Description

ACME is a relatively new company (1997) that was founded to capitalize on the growth of the WB network. The company currently owns 9 TV stations in mid-sized markets: 8 WB affiliates and 1 UPN affiliate (in Albuquerque, where it owns two stations). WB is the fastest growing network and, while coming from a small base, continues to show tremendous strength in the ratings. ACME's stations, which are relatively immature, are growing much faster than the WB network as a whole.

Until recently, ACME was an interesting business plan with an overleveraged balance sheet. At the end of 2002. however, the company announced the sale of two stations to Tribune for $275MM in cash. The deal closed in March, and ACME simultaneously retired the vast majority of its high-yield debt. At 3/31, the net debt of the company was $24MM--a number that is clearly manageable. Management noted on a recent (5/2) conference call that they expect to amend their credit facility in the second quarter, which would provide for even greater financial flexibility.

The sale of the stations was the trigger that interested me in ACME. Many media companies ostensibly sell at large discounts to asset value, but the leverage is so great that small changes in the proposed cash flow multiple can diminish the equity value sharply. While one can debate what multiple should be applied to ACME's cash flow looking out 3-4 years when the stations are more (but probably not fully) mature, under any circumstance the equity value should be considerably higher than it is today.

Jamie Kellner, who was President of Fox Broadcasting since its inception in the mid-1980's and founded the WB Network in the mid-1990's, is Chairman and CEO (part-time) of ACME. It is fair to call Kellner a television genius based on his track record. Since its inception, WB has focused on younger audiences, particularly teenage girls and young women. This is a vital demographic group for many advertisers. Over the last 5 years CPM increases in the upfront market for WB have compounded at 13%/year. This year, through the end of April, the audience increase is 11% in 18-34 and 13% in 18-49. Kellner stated on the last conference call that the WB should have its best upfront market ever this year, based on continued growth in the ratings, a stronger lineup of incumbent shows, and very high quality pilots: "I am more bullish than I've been for 4 years."

ACME's stations are far outpacing the WB Network as a whole. Same-station revenue growth in 2002 was 29%, a number that was matched in the 1st quarter.
Management has forecast that 2nd quarter same station revenue growth will be in the 15-20% range; I suspect an acceleration is likely in the 2nd half of the year as we get further away from the war's impact. Ratings, which tend to lead revenues by several months, continue to be very strong at the station level: in the February sweeps from 5 pm-midnight the ACME stations were up 31% in the key 18-49 demo. (There is a lot of info on a station-by-station basis in the 10-K).

So how much is ACME worth? I think that the value could be in the $20 range in 3-4 years. Here's a simple model that shows how:

2003 2004 2005 2006 2007

Net revs. 46 58 69 79 90
Op. expenses 44 49 54 58 62

Broadcast CF 2 8 15 21 28

I have scaled revenue growth down to 14% by 2007, which I think makes sense given a combination of rating strength, better syndicated programming, and yet more station maturity. Expense growth should dip below 10% in 2004 and I have it gradually coming down to 7%. Note that the cash flow margin is slightly better than 30% in 07, which still should create plenty of upside. Putting a 12 multiple on $28MM of cash flow gets to about $20/share. ACME sold the St. Louis station for 12.5X to a very sophisticated buyer.

I think it is likely, though, that ACME will change for the better over this period. Kellner noted on the last conference call that the staions are becoming valuable to others in their markets: "We'd like to create more duopolies ourselves and help others do this." A recast station lineup could make ACME significantly more valuable.

Catalyst

1. FCC scheduled to announce new media ownership rules on June 2, in all likelihood creating more markets where duopolies are allowed.

2. Positive broadcast cash flow beginning in the second half of 03 and becoming meaningful in 04.

3. Very strong upfront market likely for the WB network this summer.

4. Surging ratings continue for ACME stations as they mature.

5. Potential asset sales/swaps.

6. Ultimate sale of the entire company.