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Gray Television (GTN): Misunderstood FCF Cow

|Includes: Gray Television, Inc. (GTN)

Gray Television, Inc. (NYSE:GTN) is a television broadcast company headquartered in Atlanta, Georgia, that owns and operates television stations and leading digital assets in markets throughout the United States. As of 2016, they owned and/or operated television stations in 50 television markets broadcasting approximately 180 separate programming streams, including 35 affiliates of the CBS Network, 26 affiliates of the NBC Network , 19 affiliates of the ABC Network and 13 affiliates of the FOX Network.

GTN has a $2.3B EV and a market cap of $800MM. The stock is currently at ~$11 and I have a 12-18 month price target of $16, implying about 45% upside.

First and foremost, I think the TV broadcast sector is attractive. It's a mature sector that runs maintenance CapEx at about 2% of revenue, which is pretty much what depreciation is. All these companies have very high FCF margins. Additionally, the entire industry trades in sympathy with the media sector at large, even though TV broadcasters have very different economics than the big guys (DIS, FOXA, etc.). There is a general fear around what media will look like in a decade (rightfully so), and we're already seeing digital disintermediation in advertising and increasing awareness around cord-cutting (although total number of cable subscribers has been pretty stable). While these are legitimate fears, I think they are over blown in the broadcast sector.

Consider the makeup of revenues for the typical TV broadcaster (I'm generally referring to the standalone guys: SBGI, NXST, GTN, etc.) - about 50% of revenue comes from local advertising. Local advertising is a totally different beast than national advertising. First off, look at the competition for local advertising dollars: radio, newspaper, direct mail, telephone directories. If you combine those four, they account for over 25% of local advertising market share. Broadcasting is better positioned than any of those mediums. As digital takes share advertisers will almost certainly take from these lesser sources before taking from broadcasting. Additionally, another 25% of revenue comes from contracts in the form of retransmission consent fees (typically 3-5 year tenors, with a staggering of how many contracts come up in a given year). These are fees paid by cable/satellite providers (MVPD's) for the right to air broadcasters' channels to their pay-TV customers. These have been growing double digits in recent years and are projected to continue to do so (I do not fear broadcasters ability to continue to get higher retrans per sub rates, and I'm not worried with reverse retrans cuts eroding the broadcasters revenues). Another 5% of revenues are from local websites that GTN runs in their markets, internet revenues have grown by approximately 50% since 2011 and show good growth opportunities. And lastly 5% is accounted for by "other revenue" which has basically been flat for the past 5 years. Thus we have accounted for 85% of revenues.

The last 15% of revenue comes from national advertising. This is admittedly a pressured revenue stream. Here there has been a great deal of encroachment by the internet, and organic revenue growth has been anemic. However, in conjunction with the other revenue streams and their growth profiles (assuming local is flat, retrans grows at 10%, internet at 5%, and other is flat), national advertising would have to shrink by 33% in order for organic revenue growth overall to be flat.

*(I've lumped political spending into local and national advertising for the purposes of evaluating the core business, if anything, I would think this would trend positively into the future despite the recent election because of Citizens United, and I'm assuming we probably won't see too many elections like this last one).

The broadcasters all have similar profiles regarding these revenues and I think because they are small cap and considered "old media" a misperception about their near-term economics has become the norm. While the media landscape may look significantly different a decade from now, most of these broadcasters are trading at mid-teens FCF yields with resilient revenues, profiles like those don't need a runway of a decade to be profitable investments.

But that is just a general conversation about TV broadcasters, here's why I like GTN specifically.

§ M&A optionality has been largely taken out of the stock: The broadcast industry performed extremely well in the 2012-2013 period as a wave of consolidation occurred. This wave was brought about due to the introduction of the retransmission consent fees. As these fees were negotiated on a company by company basis, the large number of mom and pop broadcasters found that they did not have leverage with the Comcasts of the world. Thus, larger broadcasters (GTN, NXST, SBGI, MEG, etc.) were able to buy up small broadcasters at 7x EBITDA, and once the company was purchased their master agreements with cable companies governs all retransmission contracts, resulting in a pro forma buyer's multiple of ~5x EBITDA (the big broadcasters trade at ~8-9x normalized EBITDA).

The M&A in the industry has stopped in the last year for a couple of reasons. First, SBGI and TRCO hit the FCC household cap (39% of all TV households in the USA) and are no longer able to acquire meaningful amounts of TV stations, and NXST purchased MEG, also bringing it to the cap. Additionally, the FCC has instituted a one-time spectrum incentive auction where it is allowing broadcasters to sell back their spectrum licenses. As this asset sale is going on, M&A has stopped.

Due to the high quality nature of their stations, GTN will not participate in this auction in any meaningful way (they have the highest opportunity cost in their markets since they have the highest rated stations, explained below). The spectrum auction should conclude in 2017, and as it starts to wrap up, M&A is expected to recommence. However, this time, the M&A will be arguably more attractive as some of the more deep-pocketed companies have hit the FCC cap (TRCO, SBGI, NXST, MEG).

There are still several hundred "Big 4" stations owned by smaller private companies and GTN is at only 9.5% TV household penetration, well below the 39% FCC cap.

§ High quality performer amongst peers: GTN is the highest quality performer amongst the broadcast peer group (SBGI, NXST, MEG, MDP, TGNA, TRCO), with operating margins eclipsing 30% in election years. They have achieved this through differentiating their business strategy. GTN exclusively targets broadcast stations outside of the top 50 DMAs (specifically they target university towns and state capitals), in addition, they only operate stations which are ranked either #1 or #2 in their areas. The former has helped them with bargaining power with content providers as smaller markets have less competition for broadcast licenses. And the latter has helped them maintain strong advertising revenue as local advertising makes up the bulk of their revenue.

§ GTN has improved its business model substantially over the past 4 years: Historically these broadcast companies were heavily levered to the economy, as the entirety of their revenue came from advertising. However, in the last 7 years, retransmission revenue (again, contractual in nature, typically 5 years in tenor) has gone from non-existent to accounting for more than 25% of revenues (and growing). Over those same past 4 years GTN has been able to expand the number of stations it manages from 85 to 180, and expand its footprint from 30 markets to 50 markets, decreasing geographic sensitivity and stabilizing earnings.

I've valued the company through an earnings power value method, which resulted in an $8.50 share price based off of blended 2014/2015 performance and assuming no growth, I view this as the bear case. Assuming that GTN uses current excess cash, internally generated cash, and minimal debt GTN could use ~$350MM to purchase small mom and pop broadcasters over the next few years, assuming a buyers multiple of 6x EBITDA, increased retrans, and a market multiple of GTN at 7.5x that will add an additional $9 of value over the next 3 years, discounted at 10% to add $7.38 of additional value today.

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Supporting Documents

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  2. GTN_-_Valuation.jpg

Disclosure: I am/we are long GTN.