertising agencies at a highly discounted rate compared to what stations pay. And what they are doing now with this new proposal they've come in. And by the way, this has been creeping up because each -- several years, they cut out another feature punishing nonsubscribers like us. I won't say punishing but changing to benefit subscribers. And now there's -- the agency has got 2 levels of information, summary data and respondent data - Q3FY20 Earnings Call
Over the same period, SGA generated an average of $20.8m in earnings before tax. Earning 16.7% on average for every dollar of sale. This relatively fat pre-tax average margin offers some kind of downside protection to potential investors.
In terms of cash generation, the story is again very positive. By taking into consideration the net M&A activity that includes the divestment of TV station in FY17 and a sequence of radio station purchases, SGA was able to generate $213m in FCF during the last 10 years (FY10-FY19). Based on historical data and management's guidance, SGA requires c. $5-6m in Capex to maintain its current business.
During the last 8 years, SGA has paid $68m in dividends and has returned $4.1m via buybacks.
Risks
Tech disruption: With Spotify, Pandora and other industry disruptors gaining significant market share, tech disruption is definitely a risk. However, SGA's quality focus and strong relationship with its local market can serve as a more efficient advertising channel specifically for small businesses. Stable revenue profile probably means that the Company has built a strong listeners base and that is translated to strong advertising revenues. Many ads are now inserted electronically without supervision or quality control. SGA is following a different approach by trying to retain the highest standards of quality.
Commoditised Radio Business: National business is changing to a commodity, bulk-buying, low-rate business and is moving away from the traditional advertising based on community-specific characteristics. Management believes that compromising quality will hurt business in the long run. Hence they are focusing on personal service and moving away from bulk and commoditised advertising.
Controlling Shareholder: While that alone can simply stop me for digging deeper into a company, after reading more about Mr Christian I feel that he has proved his values and his shareholder-friendly approach.
COVID Issues: COVID forced universities to send students home and to operate in a remote class environment. Such a market-moving event decreased the number of radio-listeners significantly and apparently decreased the number of advertisement campaigns. In a post-COVID world, students will return back to physical classes. Such a cross-industry trend is only temporary in nature and doesn't imply company specific issues.
Competition Struggles: Bankruptcies of iHeartMedia (IHRT) and Cumulus (CMLS) are more related to over-leverage of good broadcasting assets than significant organic growth problems. Based on my comparable analysis, SALM and ETM look to also suffer from over-leveraged balance-sheets.
Investment Decision
SGA is trending downwards since 2017. A combination of TV station divestment, that was probably viewed as a compelling growth story, and the potential tech disruption has driven the price lower to a bargain level. Then COVID happened! Such a sequence of events makes SGA a compelling value candidate and reduces the possibility of a value trap.
Radio station is definitely not the most sexy market out there. However SGA's strong operating performance and the possibility for a post-COVID bounce back make this a compelling investment opportunity. When people start moving again, advertisers will probably re-launch their campaigns to attract clients. SGA's hiring spree, as per the latest earnings call transcript, probably gives us a hint about what lies ahead for the company. Mr Christian tends to look his radio business as an image maker and he is focused on providing personalised, high quality advertising campaigns. Such a different perspective gives an edge to the business and makes me feel that it still has a role to play in the following years.
Competitors look bad compared to SGA. They are either over-leveraged or have a poor operating history. Potential bankruptcies could make good broadcasting assets available and further reduce competition.
SGA has $10m in debt but that is more than covered by the $48.3m in cash. Management is broadly conservative and not interested in an M&A spree. However, they could be keen to add more radio stations as they see fit.
FY20 was a difficult year and could only be seen as exceptional in nature. By excluding FY20, SGA business consistently generates FCF between $18m and $22m for the last 10 years. This means that, SGA trades at 5.0x normalised FCF net of balance sheet cash ($38m excluding debt). A business with these characteristics could be trade at 8.0x-10.0x FCF level without exaggeration. This mean that SGA's fair value is closer to $38 per share, 72% higher than the current price level. Of course we should take into consideration a relatively impacted FY21 as well. However, with such an upside potential, a patient investor could wait 2 to 3 years and still get a decent return.
I have initiated a small position (1.5%) at $20. I haven't seen yet insiders buying the stock but such a move would allow me to increase my conviction.
Conclusion
All things considered, SGA is a cheap, downside-protected, value play with some qualitative characteristics in a changing market. Is not a company that could sit in a portfolio for a long time but is a company that doesn't need much to happen in order to give a good return. I feel comfortable owning this kind of companies and I don't see a significant risk of permanent capital loss.
