Description

Emmis Communications is an orphaned micro-cap Radio company, with a controversial past that is undergoing a radical transformation after a year of disposing of radio assets. The company is on the cusp of being debt free, and the CEO has been talking to small-town papers indicating that a change in both strategy and capital allocation is likely to come in the next 1 year. The core radio business is trading at <5.5x EV/EBITDA-Capex, it is about to be debt free, they are diversifying AWAY from radio, and are likely to waste less money on Emerging Technologies (Next Radio, etc.) At the price of $4.63, I think Emmis is a very cheap call option that could be worth significnatly more once the market relalizes this is a changed company. This is difficult to model without knowing what the company will be in the future, so no exact price target, but probabilitistically speaking, this stock will likely be worth much more in 2-3 years as the CEO steps back from the company that has long been his passion project.

[Note to reader – This is an illiquid micro-cap and thus only suitable for PA’s and/or the more adventurous VIC members. Caveat emptor!]

Stock Price (4/23/18): $4.63, Market Cap: $59M (12.8M shares outstanding), Enterprise Value: $84M (~$25M of debt, post close of STL radio stations)

Why does this opportunity exist?

Emmis is cheap for a variety of reasons (in no particular order): 1.) Microcap, OTC, orphaned stock with no real analyst coverage, 2) Radio is a hated business overlooked by most investors, 3) Emmis is a VERY controversial due to its CEO Jeff Smulyan who has a history of not being shareholder friendly. Smulyan has tried (unsuccessfully) to take EMMS private at unacceptable prices, was a perma-bull on radio for far too long, and has resisted breaking up the company which has traded at less than its breakup value on many occasions. Rather than reinvent the wheel, I would suggest anyone who is interested to read up on the previous VIC write-ups from  WKB319 (Oct-2014), bowd57 (July-2013), specialk992 (Oct-2012), pfq783 (July-2010), and pman908 (Dec-2005)

For the rest of the write-up I am purely going to focus on the most recent changes in the past 6 months at the company which I think makes this a very interesting micro-cap special situation investment opportunity.

Financial Overview

This is not the type of situation that a stock screener would catch, because due to large number of asset divestitures, the past financials are not a clean representation of the enterprise today. On the company website next to the quarterly financials, EMMS supplies a supplemental disclosure that nets out the disposed assets. I reproduced them here below:

Supplemental Pro Forma Information – For the seven quarters ended November 30, 2017

It should come as no surprise that when broken out by divisions, the free-cash-flow rich Radio division has been subsidizing large investments in the “Emerging Technologies” and “Corporate” line. Based on the de minimis revenue earned to date vs. the losses subsidized, this cash burn has not been good for shareholders. However, it was much easier to do when EMMS had a much larger Radio group generating cash for the company to use. I believe the most recent asset sale highlights change may be coming….

Disposal of the St. Louis stations marks a turning point for EMMS

On Jan 31 of this year, EMMS announced it was leaving the St.. Louis market.

Emmis Communications leaving St. Louis market with sale of KSHE, 3 other radio stations

I believe that the sale of the St. Louis stations is a significant behavioral signpost that gives me confidence we are in fact witnessing a meaningful change in corporate behavior/strategy.

The STL stations (4) were quite profitable, and more recently were the standouts in the portfolio, as evidenced from the CEO’s commentary from the Q3-18 earnings call on 1/11/2018 just a few weeks beforehand:

“In the third quarter, our pro forma radio revenues for Miller Kaplan were down 4% in markets, so we're down 2%. Ex-political, we were down 3%. Certainly, nothing great about the performance of our markets. St. Louis was our only market that outperformed.”

“Pro forma for all asset divestitures, our radio revenues were down 4.8% in Q3. According to Miller Kaplan, our radio markets collectively were down 2% in the quarter. Excluding political revenues in the current quarter as well as the same quarter of the prior year, our radio revenues would have been down 2.8%. Our St. Louis cluster gained share during the quarter.”

“But if you look at ratings trends, we've had some really terrific ratings in St. Louis and Austin”

Company filed an 8K with the St. Louis sale price, proceeds, and financials broken out. The four stations were sold for gross proceeds of ~$60 million, and net proceeds of $41 million (net of tax and other expenses). As you can see from the figures below, the loss of STL removes a very material portion of their operating earnings. See the table below:

On February 23, 2018, Emmis issued a press release announcing the transaction described above. A copy of the press release is furnished herewith as Exhibit 99.1.

From the disclosure you can do a pro-forma to figure out trailing EBITDA. By my count the STL stations did about $3.3M (FY 2016), $5.3M (FY 2017), and $4.9M for the trailing 12 mo. period. Taken in context, STL was responsible for about ~16% of Adj. EBITDA for the remaining stations.

Backing out STL, TTM Adj. EBITDA for EMMS would be about $26 million ($30.8M less $4.9M). Let’s ignore publishing because it is operating close to breakeven (-$621K loss on TTM period). The combined total of the Emerging Tech (-$14.9M) and Corporate overhead (-$8.2M) = -$23.1M. In other words, for EMMS to continue on its current path, Mr. Smulyan would be spending his entire remaining (and shrinking) EBITDA on those 2 cost centers.

For the sake of argument, if you could hypothetically separate the Radio + Corporate from the cash draining divisions (Emerging Technologies), you can see how cheap the stock is. Back of the envelope math gets me to EBITDA - Capex of approx. $15.7M ($25.9M - $8.2M Corp OH - $2M of CapEx). That is 5.4x the current Enterprise Value ($59M + $25M of debt).

My hypothesis is that EMMS is going to do some sort of cost rationalization in the near-term to cut back on its operating losses so it doesn’t burn all of its cash. Based on my readings of the local Indianapolis newspaper, I believe such a change in corporate strategy is likely to come in 2018.  

CEO has a change of heart

According to a surprisingly candid interview on March 16th, the CEO explained that a big change is coming to company strategy sometime in 2018. While I am not able to predict what this will be, I think that the new EMMS will look very different than the old company, and the stock is very likely to rerate as the details for the as unannounced corporate changes take place.

(I am going to put a lot of quotes from the article directly in this write-up because it is behind a paywall, and I think the CEO’s own words do a better job explaining the investment thesis than frankly I could on my own.) (Selected quotes below)

Emmis CEO says he's preparing to diversify, not wind down

“While it might appear at first glance that Emmis Communications Corp. CEO Jeff Smulyan is preparing to either liquidate or parachute out of the company he founded in 1979, he says that couldn’t be further from the truth.”

“Smulyan said he’s readying to put that love for problem solving to work by diversifying the company in a whole new direction.”

“We’re looking at some new areas. I’d like to diversify and try another area where, if we do it, people will say, ‘What do they know about the widget business?’” Smulyan said. “And that will be a fair question, but … what I’ve learned is that, every time we diversified, we were smart enough to know what we didn’t know and we got the talent we needed.”

Just what direction Smulyan is planning to take Emmis he wouldn’t say. But the when? That appears to be soon.

“2018 should be a year of great transformation for Emmis. I’m very comfortable saying that,” Smulyan said. “I’m thinking about a couple [of business opportunities], but we’re not there yet. We’re into some serious discussions in some places, so we’ll see.”

One thing is certain.

“Our next large foray will not be media-related. We’d like to be in businesses that are growing. We’ve been in an industry that has shown almost no growth for a long, long time,” he said.

“It’s hard pushing water uphill every day. We’ve really survived much, much better than many of our peers. I have a great team here, and I would like to deploy those skills in business sectors that are growing.”

‘We are not liquidating’

Over the last two years, Emmis has been selling assets like a carpetbagger at a moving sale.

It sold Texas Monthly for $25 million in February 2016; three FM stations and one AM station in Terre Haute for $5.2 million in January 2017; city magazines in Atlanta, Cincinnati, Los Angeles and Orange County, California, for $6.5 million in February 2017; a massive FM station in Los Angeles for $82.8 million in August 2017; and four St. Louis stations last month.

“We made a decision we do not want to live with debt,” Smulyan said of the sales. “We’re down to our last $20 million in debt.”

And the sell-off might not be over.

“We’re considering a land sale of 70 acres in Whitestown along Interstate 65, and WLIB-AM in New York is for sale,” Smulyan said.

He’s “hopeful” both of those sales can be closed this year. “If we sell those two [assets], our debt would be zero,” he added. “There are no fire sales.”

The biggest advantage to Emmis’ being debt-free? “The ability to get a better quality of sleep at night,” Smulyan said. “When an industry is growing, leverage can be wonderful. If the industry is not growing—and radio right now is not—leverage is not so great.”

What about the recent restructuring of Smulyan’s severance package that fueled speculation about the future of Emmis and its founder?

The new agreement states that, if there is a change in control, Smulyan can’t voluntarily leave during the period of change. And if he’s terminated within two years after a change in control, he gets his salary, pro-rated target bonus and vacation pay—but also severance of two times his base salary and bonus.

The old agreement would have paid Smulyan for three years after a change in control—including a liquidation—instead of only two.

“If I were planning to liquidate the company … I want to go from three years to five years [of severance pay],” Smulyan said.

Instead of taking the company private, Smulyan said that, with the company’s debt greatly reduced, Emmis officials might look to reward stockholders with dividends.

Or Emmis could offer an opportunity for liquidity through stock buybacks for those who don’t like the direction he’s taking the company or want to cash out for other reasons.•

[End article quotes]

In Summary - For all of the reasons above, I believe that EMMS is 1) Very cheap, and 2) has low hanging fruit they can pick to create value.

Catalyst

Company will likely be debt free in the coming year, as well as announce both a change in corporate strategy and maybe even return capital to shareholders.