E.W. Scripps: Don't Let The Debt Scare You Off
Summary
- SSP took out debt equal to 1.85x its market cap to double down on the TV broadcasting business.
- The debt comes due between 2024 and 2031, giving SSP ample time to pay off the debt.
- The combined entity should generate enough Free Cash Flow to pay off its debt.
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Investment Thesis
I believe The E.W. Scripps Company (NASDAQ:SSP) is undervalued by the market due to a misunderstanding of their debt. The market is pricing in a high likelihood of bankruptcy because the debt is 2.5x equity. SSP owes $3 billion in debt, but the debt is spread out over a period of 8 years and no portion of the debt is due until 2024. This fact, along with the expectation that SSP will generate sufficient cash to both service the debt and pay it off as it comes due, means SSP is undervalued. The debt came from a horizontal acquisition of ION Media. This makes their indebtedness different from companies that needed debt to keep the company afloat.
Overview
At face value, SSP looks like a company on its way to the corporate graveyard. SSP has a market cap of $1.62 billion and $3 billion in debt. The Altman Z score is well below 1.8, with a score of 1.21. The short interest is only at 4.62% and shares are close to their historical highs of $26 a share. So it looks like there's plenty of room to head down.
Upon closer inspection, SSP appears to be an interesting investment opportunity. For starters, the $3 billion in debt comes due starting in 2024 and the last tranche comes due in 2031, giving SSP a decent amount of time to pay down the debt.
The last time a contributor covered SSP was in Oct 2018 when they were acquiring Triton Digital to enter the digital audio business. Now they are selling Triton Digital for a profit and have completed a massive merger with ION Media. To be clear, SSP has gone through a massive reorganization. The questions are, can SSP survive long enough for their big bet of doubling down on broadcast TV to pay off?
SSP Debt Levels and Due Dates
Here is the debt schedule SSP has provided investors:
Source: 2020 10-K page 78
As you can see, nothing begins to come due until 2024. The question is, will SSP have sufficient cash to meet their obligations when they come due?
Cash Levels
To begin, let's look at the current cash on the balance sheet.
Source: 2020 10-K page 56
As of the end of 2020, they actually had enough cash on hand to pay down 19% of the outstanding debt, which is comforting. Seeing how much cash increased from 2019 to 2020 also raises some questions. Aside from cost cutting measures, they sold some assets not essential to the direction they are taking SSP in. They sold the WPIX station in NYC for $83 million. They also sold Stitcher for $265 million up front and two additional payments of $30 million due in 2021 & 2022 for a total sale price of $325 million. SSP also received $115 million for stations they were required to sell for regulatory reasons as part of the ION acquisition. As part of the ION acquisition, they gained the $300 million that ION had in cash.
In Q1 2021, they received another $30 million as part of the Stitcher sale and received $230 million for the sale of Triton Digital to iHeart Radio. The deal was signed in February 2021 and closed on 3/31/21.
At the Investor Day event in March of 2021, management pointed out their desire to maintain an average cash balance of $75 million.
In summary, SSP will have $1.061 billion in cash to pay down the debt in 2021 before taking the business performance for the year into consideration and keeping $75 million in cash. With that amount of cash, 35.5% of the debt can be paid down, or based on the debt schedule shown above can cover their obligations to 2026.
ION Acquisition, Berkshire Terms
A second and equally important part of the ION acquisition is a $600 million preferred share investment Berkshire Hathaway made in SSP. The terms that matter to us are as follows: the preferred shares are cumulative with an 8% coupon rate. If SSP fails to pay the preferred shares dividend in any year, the coupon rate increases to 9%. While the preferred shares are outstanding, SSP cannot repurchase shares or pay dividends to common shareholders. Berkshire Hathaway also receives $300 million of warrants to purchase SSP stock at a price of $13/sh. Lastly, these preferred shares cannot be retired until 2026 at the earliest.
Brutal. So essentially, the BRK investment is an albatross around SSP’s neck. Prior to this investment, SSP was paying $16.6 million in dividends. That cost is gone and replaced with a $48 million dividend expense to BRK, creating a net dividend expense of $31.4 million.
Cash Flows
Moving on to their cash flows for the future and growth expectations, there are a few bits of useful information management has provided us. The first thing to point out is Adam Symson, the CEO, stated during the February 26, 2021 earnings call regarding cash flows:
This performance will translate to about 17% of every net revenue dollar dropping to the free cash flow bottom line.
The second significant thing that was mentioned during the earnings call came from the network president & former CFO Lisa Knutson.
As for revenue CAGR, I think I indicated in my remarks that over the next several years, we think that ION’s or the combined networks revenue will grow around 10%. So we think that that’s probably a best in class. And we think that that revenue growth is certainly projected to be double-digit – low-double digit growth over the next two years.
Here are the revenue numbers management gave us along with 2020 FCF.
Source: Author with data from 2020 10-K
In 2019, Political Advertising was 23 million, so I will assume 2021 Political Advertising will be 10% of 2020’s haul. We did not get a growth estimate for Local Media advertising growth, so I chose to project a 10% growth rate given that Local advertising should increase based on how we reopen from COVID-19. Lastly, 50% of SSP Retransmission agreements were renewed and updated in 2020. Compared to what Retransmission revenues were in 2019, that translates to a $2.77 million increase for every 1% of Retransmission agreements that are renewed, and in 2021 only 4% of the agreements are up for renewal. Here is what 2021 looks like when we put all of this together:
Source: Author with data from 2020 10-K
One important caveat is that the 2020 numbers do not include ION’s revenue because the acquisition closed in 2021. I did not include the 2020 ION results because the CEO’s statement about 17% of net revenue flowing to FCF was based on the pre-acquisition numbers you see here. If ION’s results are included, SSP total revenue for 2020 would be around $2.3 billion, meaning revenue will decline in 2021. This makes sense given that 2021 is not an election year, and political advertising is worth over $250 million in revenue. Using the same expectations, I modeled out Year 2022, and a 2023 that shows the growth in Retransmission revenue because 75% of their agreements will be renewed that year. Aside from that, I did not project any growth because of the lack of guidance, but I did include the cyclical decline in political advertising.
Source: Author with data from 2020 10-K
Between 2021 & 2022, FCF is expected to increase by $80 million, which is encouraging. Once again, the reason we are doing this is to see how well SSP can pay down the debt. At their Virtual Investor Day event on March 3, 2021, they told us the current leverage ratio is 4.9 and they want to bring it down to 3.0 using “excess cash flow.”
Source: Investor Day event slide 54
In November, the SSP Board authorized a debt repurchase program to reduce the principal debt owed by up to $500 million and the authorization expires in 2023.
Now for those that don’t know or forgot, the leverage ratio is debt divided by equity. This means you can lower the leverage ratio by reducing debt and also by increasing equity. If SSP only reduces debt by $500 million and there is no increase in equity, the leverage ratio will decline from 4.9 to 4.37. Equity would have to increase by $415 million to bring the leverage ratio down to 3.0, which seems doable given that in 2020 net income from continuing operations was $209 million.
Risks
There are a two main risks SSP faces that could cause the company a lot of trouble. The most obvious problem would be an accelerated demise of cable in favor of streaming. The pandemic, as we have all seen, changed people’s habits and in general has accelerated technology adoption. A swift and sudden end to cable would in the short to medium term hurt SSP’s profitability and, by extension, their ability to service and pay their debt. Retransmission revenue primarily comes from cable operators, and satellite carriers. In 2020, Retransmission revenue made up 32% of SSP’s total revenues. Retransmission revenues are also a bright spot for revenue growth. At present, the TV landscape is shifting towards its new normal as traditional cable TV loses market share to streaming services. An eye must be kept on this changing landscape because of the influence it has on SSP’s bottom line.
The second risk is interest rate risk. As we all know, rates are at an all-time low, and a few of SSP’s obligations are on variable interest rates. The Federal Reserve has made clear they want to bring inflation back and will wait until inflation gets above 2% to begin raising rates. At the same time, with all of the stimulus that has been pumped into the economy and the trillions more the Biden administration wants to spend, the market has legitimate questions about hyperinflation. At present, SSP’s debts have a low average weighted interest rate of 4.2%. If inflation comes back with force and the Fed raises rates to say 6%, SSP's interest expense will more than double. In addition to the interest rate risk, the variable interest debt is currently based on LIBOR; but with LIBOR ending, the benchmark that will be used will also change. The replacement benchmark for LIBOR has not been named at the time of this writing, and it is my personal opinion that the replacement benchmark will not have a material impact on the interest rate. The main concern is inflation because that is what will affect variable interest rates the most.
These two risks are significant because SSP cannot control these two factors and both factors are currently in a state of flux. Both the adoption of streaming services and inflation have the potential to severely hurt SSP's ability to generate the cash necessary to service and pay down their debt.
Conclusion
To wrap it up nicely, expected FCF between 2021 and 2023 should be more than sufficient to reduce debt by $500 million. Over this time period, equity should also increase bringing the leverage ratio to management’s target of 3.0.
When you look under the hood, things are not as bad as expected. The next big question is, will SSP make a good investment? Comparing Scripps to the competition like Sinclair and AMC, there is about 40% upside for SSP. On the foolishly optimistic side of things, SSP could work its way up to be like Nexstar, which would make Scripps a 3 bagger. Within a year or so we should see enough to be able to gauge SSP’s likelihood of being a stock that increases by 100%+ over the coming years, but in a short term 2-year time horizon it seems like a straight-forward value investment play.
This article was written by
Analyst’s 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.
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