ASCMA is holding company, and essentially a special situation, that I believe shows up on a lot of deep value screens. The purpose of this post is to provide an outline of the situation and a baseline valuation analysis of the company.
Ascent Media Corporation (“Ascent”) was spun off to the holders of Discovery Holding Company in September 2008. Ascent’s primary assets are a great big pile of cash (more about that later) and a subsidiary, Ascent Media Group (“Ascent Media”). This subsidiary provides creative and technical services to the media and entertainment industries through its two operating segments: Creative Services and Content Services, from more than 40 facilities. The Creative Services group (35% of revenue) provides post-production work to help turn principal photography into a final products (feature films, television programs, commercials and new digital media). The Content Services group (65% of revenue) provides facilities and services necessary for media owners to optimize, archive, restore, manage, reformat and repurpose completed media assets for distribution. Ascent employed about 3,100 people in 2008, generating revenues of approximately $600 million, or just over $190,000 per employee. The company’s investor relations website is here.
Neither of the company’s business segments seems particularly attractive, and financial performance has been weak over the past several years. On a consolidated basis from 1/1/06 to 9/30/09, Ascent generated $173.2 million of EBITDA and had capital expenditures of $176.4 million… not exactly a free cash flow powerhouse, and it’s hard to justify the capital expenditures as an investment in growth since annual revenues have declined by around 20% (most of the decline came recently in 2009). At least management has cut costs fast enough to keep the company close to cash flow break-even as revenue has declined.
I don’t claim to have any deep knowledge of the segments of the media industry in which Ascent competes, but from the financial stats and the related disclosures in Ascent’s filings, their markets seem highly competitive, require substantial capital investment, and offer poor returns on capital. There also appears to be a secular decline in some of the traditional media services as technologies evolve, and the company has a lumpy revenue base for some of its services, with customer concentrations (Motorola at ~10%) and business that is performed on a one-off project basis (rather than a more attractive recurring revenue stream).
My potential interest in ASCMA is less related to its current business (which seems far from promising), but instead focused on its valuation relative to its substantial cash position. As noted earlier, Ascent was spun off from Discovery in September 2008. There are two classes of stock in Ascent – A shares (NASDAQ:ASCMA) and B shares (OTCQB:ASCMB). While they are economically equivalent, the B shares have ten votes for every one vote of the A shares, and they are freely convertible into A shares. As of 10/31/09, there were 13,427,479 A shares and 659,156 B shares outstanding, implying that the B shares have close to 33% of the vote. Over 90% of the B shares are owned by John Malone, giving him 31.3% voting power. Significant institutional holders of the A shares include FMR (9.9%), Gabelli (9.6%) and T. Rowe Price (9.9%). The voting control is concentrated with Malone/Liberty (35.2%), FMR (6.7%), Gabelli (6.4%), and T. Rowe Price (6.7%), giving these top holders 55% of the voting power.
Along with the A/B voting structure described above, Ascent is incorporated with plenty of anti-takeover bells and whistles: there is a poison pill (board can issue blank check preferred), staggered three year board terms, limitations on certain shareholder actions, and requirement of 80% shareholder approval (or 75% board approval) for a sale/merger. Gabelli sent a letter on 10/1/09 asking for the board to remove the company’s poison pill. However, it should be clear from the above that this is John Malone’s show, and you are largely along for the ride unless there is a major shake-up in this governance and voting arrangement. On the plus side, three sophisticated institutions are obviously intrigued enough that they’ve bought right up to the 10% threshold.
Net asset value
Based on the balance sheet analysis shown below, I peg the reproduction value of Ascent’s assets at approximately $38 per share as of its 9/30/09 financial statement. I believe that this analysis is conservative on several fronts. All deferred tax assets were written down to zero given the current loss-generating status of the operations. Clearly these assets could have value as a tax shield if a profitable operation is acquired or financial results improve, but I don’t believe that concept contributes to the tangible margin of safety for an investor buying shares in the current business. I put arbitrary discounts of 25% and 50% on net PP&E and other long-term assets, respectively. On the net PP&E, I believe this adjustment should be at least adequate based on the proportion of PP&E invested in land (over $36.7 million as of 12/31/09) and the relatively fast depreciation (3 years) on the computer hardware and software that accounts for a high proportion of the capital expenditures.
Earnings power value
My earnings power valuation is essentially a break-up value of the two segments, Creative Services and Content Services, then adding back my estimation of the truly excess cash amount of $323.4 million. My estimate of the excess cash is derived as the excess of balance sheet cash ($337.4 million) over my estimate of $14.0 million of cash required to operate the business (swag at 3% of estimated 2009 annualized revenues of $466.5 million). The analysis below excludes corporate SG&A and capital expenditure spending, which is consistent with the fact that a reasonable price for these businesses would probably only be realized from a sale to a competitor that wouldn’t need this duplicative corporate overhead. A multiple of 6x EBIT (which equates to about 3x EBITDA in this case) is relatively conservative, and reflects the fact that while the economics of these businesses aren’t highly attractive, an acquirer could likely realize certain cost savings and take a meaningful competitor out of the market. The resulting valuation is actually below the balance sheet net working capital and PP&E values of the operating businesses, which serves as another check that these multiples probably aren’t wildly optimistic.
I have intentionally omitted a growth value analysis as revenue and earnings growth have not been displayed over the prior few years.
Valuation continuum and margin of safety assessment
The chart below summarizes the valuation work above compared to the current trading price and targeted entry level. The calculated EPV is actually less than NAV, consistent with the fact that the operating business generates minimal free cash flow, and probably doesn’t generate high enough returns on invested capital to attract new entrants to the market at this reproduction cost.
Summary and conclusions
Based on the current trading level of approximately $25, ASCMA is trading at a discount of 25% to 33% of the base-case valuations calculated above. Valuing the excess cash in the business at par, you are essentially paying about $2 per share for the Ascent Media businesses that may be worth $10 to $14 per share based on the calculations above. This margin of safety might be adequate for the value investor. As a positive, it does seem like the downside is well supported by $23 in truly excess cash per share. However, given the control dynamics discussed above, it will take more than a little bit of shareholder grumbling to unlock value if the stock doesn’t close this gap – the Malone/Liberty group should be viewed as extremely sophisticated in terms of the ability to defend itself from unwanted activism. The outside risk is that this control group either does nothing or enters into a deal (or series of deals) that stands to destroy the value of the $23 per share war chest, though an accretive transaction could obviously serve to increase value. The continued deterioration of the Ascent Media operating businesses also stands to erode the margin of safety if no catalyst occurs and/or financial results don’t improve. Not an easy call.
Disclosure: A family member of the author bought shares of ASCMA in October 2009 at a price of approximately $25.40.