Description

Summary

Emmis Communications is a diversified media company which owns 25 US radio stations (many of which are in extremely attractive large metropolitan markets such as Los Angeles, Chicago, and New York), 16 television stations, and several regional magazines.

Disclosure Statement: This is not a recommendation to buy or sell the stock. We reserve the right to buy shares or sell shares at any time without notification.

Responding to shareholder frustration over the stock price, the company recently announced and completed a dutch tender for 20.2M shares (36% of shares outstanding) at $19.50 per share for an aggregate purchase price of $394.9 million to be funded by the sale of the television assets.

After the completion of the TV sale (estimated at $1.3B pretax, $1.1B-$1.2B post tax) and subsequent deleveraging , the stock will trade at pro-forma 12x FCF or 8x-9x FCF excluding two underperforming Chicago radio stations that generate virtually no cash flow but have enormous “stick value” due to their attractive locations. Over time, I would expect these FCF/per share to grow at 5-10% per year through growth and debt paydown or share repurchases.

The following are my pro-forma valuation estimates based for FY 2007 (Feb 2007)

Pre TV sale Post TV sale and Tender
Price $20.00 $20.00
Shares 56.4 36.1
Market Cap $1,128M $722M
PV of Tax Asset ($100) ($100)
Adjusted Market Cap (AMC) $1,029M $622M
Debt $1,185 $454
Preferred $143 $143
Enterprise Value $2,357M $1,220M

Revenue $698M $421M
EBITDA $215M $122M
FCF $87M $50M

EV/EBITDA 10.9x 10.0x
AMC/FCF 11.8x 12.2x

Chicago adjusted
Adjusted Market Cap: $622M
Less: Chicago ($200M)
Ex Chicago Market Cap $422M

FCF $50M
Less: Chicago ($2M)
FCF $48M

MC/FCF 8.8x

Segment Discussion

Radio:

EMMS benefits from having heavy exposure to the most attractive radio markets. Roughly 31%, 27%, and 10% of radio revenues are from stations in NYC, Los Angeles, and Chicago, the top 3 DMA’s in the United States. The benefit of owning large market radio stations is twofold. First, larger markets tend to be more profitable than smaller markets because they reach a much larger audience (and hence are much more productive from a revenue standpoint), with costs such as salaries and rents only somewhat higher. The company’s station cash flow margins have historically been 45%, at the high end of the industry, but are currently depressed by the Chicago stations which do not generate significant EBITDA. Second, there is scarcity value in radio stations in the top 3 markets, and therefore these radio stations could theoretically be sold for above average multiples (potentially 15x-20x EBITDA).

Over the next several years, I assume the company should be able to grow its radio revenues at 7-8% driven by the following factors: 1.) industry revenue growth of 2-3%, 2.) 1-2% revenue growth in excess of the industry, 3.) 1-2% excess revenue growth from improvement of Chicago radio stations, 1-2% excess revenue growth from international radio stations

1.) Industry growth of 2-3%: Throughout the late 1990’s, the industry grew revenues in the high single to low double digits driven by great pricing in a strong economy. Due to increasing competitive threats (Internet, Cable) as well as declining listener hours (Ipod, Satellite), industry revenues have slowed in recent years to 3-4%. 2005 industry revenue looks like it is going to be flat due to Clear Channel (roughly 20% of the industry) reducing its commercial load by over 20%. Without this initiative as well as some difficult political comparisons, industry growth would have been 4-5%

2.) By owning a relatively small group of radio stations, the company has been able to focus specifically on producing original content and driving strong local revenues in its individual markets. As a result, the company has consistently generated revenues in excess of the industry.

3.) In late 2004, the company arranged a deal with Bonneville to swap 3 Phoenix radio stations in exchange for 1 Chicago rock station (WLUP FM-The Loop) and the receipt of $70M of cash. EMMS benefits from this swap in two ways. First, the station had been underperforming due to certain advertising restrictions placed on it by Bonneville. By simply accepting advertisement from alcohol or gaming, EMMS has the opportunity to significantly increase revenue. Second, the company can gain some demographic synergies with its existing alternative rock station, Q101, which was also underperforming due to difficult competitive issues with Disney station. Recently, the Disney station has switched foramts leaving significant revenue opportunities for the two radio stations which could add 1-2% to radio revenues over the next several years. Industry sources have indicated that although these radio stations are not significantly profitable today, they could be worth roughly $200M to a buyer, given the strength of the demographic. Overall, these station could contribute as much as $10M of EBITDA once they are fully productive

4.) International: The company owns one radio station in Hungary, nine in Belgium, and one radio network in Slovakia. Although the International Segment represents only 5% or so of revenues, it is growing quickly enough to contribute 1-2% to total radio revenue growth.


Overall, I assume that radio revenues increase 7% from $308M in FY 2006 (Feb 2006) to $330M in FY 2007 (Feb 2007) and that station income increases 8% from $130M to $142M

Television:

EMMS has completed the sale of 9 of its 16 television stations for $681M. The company has agreed to sell another 4 stations (currently awaiting FCC approval) for $259M. There has been no announcement yet for the 3 remaining stations but analysts expect the company to get $300M-$400M for the remaining 3 stations, including a New Orleans station whose sale has been delayed by Hurricane Katrina. Assuming the mid point of the $300M-$400M range, the company should generate $1.3M in pretax proceeds and $1.2M in after tax proceeds (tax basis of $1.02B consisting of $760M in tax basis and $260M in NOL’s). TV is excluded from my pro-forma valuation

Magazines

The company owns 6 regional magazines and 5 specialty magazines which I assume generate $88M of revenues and $9M of operating income in FY 2006 (Feb 2006) growing to $93M of revenue and $11M of operating income in FY 2007 (Feb 2007).


Consolidated (FY 2007 Proforma)

Revenue
Radio $329
Magazine $93
Total $422M

Station Income
Radio $142
Magazine $10
Total $152M

Station Income $152
Less Corporate: ($20)
Less Non cash Comp ($11)
EBITDA $122M
Less Cap Ex ($6)
Less: Interest ($30)
Less: Cash Taxes ($26)
Less: Preferred ($9)
FCF $50M


Concerns

CEO Jeff Smulyan has acknowledged that EMMS could potentially contribute $100M to a limited partnership that would purchase of the Washington Nationals. Given that EMMS does not own a radio station in the DC area, this move has taken a lot of investors by surprise. Many investors would prefer Smulyan’s efforts to be focused on radio, without the distraction of a non-core asset.

Additionally, Smulyan owns 4.8M class B shares which make up only about 13% of shares outstanding, but with 10 vote for each shares, make up about 60% of voting shares. Given that Smulyan has shown little interest in selling the business, shareholders are unlikely to benefit from the sale of these valuable radio properties which may be worth double the current stock price. However, it is conceivable that the Smulyan may take the company private if value is not realized in any other way.

Catalyst

1. The Washington Nationals deal not getting done
2. Cash flows used for more share repurchase and continued strong revenue growth.
3. Potential LBO by CEO and Founder