Description

Long IHRT 1L bonds at $78 vs. long 5y CDS at 23.5 pts upfront in a 3:1 or 4:1 ratio can generate mid- to high-teens returns net of funding costs in modest spread tightening scenarios and ~30% net returns in a stress scenario with ~10-15% downside risk. With no significant debt maturites before 2026, $750+mm of liquidity, and ~$200mm of likely FCF in 2023 even in a recessionary ad environment, IHRT spreads should revert to early 2022 levels over the coming year, implying tightening of >300 bps on the 1Ls and ~1000 bps on the 2027 unsecureds. The company's digital audio segment is growing 20%+ and now comprises >25% of IHRT revenue, offsetting now gentler secular declines in the multiplatform audio business. Finally, IHRT is aggressively buying back its unsecured bonds, an attractive use of excess liquidity with bonds offered at $70.

Business description: iHeartMedia ("IHRT") is the largest broadcast radio business in the US with 860 radio broadcast radio stations in 160 markets and with twice the broadcast audience of its closest competitor. IHRT's podcast business is more than twice the size of its next largest competitor by streams and downloads (412mm vs. NPR with 192mm) and by US monthly unique listeners (33.1mm vs. Wondery at 24.8mm). IHRT's digital audio segment produced 26% of 2022 revenue and grew 23% y/y. Within that, podcast revenue accounted for 9% of total revenue and grew 42% y/y.

Key points:

• Podcast business likely generates >$100mm EBITDA and is growing >40% y/y with unmatched economics: IHRT dominates the podcast space on every measure (412mm streams vs. NPR with 192mm; 33.1mm US monthly unique listeners vs. Wondery at 24.8mm, and $358mm of revenue, vs. Spotify with €123mm). Revenue growth has outpaced MAGNA Global industry estimates as IHRT has expanded its lead over the competition (see table). Because of its reach and scale, IHRT is the natural first destination for the most coveted content creators. Consequently, management has been able to stay away from large upfront deals (e.g., Spotify's ~$200mm deal for Joe Rogan, among others). IHRT controls and produces all of its podcast content and therefore captures all associated ad revenue. Finally, IHRT's ability to promote its podcast on the company's broadcast radio stations is a powerful differentiator: broadcast stations reach 90% of the US population, giving IHRT $100mm/year of free advertising on what might otherwise be unsold broadcast inventory. Altogether, IHRT's podcast margins have been accretive to overall consolidated margins since FY'19; by comparison, Spotify still talks of its podcast business being a "drag" on margins and says profitability is still 1-2 years off.

• Capital-light business model and working capital release to provide FCF floor even with unfavorable margin mix: IHRT's multiplatform group contains the company's broadcast radio stations, networks business (i.e., syndication of IHRT content from Ryan Seacrest's morning program to traffic & weather to non-IHRT stations), and events business, and generates 2/3 of IHRT revenue and 64% of pre-corporate EBITDA. Content costs in this segment vary with volume and mix of songs played on stations, not with listenership, and thus incremental margins are high (75-85%). By contrast, content costs in IHRT's digital audio segment vary with the volume of listening hours on the company's digital platforms; thus, incremental margins are much lower (30-50%). This presents an unfavorable dynamic for 2023 with MAGNA Global forecasting linear radio ad formats will decline 4% y/y while digital audio (streaming, podcasting) will rise by 9%. Indeed, I see consolidated margins falling 300 bps y/y  and 600 bps vs. 2019 to 21.3%, before gradually recovering mid-20s margins by 2025. IHRT generated postiive FCF of $131mm in 2020 even as revenue fell by 20% and EBITDA was cut in half. Management cut capex to $85mm, and working capital release improved FCF by $117mm. 1% of incremental revenue decline in IHRT's multiplatform group vs. -10% base case for 2023 = -2.3% impact to EBITDA and -6.9% impact to FCF. 1% of incremental revenue growth in IHRT's digital audio group vs. +5.7% base case for 2023 = +44 bps impact to EBITDA and +1.1% impact to FCF, all else equal
• Pending slowdown may not impact radio ad revenues as much as in past recessions: US radio ad revenues declined by ~20% in the 2001 and 2008. In 2020, IHRT's multiplatform revenue fell by 28% y/y, with IHRT's Digital Audio Group (+26%) driving overall declines of 20%. In a garden variety recession this time around, radio should benefit relative to other legacy media due to
  • Better rel val vs. broadcast TV: radio reaches 90% of Americans on a monthly basis (flat vs. 2001 and 2009), where largest TV broadcasters reach <40% and cable networks reach ~25% (down significantly vs. 2001 and 2009 as viewing has shifted to streaming platforms); TV CPMs today are 4x radio, vs. 2x for most of the last decade and 1x in the 1990s
  • Improved relative positioning vs. digital: Digital ad industry more mature; now 60% of ad spend vs. negligible in 2001 and 2009; less risk of sudden share shift away from legacy media
  • Improved cross selling ability: IHRT can tap digital marketing budgets in ways in could not in past recessions. The company's SmartAudio platform allows it to turn broadcast radio ad inventory into digital-like inventory that can be purchased and analyzed in a way similar to digital advertising

        Further, IHRT has been a net share gainer within radio (see chart), picking up 370 bps of market share from its competitors annually since 2009

• Digital audio group growing to >1/3 of EBITDA to provide EV support: IHRT's digital audio group generated 26% of its pre-corporate expense EBITDA in 2022 and should generate 1/3 by 2023. The podcast business should generate 11% of pre-corporate EBITDA by 2023. Together, these segments will grow revenue at a ~30% CAGR from 2019-2023 even assuming materially slowing in 2023 (~5.5%). That should support an EV multiple of 6-7x or better assuming return to trend gradual declines in the legacy broadcast radio business, particularly in light of IHRT's capital-light nature (6.0x 2024E EBITDA implies just 6.8x 2024E EBITDA-capex). IHRT's 1Ls in the $78-80 context create the company at 3.6x 2023E and 3.0x 2024E EBITDA, or 4.2x 2023E and 3.4x 2024E EBITDA-capex

Risks: 

• IHRT's unsecureds are at all-time relative wides vs. the 4.75% '28 first liens (see spread history below). The primary risk to a 3:1 or 4:1 trade is that the unsecureds could tighten materially while the 1Ls remain around +700. I find it hard to see why the CDS could tighten to +800-900 from +1310 with the 1Ls staying put but would note (1) the CDS has traded at a negative basis vs. the unsecureds historically and (2) IHRT is aggressively buying back the unsecureds in the open market (IHRT has just ~$33mm of remaining repurchase capacity before it must formally tender for bonds).
• Further ad market deterioration (i.e., if broadcast radio starts looking like -20% y/y instead of -10% y/y, or if podcast/digital revenue growth slows materially) could take radio valuations down to ~4x on trough EBITDA, which could take estimated 1L recoveries down to the 50s. In that scenario the CDS should move to 70+ pts upfront but losses on a levered long 1L position would dominate gains on the CDS leg
• Auto OEMs could drop radios in new models: per The Drive, some carmakers are already leaving AM radios out of new electric vehicle models, citing interference from EV drivetrains. As of June 2022 Detroit's big 3 still included AM radio on EVs, and drops by European manufacturers could be more because AM radio has fallen out of favor in Europe, having been superseded by the DAB format. 89% of US respondents in a 2021 survey said radio should be standard in new cars, while just 84% said the same of USB ports. A March 2023 article by The Verge said the 2024 Ford Mustang will hit US dealerships without AM radio. See the table below for context: The US car parc is currently approximately 300mm vehicles, of which ~4mm are EVs. EVs should be ~6% of US SAAR in 2023, growing to 35% by 2030, and to 50% by 2035. If 80% of EVs manufactured in the US from 2024 onward drop AM radio, then the portion of the US car parc without AM radio will be just 6% by 2030 and 11% by 2035. If 100% of EVs drop AM radio from 2024 on, the portion of the car parc without AM radio will be 7% by 2030 and 13% by 2035. Of IHRT's 864 owned and operated stations at 12/31/22, 249 were AM and 615 were FM. 

Upside/downside: 

• Assuming S+75 margin cost, long the 4.75% 1L '28s at $78 vs. long 5y CDS protection at 23.5 pts upfront at a 3:1 ratio generates one year net returns of 15-20% assuming IHRT 1L and CDS spreads return to near year or two ago levels (see Trade 1 in table below and spread charts in appendix below). In a near distress scenario where the 1L trades to +1500 OAS and the CDS blows out to 80 pts upfront, the trade generates net returns of ~30%.
• For accounts that cannot utilize leverage, see Trade 2 below. Net returns assume 4:1 long IHRT 5.25 1L '27s against long 4y CDS protection at 21 pts upfront, and are calculated based on total dollars at risk (i.e., $320 for 4x 1L bonds offered at $80, plus 21 pts for the CDS = $341 cost basis)

Exhibits:

Capital structure and valuation

Historical relative spreads

Catalyst

2023 broadcast radio and podcast ad spend development, further repurchases of IHRT unsecureds