Description

We believe that the merger between Entercom and CBS Radio will create a new Entercom run by a phenomenal management team with the scale to drive revenue and operational synergies, resulting in revenue/EBITDA growth. The business is currently trading at 3x 2019 PF free cash flow of $2.90. As the market realizes the quality of the management team and combination of the assets, we believe the stock should rally to $16.66 over the next year, 7x $2.37 in 2018 FCF, offering 66% upside and potentially 100%+ upside based on our 2019 FCF/share.

Entercom

Entercom is a radio broadcast company that owns and operates 125 stations across 28 US markets, making it the 4th largest player in the industry pre-CBS merger. Entercom has been consistently outperforming the rest of the industry by growing revenue at mid-single digits and is run by the Field family (Chairman Joe founded the business and his son David is the CEO). Over 50% of revenues are from clusters of stations in 8 of 28 markets: Boston, Buffalo, Denver, Kansas City, Miami, Sacramento, San Francisco and Seattle.

CBS Radio

CBS Radio consists of 117 stations in 26 markets, including 19 of the 25 top markets in the country. These stations are considered some of the most valuable assets in the industry:

·         CBS has the number 1 or 2 ranked station cluster (3 or more stations in the same market) in 64% of its markets

·         Owns several popular big-market brands such as WFAN and 1010 WINS in New York and some of the most recognizable on-air talent in the industry

·         Very strong in Sports: #1 rated local sports radio station in 13 of 14 markets where CBS programs a local sports format. Broadcasted over 3,000 games for over 30 different pro franchises last year, including the NY Yankees, NE Patriots, and Chicago Cubs

Despite its trophy assets, CBS radio has been underperforming over the last few years, with spot revenue and market share declining since 2013. Part of this can be attributed to an industry wide decline in ad spend, although CBS has also neglected its radio assets.

Investment Merits / Merger Benefits

1.    Revenue Synergies Through Scale

Post-merger, Entercom will own 244 stations, 186 FM and 58 AM. CBS and Entercom’s stations fit well together, with CBS assets mostly concentrated in the largest markets and ETM operating in slightly smaller (but still big) markets. Together, they cover nearly all of the 50 largest markets in the US, including 23 of the largest 25, providing extremely broad scale for the new ETM. While the FCC requires them to divest 15 stations, these are all in markets where they own too many stations, so the number of markets they reach won’t change. There are several benefits to scale:

·         The number of markets served can entice national advertisers to consider radio ads when they otherwise wouldn’t. As evidenced by iHeart Media’s efforts, extreme scale coupled with the cheap costs of radio ads can overcome many of the disadvantages of radio advertising, and convince many national advertisers buy radio ads.

o    As per discussions with Entercom management and industry experts, the CMO of any Fortune 100 consumer brands business, for example, has likely never taken a meeting with a radio executive because a single radio company’s reach is too sparse to be worth his/her time. The scale of the new ETM will allow them to meet with large companies and sell ads across the country to potentially grow national advertising revenue.

·         The combined Sports radio assets of the two companies gives them the top sports radio stations/personalities in many markets and the “flagship” stations for the most popular and successful franchises across all 4 major leagues (Yankees, Red Sox, Patriots, Cowboys, Warriors, Red Wings, etc). Management believes that given their direct relationships with the teams and the leagues, their scale can attract large advertisers.

o    As per discussions with management, they hired former San Diego Padres CEO Mike Dee as head of Entercom Sports to target the Nike’s of the world who have previously never advertised on radio but ETM’s large scale will now offer them the ability to advertise across cities during the most popular games, also allowing them to potentially grow national advertising revenue

·         Owning more stations in each market will allow new ETM to target different demographics within a market which is beneficial to both local and national advertisers

o    By owning the country music, rap and talk radio stations in a particular market, a single salesperson with a local advertising relationship can offer the client targeted advertising for each demographic

Bottom line – radio revenue has declined due to limited appeal to national advertisers and limited targeting of listeners. The scale of the combined business should help alleviate some of these issues currently stymying revenue growth. (See Radio Industry Trends Segment below)

2.    Industry Leadership – Extremely High-Quality Management with Skin in the Game

Entercom has been extremely selective with their M&A, turning down large deals for ABC Radio in 2006 and Citadel Broadcasting in 2011 (both were rolled into Cumulus at peak multiples, resulting in almost insolvency). ETM’s most recent acquisitions have both been much smaller, buying 15 stations from Lincoln Financial in 2014 for $106m and 4 radio stations in Charlotte in 2016 for $25m. The Field family are phenomenal operators with a knack for savvy M&A.

The Field family will own about 10m shares in the pro-forma company, ensuring an alignment of interests. Joe Field has also been buying in the open market post-merger announcement (583k shares around $9.90-10 for almost $6m).

Tarnished Industry Image – While iHeart Media (IHRT) and Cumulus (CMLS) are large companies, they are excessively levered, (around 11x) from consolidating the industry at extremely high multiples. While they were able to use their size to attract national advertisers, they have hurt the image of the radio industry, giving off the perception that radio is an ailing industry that should be avoided by advertisers.

In contrast to IHRT and CMLS, the post-merger Entercom will have a very manageable 4x leverage, which is lower than the industry average by a full turn. Management is focused on keeping debt manageable, and combined with their great operational track record and capital allocation discipline, they should be able to turn Entercom into a model company for the radio industry which will resonate with advertisers of the product and investors in stock.

3.    Operational Improvement

Based on conversations with industry experts, we have learned that CBS Radio has often been referred to as the forgotten stepchild within CBS. Les Moonves has deemphasized radio and has openly discussed his intention to sell the segment. Given the neglect within CBS, the radio division has had trouble retaining talented management and local salespeople. Despite being poorly managed, many of CBS’s stations remain dominant within their markets. As the CBS assets are turned around by ETM’s great management team, they should help drive margin expansion through cost-cutting and revenue growth. ETM management estimates that they can realize $25m in cost synergies 12-18 months after the deal closes by combining facilities for different stations in the same market and eliminating redundant corporate expenses. Given where CBS’s Radio’s margins currently stand vs. IHRT (it’s closest comp given the size of its markets) plus corporate synergies in the deal, we believe management’s synergy guidance is conservative.  

4.    Enhanced Liquidity/Technical Pressure

Entercom is issuing 101.4m new shares of Class A common stock (300% increase) as part of the merger process and the Field family is converting their super voting shares to Class A. This should massively improve liquidity for the company, which, along with its very manageable 4x leverage, should attract new investors looking for radio exposure.

Since the transaction is utilizing a Reverse Morris Trust structure, arbs have shorted an illiquid ETM stock against buying CBS shares, further adding to the mispricing.

Risks

ETM receives all of its revenue from spot advertising and its incremental margins are 75%. Any problems in the macro environment could cause advertising revenue to drop which would dramatically effect free cash flow. While radio has weathered the tape, CD, ipod and connected car, as autonomous cars gain traction (pun intended), we could see consumers shift way from listening to the radio to the same tasks they do at home (television, books, internet..etc), causing a massive decline in radio listenership.

Radio Industry Trends

Radio Listenership is Flat but Ad Spend is Down

Radio still has the widest reach of any mass media format, reaching 93% of adults in the US every week compared to 89% for TV and 83% for Smartphones. 77% of the US population are weekly listeners of radio, particularly in-car, where radio is both by far the most listened-to medium and most in-demand feature for a car’s media ecosystem. These figures have held largely constant over the last few years, while television has been steadily declining in reach due to cord cutting.

While radio listenership has held up, many of the players within the industry have been struggling in recent years. Since broadcast radio is mostly free to listen, radio revenue is generated through the sale of ads. As more robust advertising platforms become available through the internet, advertisers have shifted away from radio advertising, where ad customization/targeting and customer interaction is limited. Radio spot revenue has declined annually since 2012 at a -1.5% CAGR and the rate of decline is expected to increase over the near future, despite healthy growth in total advertising spend.

Local vs National

Radio advertising typically comes in two forms: local and national. Local advertising is usually handled by sales teams at the individual stations who sell directly to local businesses. While radio faces some decline as an advertising medium, the local radio station is extremely resilient as it’s the most effective and affordable way for local businesses to reach out to customers (a 30 second radio ad costs $10.97 on average, compared to $14.63 for a 1/3 page newspaper ad and $24.40 for a 30 second primetime network TV ad on a CPM basis). Local advertisers are also entrenched given their relationship with the salesforce and their inability to know who their exact customer might be.

National advertising on the other hand is typically handled for all stations by a third-party advertising agency, which negotiates on the radio company’s behalf with large national-level advertisers. National has been the primary source of advertising revenue declines for most stations, as the factors that make radio attractive to smaller advertisers do not appeal equally to larger ones. Since national advertisers typically have much broader and more widely dispersed audiences, negotiating with radio companies can often be viewed as a waste of time, since even the largest radio broadcasters cover fewer people than well-followed website banner ads or network primetime commercials.  

Additionally, the local radio personalities who promote a business on a local scale hold little clout on a national stage. The presence of a middleman also eliminates the radio-advertiser relationships at a local level. As a result, national advertising comprises only 20% of total radio industry revenue and is continually shrinking with the shift to digital.

Valuation

Revenue: Given the aforementioned revenue synergies in national advertising and stability of local advertising revenue, we believe a 2.5% revenue CAGR from 2018-2020 is very probable. This is below the company’s 3.1% CAGR in the proxy (also included below).

EBITDA: As previously discussed, we believe the company’s synergy targets are conservative and at a 75% incremental broadcast cash flow margin, plus backing into Corporate, General & Administrative synergies as per the proxy, we believe ETM can grow EBITDA margins to 32.1% by 2020 from 27.7% in 2017, resulting in a 7.7% EBITDA CAGR.

Interest Expense & Taxes: We assume 50% of free cash flow is used to retire debt as per management guidance and debt agreements, along with a 31% cash tax rate as per management’s guidance since they will accelerate the depletion of their NOLs.

Buy Back: We further assume the other 50% of FCF is used to buy back stock since the company has discussed they will introduce buy backs for the first time given the significantly more liquid stock.

Price Target: We have a one-year price target of $16.62 (66% upside) based on 7x 2018 FCF, a two-year target of $20.30 (103% upside) based on 7x 2019 FCF and a 3-year target of $24.15 (142% upside) based on 7x 2020 FCF.

Catalyst

Turnaround at CBS Radio and revenue/operating synergies for the combined company