Description

Citadel Broadcasting (CDL) offers investors a compelling current yield and significant upside potential.  The company essentially pays investors while they wait for a possible upturn in the radio industry.  The yield also provides downside protection.  CDL owns radio stations in mid-sized US markets.  Forstmann Little, a pioneering LBO firm, controls the company.  In February 2006, CDL announced it would merge with ABC Radio, a subsidiary of Disney.  (The ABC radio network does not include ESPN or Radio Disney).  The deal would make the company the third largest radio group in the US. 

 

CDL has traded down significantly over the last few months to just over $9, almost 40% below is 52-week high of $14.74.  The stock has moved down due to: 1) general weakness across the radio industry and 2) concern over the ABC merger.  ABC station ratings have deteriorated more than the industry and CDL will assume more debt with the merger based on its stock price.  It is a vicious circle: the worse ABC does, the lower CDL stock price goes, the more debt CDL has to assume (capped at $250m additional debt).  However, CDL’s cash flow proforma for the merger is still very strong as discussed below. 

 

The proforma company is valued at approximately 11x 2007 estimated EBITDA.  While this is not a cheap multiple, broadcasting is traditionally a high multiple business because of its strong free cash flow and the valuation is not out of line relative to the comps.  The proforma valuation is based on the following:

 

CDL Current Stock Price	$9.20
less: 2 quarterly dividends	(.36)
less: special dividend	(2.46)
PF Stock Price	6.38
CDL Shares	114.1
ABC Radio Shares Issued	127.2
PF Shares	241.3
Market Capitalization	1,539.0
Debt
Est. CDL debt at 12/31/06	650.0
ABC Radio Debt*	1,650.0
Special Dividend	281.1
Total	2,581.1
TEV	4,120.1
Est. 07 EBITDA	375.0
TEV / Est. EBITDA	11x
* Based on stock price of $9.20 CDL would take on base debt of $1.4b + $250m of additional debt

 

 

Yield

CDL stock currently pays a $.18 per quarter dividend for a yield of approximately 8%.  Prior to the merger, the company will pay a special dividend (depending on its share price at the time) of approximately $2.46, almost 30% of its current price.  When CDL announced the ABC merger in February, it stated ABC had 2005 EBIT of $200m.  Even if this EBIT level has deteriorated significantly, the proforma company will still have substantial cash flow generation capability and likely offer a solid yield.  The table below projects the company’s 2007 cash flow proforma for the merger and excluding NOLs (which would increase free cash flow):

 

	High	Medium	Low
EBITDA
- CDL	$190	$185	$180
- ABC	200	175	150
- Synergies	20	15	10
Total EBITDA	410	375	340
FCF	187	166	145
Per Share	$.77	$.69	$.60
Yield*	12%	11%	9%
* Stock Price: Current price of $9.20 less $2.46 special dividend less $.36 of quarterly div

 

Upside Potential

Even at current levels, the stock is a compelling investment.  Investors will earn $2.82 dividends through the end of the year (2 x $.18 quarterly dividend + $2.46 special dividend).  Assuming the company pays a $.50 dividend following the merger and it trades at 5% yield, the stock would be $10.  Including dividends, investors would earn a 40% return.  The company’s financial and operating leverage could drive CDL’s stock price significantly higher over the long-term if advertising spending increases. 

 

Beyond the cost of acquiring the station itself, broadcasters require minimal capital expenditure and operate cheaply.  Operating costs are mostly fixed (approximately 75%) and EBITDA margins are very high.  Even during this difficult time, CDL has produced solid cash flow.  For the most recent quarter, CDL reported EBITDA margins of over 40% and had a basically in-line quarter.  The combination with ABC Radio will also allow the company to spread its corporate overhead costs over a larger platform and realize cost saving synergies. 

 

The great cash flow characteristic of broadcasters has made the industry attractive for LBO firms such as Forstmann.  The leveraged capital structure of CDL has the potential to generate strong equity return.  CDL has further increased the potential equity upside by purchasing over 40% of its public float under its share repurchase program.  The company will clearly use cash flow to drive shareholder returns through repurchases and dividends. 

 

The broadcasting industry has slumped for the last few quarters as advertisers, especially the important retail and automotive segments, have decreased spending.  Broadcasters have only a limited ability to cut expenses during a soft patch as most costs are fixed in the short-term.  While radio has attracted its shares of long-term bears who believe the medium is doomed due to competition from satellite radio, Ipods and other digital players, radio remains a relatively inexpensive form of advertising.  And while there is now more competition, radio is still enjoyed by many and has one compelling advantage for the consumer over satellite radio: it’s free.  Radio also offers local content.  If you believe that radio has a future, CDL offers traditional private equity return potential and a nice yield while you wait for the big payoff. 

Catalyst

CDL offers shareholders great upside when the broadcasting industry recovers, which I believe will occur in the medium term. Meanwhile, shareholders receive significant dividend payments during the turnaround period. Any industry uptick would likely lead to a major upward move in the company’s stock. There has been some articles and rumors of CDL and DIS renegotiating the merger agreement to make it more favorable for CDL. Such an event, though probably unlikely, would also benefit the stock. There are also rumors that Howard Stern could come to CDL, perhaps also unlikely, but a potential major upside catalyst. Additionally, the company has mentioned assets sales that would reduce debt and be shielded from taxes with its NOLs. The impact of any of these drivers would be augmented by the nature of its ABC merger agreement. Just as its low stock price is now hurting CDL because the lower the stock price the more debt it incurs, a higher stock price would have the reverse impact. Instead of a vicious cycle, the company would have a virtuous cycle with a higher stock price leading to lower debt and even a potentially higher special dividend.

The risks for the position are: 1) leveraged balance sheet (though this is a strong cash flow business) and 2) deeper slump in radio. While the industry could continue to perform badly, the company’s latest quarter was decent and its operating structure provides a degree of safety.