Description

THESIS:

I believe an investment in Grupo Radio Centro, S.A. de C.V. (“RC”) provides investors with a very realistic 100-200%+ appreciation opportunity within 12-24 months, with considerable downside protection in the emantime. As with most of my investment ideas, RC’s business is fairly easy to analyze – the company owns and/or operates 14 radio stations in Mexico, 12 of which are in Mexico City, where it has approximately 35% market share. I refer you to the company’s financials for more detailed information if you are interested. I will focus instead on the investment opportunity, which I believe is completely undiscovered by U.S. investors. Additionally, I believe there are several catalysts that may provide an acceleration in the realization of value.

RC is just too cheap to ignore and is now on the verge of being “discovered.” Currently, the stock trades at approximately 3.5-4x my 2003 EBITDA projection of $30-35MM and the company should be debt-free by early next year. Even on a trailing basis, based on a terrible operating year for the company (2002 – weak Mexican economy, failed internet and other ancillary ventures, a more bloated cost structure, residual effect of leveraging up do make a special one-time dividend payment), RC trades at only 6x EBITDA. Moreover, the company has superb cash flow characteristics (nominal cap ex and working cap requirements) which makes the valuation even more compelling on a FCF basis, at a true FCF yield (after interest, taxes, required cap ex, etc) of 15-20%+. While one may want to discount RC based on the fact that it is entirely Mexican-based and it is 51% owned and controlled by one family, the disparity in valuation between RC and the average U.S. Broadcaster 15-20x EBITDA and 30x FCF). is enormous, particularly when one considers that radio stations across borders tend to have similar economics.

The company’s average EBITDA over the past 6 years (which accounts for the political spending and economic cycles) has been approximately $25 million. While this year’s numbers benefit from the first midterm elections since Mexico's transition to multiparty rule (and the opposing parties spending fortunes), this story is clearly not dependent on a one-time bump in revenues to be successful. Ex political advertising, I except revenues to grow by 3-4% longer term, essentially in-line with the Mexican economy (revenues are running about +7% this year ex political spending, as Mexico recovers somewhat from a difficult recession).

Re downside protection, even at trough levels in non-election years, RC’s cash flows (based in part on a streamlined cost structure) appear to support (currently) an intrinsic value of at least $6-8 per share. Trough FCF levels ex one-time items appear to be about $10-15mm (the company did ~$20mm in EBITDA in 2002 and 2001, two non-political years in which EBITDA was also impact cumulatively by at least $10mm due to internet and other non-core spending). Ongoing maintenance cap ex is at most $2 million. And after this year, the company will be debt free. Essentially, in a worst case, it appears that the company will be able to generate almost $1 per share in FCF.

On the upside, assuming a stronger (sustained) Mexican economy, a continued focus on core radio operations, the occurrence of a dual presidential/congressional election in 2006, I suspect that EBITDA will peak out this “cycle” at over $50mm, which could certainly support a market value of ~$20 per share without making a leap of faith re huge multiple expansion. I am not proposing that RC should be valued based on this number. However, it does give you a sense of the upside potential that exists – for example, even just a 6-7x EBITDA multiple on $40mm in EBITDA gets you to a $16-17 value. And for those of you that like to analyze FCF yield, just getting to a 10% FCF yield on $30mm in FCF results in a similar $16-17 price target.

M&A POTENTIAL:

RC has been family owned and managed for many years. The controlling family owns 51% of the outstanding shares and has essentially run RC as its private enterprise (not in a negative way). However, it is widely known that the family is a willing seller at the right price. In 1998, Chancellor Media proposed to buy 50% of RC for north of $20 per share. And in 2000 Grupo Televisa offered to buy the entire company for approximately $18 per share. I was alerted to this situation late last year by a source who is close to the company, who suggested that business was improving so dramatically that it was likely that the company would once again become a viable takeout candidate. That was at $2 per share. After the strong first quarter results (and in light of the streamlined operations, the deleveraging, the rebound in Mexico, etc.), it became clear to me that a takeout could not be imminent, as the difference between the stock price and “fair value” was too significant to make a buyout viable. However, as the stock price appreciates, as operations stabilize, and as RC proves its viability through yet another complete economic and political cycle, it has become increasingly clear to me that the family not only would like to monetize this valuable asset “this time around,” but will probably end up doing so. My sources indicate that they wouldn’t accept less than $12-15 per share, with $15-20 (within the next 12-24 months) being a more reasonable target. More reasonable valuations (say, media M&A multiples discounted by 25%+) support values north of $20, as do the prior offers made for RC, when it wasn’t as strong as it is now.

RISKS:

The Mexican Economy – RC, just like any other broadcaster, is subject to economic conditions. However, recent history provides clues as to how the company may fare under difficult circumstances. After the failed Televisa transaction, for example, management borrowed over $30 million from which it paid a special dividend. Subsequently, the Mexican economy (along with the rest of the world) took a sharp turn for the worse (the Mexican Peso also experienced devaluation vs. the US Dollar). RC also ended up buying back approximately $20mm stock as the recession began (at ~$9 per share), and even made $7mm in non-core investments (which were ultimately written off), as well a radio station acquisition. One can criticize management for these mistakes, to which they pleaded guilty (and from which they have clearly learned a lesson that I suspect will not be repeated) or one can realize that notwithstanding the confluence of negative events, RC has still never been FCF negative. This is a testament to the downside protection that exists at these levels and provides a bit more clarity than simply stating that the company has book value of approximately $6 per share.

Failed acquisitions, non-core investments -- See prior paragraph. Always a possibility, I suppose, but given recent experience, very unlikely.

Illiquidity -- self-explanatory.





I apologize if this recommendation lacks detail – I wanted to get this to VIC before this weeks earnings announcement to allow club members some time to look this over. In fact, RC is a difficult trader and investors had plenty of time last quarter to buy the stock AFTER EPS were reported. Nonetheless, I feel as if we may be approaching a critical juncture, just as in 1997 and 2000, when the stock appreciated by 100%+ in very short periods of time. I will be happy to respond to questions in more detail.

Catalyst

July 23rd – I guess it doesn’t get much more direct than this. RC will report earnings on July 23rd. I believe that people who follow the company understand that this will be a very, very good quarter due to the heated political contests that took place in Q2 in Mexico. However, I am hoping that the magnitude of the numbers that are reported make this just too obvious to ignore. We will hopefully get a chance to see real operating leverage at work in this quarter. And while I would not expect investors to capitalize this quarter to eternity, I do believe that that absolute level of EBITDA and cash flow in the quarter will serve notice that this stock is undervalued, on a fundamental basis, even at $10. Once it reaches that level, we can have a more reasonable debate re: M&A activity, the economy, the appropriate valuation level for a Mexican broadcaster, whether the company will pay a $0.40 or a $0.60 dividend this year, etc. (something I should have mentioned earlier – the company generally approves a dividend for the CURRENT year in March/April of the FOLLOWING YEAR. I currently expect the Board to approve at least a $0.40 dividend payment for 2003. While RC could likely pay a higher dividend from cash flow from operations, I suspect they may want to keep some cash in reserve as next year is an off year re political spending).

As an aside, Televisa recently reported results for the same period, which were very strong . Despite the fact that Televisa is widely followed and had telegraphed the strength of election spending, the stock climbed ~15% in two days (and RC as a radio broadcaster is even more exposed to spot rates, which have been particularly strong). I’m not recommending this as an earnings play as it is illiquid; however, I do believe the earnings release may be a catalyzing event, as management will likely discuss: the paydown of the special dividend debt; the new, streamlined cost structure; the return to a pure focus on radio operations; and importantly, what it intends to do with the significant excess cash that will accumulate between now and 2005/2006.

Expectation of analyst coverage – Nothing definite, but certainly a possibility as most of the major investment banks are familiar with the company and the potential for M&A activity.

The announcement of a buyout itself (to which I assign a reasonable probability within 12-18 months) – self explanatory.