Background

Hemisphere Media Group is a unique opportunity, one that I believe hits on multiple traits investors look for in a long-term holding: secularly growing end markets, an ability to organically grow earnings, an opportunity to make accretive acquisitions and a strong alignment of incentives with management/the Board.  Together with a very attractive valuation, I believe I’ve found a great investment for years to come. 

HMTV is a media company focused on the Hispanic market in the US and in Latin America; in fact, it is the only pure-play Hispanic TV company in the US and only true consolidator of assets in this niche industry.  Presently, HTMV has three businesses: two Spanish-language pay-TV channels, WAPA America and Cinelatino, and a broadcast network in Puerto Rico, WAPA TV.  HMTV was formed in April 2013 by way of a reverse merger between a special purpose acquisition vehicle and the parent companies of the aforementioned businesses, which were owned by the private equity firm InterMedia Partners.  At closing, the SPAC’s public shareholders owned 27% of HMTV and the private equity sponsors owned 73%.  It’s worth noting that the sponsors own Class B shares, which have 10 votes per share versus the A’s with 1 vote per share; the A shares are what are publicly traded.

My price target is $22.50 for HMTV.  While the stock traded as high as nearly $16 last summer, it has since traded down to the low-$9’s and is now at $11.25 as of the time of writing.  The reason for this weakness appears twofold.  First, there was massive technical pressure as the holder of 25% of the A shares began dumping its shares in May; since this fund invests as an arbitrageur in pre-deal SPAC’s, I believe this selling had nothing to do with fundamentals.  According to its 4Q13 13F, this fund currently owns less than 1% of HMTV’s A shares.  The second reason for HMTV’s weakness has to do with apparent concerns over Puerto Rico’s economy; as these concerns flared up last summer, amidst the aforementioned heavy selling pressure, this exacerbated the selloff in HMTV.  As elaborated on below, I believe the “Puerto Rico risk” is overstated and manageable.  Additionally, HMTV is an “under the radar” stock as its public float is only $140mm and it is covered by only one (boutique) sell-side firm.

Thesis

HMTV is not only an attractive organic growth story, leveraged to the growing Hispanic population in the US and Latin America, but is also a consolidation story.  The CEO of HMTV is Alan Sokol, who previously was COO of Telemundo.  Mr. Sokol joined Telemundo in 1998 following its acquisition by Sony and Liberty Media for $730mm.  Along with former CEO Jim McNamara (who is on the Board of HMTV and is an advisor to the company), Mr. Sokol helped engineer a turnaround at Telemundo and in five years the company was sold to NBC for $2.7bn.  HMTV is essentially their second act, and I think it’s worth betting on them.  Importantly, management’s interests are aligned with shareholders as sponsors and management own 61% of the company.

For FY13, I estimate pro forma results (as the initial merger had closed as of January 1) of: revenue of $94mm, EBITDA of $40mm, EBIT of $25mm, net income of $10mm and EPS of $.24.  While HMTV ended the year with negligible net debt, it did have gross leverage of 4.4x as the company is sitting on $173mm of  cash to use for acquisitions; absent the interest drag from holding onto this dry powder, FY13 EPS would’ve been $.40.

For FY14, I estimate standalone revenue of $106mm, EBITDA of $48mm and EPS of $0.40, with topline growth driven by subscriber and advertising revenue growth (more below) and margin expansion from the inherent operating leverage in the TV business.  However, later this quarter, HMTV will close on its first acquisition.  It announced last month that it was deploying $102mm of its cash to acquire three Spanish-language cable networks from privately held Imagine US.  These assets generated $12mm of EBITDA in FY13 on estimated revenue of $31mm; since the deal is structured as an asset sale, HMTV assumes no debt.  Pre-synergies, HMTV paid 8.4x TTM EBITDA, a very attractive multiple in its own right; I estimate synergies of ~$3mm over the next two years (primarily through cross-selling opportunities), putting the post-synergy multiple at 6.7x.  Pro forma for the acquisition, HMTV’s FY14 revenue is $137mm, with EBITDA of $63mm and EPS of $.57.  In FY15, absent additional acquisitions, I estimate revenue of $158mm, EBITDA of $81mm and EPS of $.84.

With its existing assets alone, I believe HMTV has strong opportunities to grow both subscriber and advertising revenue.  WAPA TV is the dominant broadcast network in Puerto Rico, with 25 of the top 30 rated shows on the island and a viewership share higher than all four of the US networks combined.  Despite this dominance, WAPA TV currently earns retransmission fees of less than half the $2.00/sub/month that CBS recently agreed to with Time Warner.  Its contracts with local MSOs are on 2-3 year terms, with its next significant contract renewal coming in late 2014 with Liberty Cablevision; based on primary research, Liberty appears to represent ~60% of WAPA TV’s households.  While it will likely take at least a couple contract renewal cycles to get its retrans fees in-line with the mainland broadcasters, HMTV stands to earn an incremental $10mm of EBITDA between now and then.

Another leg of the HMTV thesis is advertising revenue at its Cinelatino channel.  Currently, Cinelatino doesn’t air any commercials (similar to HBO, Showtime, etc.).  However, management has decided that, beginning later this year, rather than have dead air time between movies (which are currently filled with relatively uninteresting programming like red carpet interviews and the like), Cinelatino will begin to air commercials on its US channel during this time, adding an additional source of revenue on top of the fees it earns from its ~4.6mm US subs.  The opportunity here could be relatively enormous, as Cinelatino is the #1 rated Spanish-language cable channel in the US, recently surpassing Discovery en Español, which earns ~$30mm in advertising revenues.  While Cinelatino will only air approximately half of the commercials as Discovery, net of relatively minor associated costs, Cinelatino advertising in the US represents a nearly $15mm EBITDA opportunity, which should be achievable within 2-3 years.  This excludes any potential advertising revenue from Cinelatino’s nearly 8mm subscribers in Latin America.

The opportunity for Cinelatino to grow earnings in Latin America is also compelling.  For starters, Cinelatino is meaningfully under-distributed in Latin America (ex Brazil), with only 21% of pay-TV subscribers receiving Cinelatino.  Management has said they are targeting a 54% penetration rate (20mm of the current 37mm pay-TV customers in Latin America, ex Brazil), which I estimate would add an additional $7mm of revenue (at an incremental margin of somewhere north of 50%).  (Additionally, pay-TV penetration itself is low in Latin America, at 56% vs. 86% in the US.)  Included in this is the opportunity to have Cinelatino distributed to Grupo Televisa’s 8mm subscribers, which the company has indicated they are working on.  Were HMTV to get new distribution across Televisa’s pay-TV subscribers, it could also include advertising, as opposed to the commercial-free feed that currently airs across Latin America.  (Also, while pure speculation, it’s also easy to see how a company like Televisa, with aspirations to enter the US market – but currently restricted by FCC guidelines from increasing its stake in Univision – could be interested in acquiring or taking a strategic stake in HMTV.)

Finally, I believe perhaps the biggest growth driver for HMTV is coming in the form of a tectonic shift in how the Hispanic cable TV market in the US functions.  Through my primary research and commentary from satellite and cable operators, I believe that the US pay-TV industry is about to move towards an over-the-top (OTT) solution to address the Hispanic market.  While Hispanic households subscribe to pay-TV at a rate similar to the overall US rate (81% of Hispanic households subscribe to pay-TV vs. 86% nationwide), the percentage of Hispanic households subscribing to Spanish-language programming packages is only 30%.  While some of this reflects a preference for English-only programming, much of it can be explained by cost and marketing considerations.  A Spanish-language programming package is typically an additional $25-50/month on top of a basic cable package, which is problematic for a demographic with below-average income levels; additionally, since the Hispanic population also moves households/cities at an above- average rate, cable companies don’t pursue them as aggressively since they have a lower lifetime value than less transient demographics.  (There’s also a third issue, which is that some potential customers of Spanish-language programming packages are undocumented residents and, therefore, are ineligible to sign up for many cable services.)  Forthcoming Spanish-language OTT offerings aim to address this, offering a concentrated slate of popular content (including Cinelatino) for a fraction of the cost of paying for basic cable plus a Spanish-language programming add-on (my research indicates the cost of such OTT subscriptions would be ~$10-15/month); and since such content would be accessed over the internet, a customer who moves to a new city need not unsubscribe from her existing package.  With ~14mm Hispanic households in the US and only 4mm of them subscribing to Hispanic programming packages, there is tremendous room for growth.  While the economics have yet to be finalized, my research suggests that HMTV will receive the same carriage fees for these OTT offerings as they do for traditional cable.  Advertising, in some form, will likely be offered, too.  By the second half of this year, I expect to see multiple cable and satellite operators offering internet-based packages of Spanish-language television content.  Over time, I anticipate this to lead to penetration rates for such packages rising from 30% currently to north of 50%, adding over $12mm of revenue to Cinelatino (more to HMTV if its other channels are eventually included); and since this is content that HMTV already owns/controls, there are de minimis incremental expenses associated with this revenue.  All the while, this inflection in penetration rate is occurring against a backdrop of fast growing Hispanic population in the US (in fact, last decade, the Hispanic population accounted for more than half of the total population growth in the US).

Notably, the above analysis excludes a detailed discussion of prospects for the three networks that HMTV agreed to acquire last month.  These include Pasiónes, an 11mm-sub network dedicated to airing popular telenovelas; Centroamerica TV, a 3mm-sub network targeting Central Americans in the US; and TV Dominicana, a 2mm-sub network targeting Dominicans in the US.  After closing on the acquisition of these three networks later this quarter, HMTV will be in a better position to negotiate distribution deals with cable/satellite operators, as well as to offer cross-selling opportunities to advertisers across its expanded programming lineup.  And beyond this pending deal is the stated goal of further acquisitions.  Management has stated a willingness to take net leverage up to 4x, which, assuming  similar economics to the aforementioned deal, would grow FY15 EBITDA by 70%, from my current estimate (which assumes no further M&A) of $81mm to $137mm and would be 30% accretive to EPS, growing to $1.09 vs my current $.84 estimate.

Valuation.

On my FY14 numbers (which include the pending acquisition but assumes no further M&A), HMTV trades at 9.7x EV / EBITDA (7.2x on FY15).  This is particularly inexpensive relative to several comparable valuations.  First, the independent cable channels (which each has varying degrees of takeout likelihood), DISCA, SNI and AMCX, trade at 10.5x FY14 EBITDA; this is despite having slower organic growth compared to HMTV.  Second, the large US broadcasters (CBS, FOXA and DIS, but excluding CMCSA because of the impact of its MSO) trade at 11.0x FY14 EBITDA; this is despite not having any possibility of being acquired (as well as lower growth prospects).  Third, it’s been reported that Univision equity recently traded in a private transaction at 12.5x FY14 EBITDA; though it is levered to the favorable Hispanic growth demographic trends that HMTV is, and it does have some potential for an acquisition by Televisa (if FCC rules on foreign ownership of broadcasters change), it has much higher leverage than HMTV (8.5x vs 1.8x for HTMV) and should also be valued at a discount given that it’s not publicly traded (plus, we think its organic growth and takeout prospects are inferior relative to HMTV).  My $22.50 price target is based on my FY15 EBITDA estimate of $81mm using a 13.5x multiple.

Risks (and Mitigants)

• Puerto Rico’s economy: given the noise around Puerto Rico’s fiscal situation, this is probably the key risk, though I view it as more of a “headline” risk than representing meaningful fundamental risk:
  • In a downside scenario, I estimate a 10% decline in advertising rates in Puerto Rico translates to a $5mm hit to EBITDA, which is 8% of FY14 PF EBITDA and 6% of FY15
  • In addition to WAPA TV’s aforementioned dominance, broadcast TV as a medium is still the primary advertising medium in Puerto Rico, and therefore should be more resilient than other media
    • Part of this importance owes to the fact that broadcast TV is the exclusive source of television for ~48% of Puerto Rican households (compared to ~14% for the mainland US)
  • Finally, my channel checks indicate that Puerto Rico’s recently completed upfronts (which occur 5-6 months before the mainland US upfronts) were flat vs 2013, indicating that the island’s fiscal woes are not having an overly negative impact on TV advertising
• Dual share class: with the dual share class structure, holders of the publicly traded (Class A) shares are unable to exercise control over HMTV.  While this is not unique to HMTV (and particularly within the media sector, it’s not unique (see: VIA, CBS, NWSA, FOXA, SNI, DISCA, etc.)), it does represent a potential risk.
  • Based on my interaction with management and their strong track record of value creation for their past shareholders, this is a risk I am personally comfortable with. 

Catalysts

• Increased public exposure (especially as it begins to attend investor conferences, starting with the Deutsche Bank media conference in March)
• Increased sell-side coverage (currently only one analyst covers it)
• Closing of its recently announced acquisition of three cable networks (expected by end of 1Q14)
• Future acquisitions
• Announcement of the first Spanish-language OTT offering in the US (expected sometime in 2H14)
• Potential announcement of a distribution deal with Grupo Televisa
• Announcement of increased retransmission fees in Puerto Rico (expected in late 2014)