Hemisphere Media: Low-Risk Take Private Transaction With A Free 30-70% Price Increase Optionality

May 19, 2022 1:59 PM ETHemisphere Media Group, Inc. (HMTV)8 Comments3 Likes

Summary

  • US-Hispanic-focused media company Hemisphere Media is being taken out opportunistically.
  • The current deal offers a single-digit low-risk return.
  • There is also a "free option" of receiving a higher (30-70% offer).

Hispanic family watching television together

Ariel Skelley/DigitalVision via Getty Images

U.S. Hispanic and Latin American market targeting media company Hemisphere Media Group (NASDAQ:HMTV) has entered into a definitive agreement to be taken private by insiders (own 45% shares outstanding). Under the agreement, shareholders will receive $7/share cash or $280m in total. Conditions include approvals from majority of dissatisfied shareholders, regulatory approvals, and divestment of HMTV's Spanish language streaming platform Pantaya. The merger was unanimously approved by both the special committee and board and is expected to close in Q3. The merger involves a 30-day go-shop period, which ends on the 7th of June. The downside to pre-announcement prices is very steep at 78%, however, the deal is unlikely to break.

A quick overview of the company's assets:

  • Legacy broadcast and cable network businesses:

    • 5 Spanish-language cable television networks in the US;

    • 2 Spanish-language cable television networks in Latin America;

    • #1-rated broadcast television network in Puerto Rico (the only nightly newscast from Puerto Rico created for U.S. Hispanics) WAPA.

  • 40% stake in #3-rated broadcast television network in Columbia;

  • Distributor of content to television and digital media platforms in Latin America;

  • Pantaya - a premium Spanish-language streaming platform distributed in the US. The company has focused its efforts on growing this platform as of late.

The business is based on the ever-growing Latin American population growth in the US. According to the company, Hispanic television households grew 5x since 2010, and the growth from now till 2030 is expected to be at 21%. Also, 96% of Latinos believe it's important for future generations of U.S. Hispanics to speak Spanish.

However, the acquisition received pushback from a substantial long-term shareholder (owns nearly 15% of the publicly traded A shares). The shareholder was dissatisfied with the offer price suggesting a fair value of at least $12/share would be appropriate.

[…] we believe this transaction is unfair to public shareholders as it undervalues the Company and allows insiders to disproportionately benefit from the very share price erosion they are responsible for. In our view, a deal to take the Company private at anything less than $12.00 per share is indefensible and would raise serious questions about the process, motivations and conflicts of interest surrounding the Insider Takeover.

The shareholders' sum of the parts valuation is provided below (note: the proposed $7/share offer EV comes to $494m based on 40.4m shares outstanding):

  • Legacy broadcast and cable network businesses produced approx. $64 million in EBITDA in 2021, excluding operating losses for Pantaya. 2022 EBITDA is expected to be around $70m (the shareholder estimates WAPA to comprise the majority of EBITDA, and deserves a higher multiple). Applying the average $67m EBITDA from these two periods and a 6x multiple, outputs a value of $402m for this segment;

  • Pantaya (the number one Spanish-language streaming platform in the United States by subscribers). The remaining 75% of the business was acquired by HMTV in April 2021 for $124 million, putting a valuation on the business of approximately $165 million. The company repeatedly mentioned significant value creation from this investment;

  • Canal Uno, the Company's joint venture in a Colombian broadcast network: Hemisphere has invested approximately $130 million in Canal Uno in recent years;

  • Other Assets: Includes equity stakes in Snap Media, a content distribution business, and Remezcla, a Latin American cultural media company. Disclosure on these businesses is limited, so a $0 valuation is ascribed.

The resulting EV is $697m. Subtracting Net Debt of $212m yields a value of $12/share (71% higher than the current agreed price) based on simple market trading multiples. $12/share is also quoted by two primary analysts who cover the stock, according to the shareholder.

It seems that management is trying to take the company private opportunistically. The company was trading at around $11/share (the lower limit of the usual price interval of $11-$14/shr.) in November. Strong Q3 results were announced with the CEO expressing confidence in the company's undervaluation during the conference call:

"We're confident that over time our continued execution and enhanced investment in Pantaya will unlock value and minimize the dislocation in our current market value."

10 days later the company did a complete 180 and announced a surprise secondary offering for another 15% shares outstanding or around $66m in total with no express purpose other than general working capital and corporate business needs. Strange considering the company had a revolving credit facility of $30m, which was not used up to that time. This was a complete contradiction from the upbeat Q3 earnings announcement and shares started falling sharply until the offering was canceled two days later as the then-current market price was not sufficient for an equity offering. Interestingly, management stated in the same press release that the company has ample liquidity needed for its operations (Pantaya included). So the real reason for the equity raise was still unknown.

Subsequent Q4 results showed little to no weakness in both QoQ and YoY despite share price dropping north of 50%. Despite continued investments in Pantaya, the balance sheet remained practically unchanged in Q3 results with the revolver still undrawn (suggesting there was limited need for the aforementioned equity raise). The CEO was quoted as seeing the year ending strongly and seeing an outstanding 2022.

The CEO praised the quality of their assets, said the company will deliver long-term shareholder value, they have never been more excited about prospects, and said this about their ever-increasing divergence between value and stock price on the March 8 earnings call.

"We have an incredible high-quality portfolio of assets, including the clear market leader in Spanish-language streaming and a consistent and market-leading networks and production business, all with tremendous upside potential. Yet our market value has little correlation with our true underlying value."

"Before I dive into our performance, I want to briefly address the market value of our business, which has deteriorated in recent months. Very simply, our stock price does not in any way reflect the fundamental value and strength of our company. We have consistently delivered strong results in growth and in particular during 2020 and 2021, we delivered industry-leading growth, and despite the headwinds relating to the pandemic, we set all time revenue records."

"[...] Our business model is proven and has tremendous runway for growth. We have never been more excited about the prospects for Hemisphere."

The company has a dual-share structure - A and B class with around 20m shares outstanding for each class with class B shares having voting power of 10 to 1. The buyer owns 45% of shares (A and B class), but it seems their vote will not be counted in as the shareholder says:

"The Insider Takeover must be approved by a majority of the disinterested shareholders, which purports to be fair because it removes the super vote from most of the private holders, who are interested in the transaction. We suspect, however, that certain key class B shareholders, whom the Company counts as disinterested and who will likely determine the outcome of the vote, are, in fact, not disinterested at all due to related party transactions and economic ownership, as well as business and personal relationships"

The mention of "certain key class B shareholders", who may be counted as disinterested (despite very likely still in support of the merger) is key here. Assuming the dissatisfied shareholder is correct in his assumptions, we see a 12.5% holding by Grupo MVS Capital. I am not sure about the details of this shareholder, but his 2.7m class B holding gives it voting power equal to 27m of class A shares, i.e., it can single-handedly outvote all of class A shareholders. Phrasing it differently, the current deal will most likely not get blocked by unsatisfied class A shareholders.

Substantial shareholders

Substantial Shareholders (Proxy)

Substantial shareholders:

  • Edenbrook Capital (the dissatisfied shareholder) - now owns 15% of Class A shares. The fund has started an acceleration of share accumulation post the November secondary offering announcement to average his cost down. Originally acquired an initial position in 2016.

  • Fine Capital Partners - owns around 30% of Class A shares. Has started aggressively accumulating shares in April, increasing its stake from 2.5m class A shares to over 6m in just over one month. It is not clear what the intentions of this fund are, but the accumulation began before the merger was announced. It seems that the cost basis of this accumulation has been under $4/share.

I believe that the company is indeed being taken out opportunistically. Hence I don't believe management will back away from their offer.

The legacy assets have been quite stable with $59m of EBITDA in 2020, $67m in 2019, and $60m in 2018. Pantaya's business has been growing quite well, with over 1m users as of today (vs below 1m at the end of 2021). According to the company, there are over 34m Spanish-dominant adults, who access at least one streaming platform. 25% of said people want more reflective characters, and only 32% (or less than 3m potential users) are aware of the Pantaya product. Also, Pantaya had the #1 grossing Spanish-language entertainment app for Android and iOS, both ranked in the top 20 entertainment apps in the US. Pantaya has been the most downloaded Android app in Puerto Rico since June 1, 2021.

Similar market transactions indicate the suggested 6x EBITDA multiple for legacy business is definitely doable (I think an even higher multiple would be reasonable for the WAPA station). Noteworthy, the valuation for Pantaya only includes the cost basis (i.e., any non-acquisition investments into the business, which were recently done, are not included). These two aforementioned segments alone can be valued at nearly $9/share, with the remaining Canal Uno, the #3-rated broadcast television network in Columbia, and other assets being valued at 0.

As mentioned in the beginning, the offering is subject to a 30-day go-shop period, which ends June 7. Assuming there will be a white knight with a higher offer, I'd imagine the special committee would have to acknowledge the higher bid as being superior. As a result, management would most likely have to at least match it (or face potential lawsuits). Management can also sweeten the deal themselves to save face. Hence, I suggest there is still a free option of a higher bid. Taking into account the suggested acquisition price of at least $9/share, I would believe this free option implies at least a 30% upside.

Conclusion

While the current opportunistic offer will most likely close with a small single-digit upside in a relatively short time period, I believe the free optionality of a higher offer combined with the low likelihood of the current offer breaking provides a decent arbitrage opportunity.

This article was written by

Private investor focused on event driven trades and special situations. 15+ years of investing and equity research experience globally across various sectors. Always looking for an edge.
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Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, but may initiate a beneficial Long position through a purchase of the stock, or the purchase of call options or similar derivatives in HMTV 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.

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