Description

(NYSE:LIN, f.k.a. TVL)

With LIN’s recently completed corporate and JV restructuring, it has the potential to be a double within the next six months.  I am recommending a LONG investment in LIN, with a target price of $23 (~55% upside) as a standalone company and $33 (~120% upside) as a buyout target.   

While LIN has always boasted a strong management team, attractive station assets in upper-mid-sized markets, and a top notch digital platform (“LIN Digital”), the Company’s credit guarantee of an under-water $816mm note (the “JV Note”) at its joint-venture (the “JV”) with NBC Universal (“NBCU”) persistently threatened the Company’s solvency.  However, on February 12, 2013, LIN announced it had entered an agreement with NBCU, which dissolved LIN’s guarantee of the JV Note in exchange for (i) a $100mm capital contribution to the JV and (ii) LIN’s equity stake in the JV.  This agreement was very favorable to LIN, but resulted in a substantial tax liability.  To avoid this tax liability, LIN has since been working on a conversion from a C-corp to an LLC.  This conversion was successfully completed on July 30^th and effectively lifted the overhang that had persisted over LIN’s stock since the Great Recession.   

Now, LIN could be a buyer or seller of assets, but I believe HM Capital (“HM”), the ~38% equity holder of LIN is readying the Company for a sale transaction that could result in over 120% upside for the stock.  Based on 2013-14E EBITDA of $250mm, LIN trades at a multiple of 7.1x, which reflects a meaningful unjustified discount to its public peers and an even greater discount to the 10-12x sellers’ multiples being realized in recent M&A transactions across the sector.  There is no rationale for LIN’s current discount to its peers; in fact, I expect LIN will soon trade at a premium to its larger peers (SBGI/NXST), given its high potential to be a near-term takeover target. 

I believe this opportunity exists, because (i) LIN is not widely covered by the Street, (ii) investors do not yet understand the impact of LIN’s recent JV restructuring and the magnitude of LIN’s valuation discrepancy relative to peers, and (iii) investors are misunderstanding recent insider selling by HM, discussed in detail below. 

A word on the very recent volatility in the sector:  Over the past few weeks, broadcast stocks have experienced heightened volatility.  This selloff has been primarily caused by some negative headlines around retrans negotiations (CBS/TW) and regulatory issues, as well as sentiment that consolidation in the space is taking a pause or slowing permenantly.  I believe these concerns are not valid and certainly being over-discounted, but this is a sector prone to bouts of volatility from headline risk.  For those looking to hedge out some of the sector's beta, SBGI is probably the best hedge given (i) liquidity, (ii) it's too big to be acquired and its size means future acquisitions are far less likely to move the needle, and (iii) it's the largest pure-play broadcaster and has tended to be a bellweather for sector valuations in general.

Business Overview

LIN is a TV broadcast affiliate that owns/services 43 stations and 7 digital channels in 23 markets primarily in the Midwest and South (see slide 8 here for a map of LIN’s markets and stations: LIN Slide Deck).  Its stations have a reach of 10.5% of US households and are primarily located in the top 75 DMAs.  LIN’s largest markets are KOIN-TV in Portland and WISH-TV in Indianapolis (both are CBS affiliates).  Two-thirds of its stations have Big 4 network affiliations (11 CBS, 10 FOX, 7 NBC, 5 ABC) and the remaining stations include 8 MNTV, 8 CW, and 1 TEL.      

LIN Digital, recently rebranded from “RMM”, is rapidly growing and among the strongest digital platforms of any of the TV broadcasters.  This segment has high upside potential and is differentiated from its peers, as it seeks to reach beyond its regional footprint, which primarily involves advertising on banners on LIN’s TV websites, to provide services on a national level.  Through organic growth and small tuck-in acquisitions focused on building IP, LIN is building out its offering, which includes display, video, mobile, search and creative solutions.  While digital comprises less than 10% of revenues currently, management sees Digital’s share going to 20% over time and operating margin expansion in the segment continuing.

Specifically in 2H’13, LIN has some great things going for it on the operational side.  First, it is in a great net-retrans (retransmission consent agreements discussed in more detail below) position with many of its major contracts renewed in 2013 (CHTR, CMCSA, DISH, COX, VZ, T, TWC, Bright House, DTV).  Second, advertising dollars related to the Obamacare transition are expected to contribute windfall profits to the TV advertising sector in the 3^rd and 4^th quarters of this year.  Starting in October, health insurance companies are going to begin marketing policies to uninsured Americans, as Obamacare requires that every American buy a policy by the end of 2013 or start paying a penalty tax.  In addition, there will be political dollars related to this transition flowing from both sides of the aisle.  All of this adds up to a potentially large basket of incremental ad dollars that are not yet baked into managements’ budgets and Street’s estimates.

LIN has been controlled by its largest shareholder, HM (formerly Hicks Muse) since the late 90s.  HM has ~38% economic interest and ~35% voting interest, though HM could convert Class B shares to Class A and/or dilute the sole other Class C share holder to raise its voting interest above 50%.  The fund is currently in wind-down, and it is very likely that HM will pursue an exit strategy in the near-term.  It is well-known by operators in the TV sector that private asset valuations exceed 10x EBITDA.  With LIN trading near 7x EBITDA, HM’s best avenue to exit its investment would be a sale transaction of the company.  In fact, it was rumored that HM was exploring a sale of LIN in 2011 that never happened.  While a monetization of HM’s position through secondary offerings is possible, it is highly unlikely (and would be unfavorable to HM) given the substantial spread between LIN’s current valuation versus public/private multiples in the sector. 

Historical Context

As part of its acquisition of LIN in 1998, HM formed the JV with NBCU, which was owned by Comcast (51% ) and GE (49%).  The JV owned two NBC-affiliated television stations, KXAS-TV in Dallas and KNSD-TV in San Diego, and was operated by NBCU.  LIN held an 80% equity stake in the JV and a 50% voting interest.  When the JV was originally formed, HM took out the $816mm JV Note from GE Capital Corp that would be secured by the JV assets, and proceeds were used to help finance HM’s acquisition of LIN.  While the JV Note was the obligation of the JV, it was fully guaranteed by LIN, thus creating a potentially large liability if the KXAS-TV and KNSD-TV failed to perform as expected.    

When the recession hit in 2008, the JV’s cash flow fell below the debt service of the JV Note.  To cover the debt service shortfall, LIN entered an agreement with NBCU under which each party would fund the JV’s shortfall according to its respective equity ownership.  However, despite this shortfall agreement, LIN’s guarantee of the JV Note meant it was still fully on the hook for the full amount if the JV were to default.  To address this guarantee and the substantial overhang it posed to LIN’s stock, management retained advisors who began privately exploring restructuring alternatives for the JV. 

In February 2013, LIN announced that it had entered an agreement with NBCU to walk away from the JV and dissolve its guarantee of the JV Note in exchange for a $100mm capital contribution to the JV.  This agreement was very beneficial to LIN and was likely possible as a result of Comcast’s acquisition of GE’s stake in NBCU in February 2013, though the true motivations of Comcast/NBCU are not known. 

One negative consequence of the JV dissolution was a $716mm taxable gain on defeasance of debt.  To shield this tax liability, LIN pursued a strategy of converting from a C-corp to an LLC, which would create a taxable loss to help offset the taxable gain from the JV restructuring.  The interesting dynamic surrounding this LLC-conversion is that the magnitude of the resulting tax shield depended on LIN’s stock price at the time of the conversion.  At a stock price of less than $10.80, the taxable loss would be sufficient to offset entire capital gain and would preserve LIN’s operating NOLs.  At a price between $10.80-12.35, LIN’s operating NOLs begins to get used up, and at a price above $12.35 (up to $20), each $1 appreciation in the stock price resulted in a $20mm cash tax liability to LIN.  So for example, at a $13.35 stock price, LIN would use up all of its NOLs and incur a $20mm cash tax liability.  Management guided to a third quarter close of the restructuring. 

Trade Setup

This relationship between stock price and tax liability meant that the increase in LIN’s valuation would accelerate as its stock price rose above $12.35 (due to the ever increasing tax liability which would need to be funded).  In addition, it also created incentives for the Company and its largest equity holder, HM, not to promote stock price appreciation while the restructuring was pending.  So at the time, I believed that until the restructuring was completed, there would be heavy downward pressure on the stock, and any rise in the stock price would be short-lived.  As is illustrated in the stock’s price action in the February through early June period, this turned out to be accurate.  In this period, where the S&P 500 Index rose over 6% and comparable TV broadcasters were up 100-200%, LIN (with a BETA approaching 2x) was range-bound and did not appreciate. 

Then on June 13th, GCI (an owner of broadcast and newsprint assets) announced an agreement to acquire BLC (one of the larger pure-play TV broadcasters) for $2.2bn.  This deal, which represented a 28% premium to Belo’s stock price and a valuation of 9.4x EBITDA, was a positive catalyst for all of the stocks in the TV broadcast space.  It marked the first large public broadcaster asset that has been acquired in years, and the deal’s multiple represented a healthy premium to other public valuations.  As a result of this transaction LIN broke out of its range.

The episode took another interesting turn in the week of the BLC acquisition, as HM filed a 13D that reported it had converted 2.5mm shares (~11% of its total holdings) from non-trading B-shares to publicly-traded A-shares.  In addition, they intended to sell these 2.5mm shares pursuant to a 10b5-1 plan.  Based on these filings, it became clear that HM was going to be selling a substantial amount of stock into a market that typically trades ~500k shares per day.  This new seller in the market was sure to weigh on the stock price, and given HM’s status as an insider, would also likely be misread by the market as a negative sign. 

By converting and selling 2.5mm shares, HM would incur the opportunity cost of selling these shares below intrinsic value, but would realize value equal to LIN’s tax savings multiplied by HM’s pro forma ~38% stake in the Company.  At the time of HM’s share conversion, LIN’s stock was at ~$14 (subsequently peaking at ~$18), and valuations across the sector were appreciating rapidly.  If the stock continued to grind above $20, the Company would incur the full $162mm tax liability.  At HM’s ~43% stake in the Company, that’s a ~$70mm hit.  By weighing the stock down below $12.35, they would save the entire $70mm, and if the stock closed below $10.85, they would also preserve the Company’s ~$131mm of NOLs.  At most valuations for the Company, this math meant that the upside of tax savings to HM’s pro forma stake was far greater than the opportunity cost of selling ~11% of its stock at below intrinsic value.  On July 15th, the selling began, and persisted every day at 5-10% of volume.  In the following two weeks, the stock would fall almost 20%.

As the end of July approached, it became clear that a number of factors were coming together that made a completion of the LLC-conversion on July 30th highly likely.  The shareholder meeting to vote on the LLC-conversion was scheduled for this day, and management had scheduled its 2Q earnings release for the same morning.  Also, LIN was being removed from the Russell 2000 index on this day, which would bring selling by index funds and pressure the stock. 

On July 30th, LIN reported an earnings miss and the stock was weak on very high volume of over 9mm shares.  This earnings miss and commentary around a weak ad market (for the second quarter in a row) flew in the face of what all the other TV broadcasting comps were reporting.  The stock closed at $14.90, and as expected, after the close on July 30th, LIN announced it had completed its LLC-conversion.  Since the stock was above $12.35, they incurred a $48mm tax expense, but the conversion successfully shielded $115mm of tax liability and finally removed the long-standing overhang from the stock. 

Based on 2013-14E EBITDA of $250mm, LIN trades at a multiple of 7x, which reflects a meaningful unjustified discount to its public peers and an even greater discount to the 10-12x sellers’ multiples being realized in recent M&A transactions across the sector.  By just closing the valuation gap with other public comps, LIN has upside to $23 (up ~55%), and upside as a buyout target could exceed $33 (up ~122%).     

Through August 8^th, HM was still selling shares every day pursuant to its 10b5-1 plan.  Since 10b5-1 plans are preset and essentially run on auto-pilot, it is likely that HM could not cancel the plan even after the LLC-conversion had been completed.  However, on the evening of August 8^th, HM did a drive-by secondary of all of its remaining Class A shares.  HM now holds only non-trade B shares, and I believe this secondary has lifted the overhang of insider selling that has likely caused many investors to stay on the sidelines. 

Sector Overview

The pure-play TV broadcaster stocks include SBGI, NXST, BLC (currently being acquired by GCI), MEG (recently merged with Young), GTN (high leverage), FSCI (currently being acquired by SBGI) and LIN.  In addition, there are many other more diversified companies that also operate broadcast assets, including GCI, TRBAA, MDP, JRN, and the networks (NBC/ABC/FOX/CBS/etc).  Below is a summary of public valuations for pure-play TV broadcasters:

Company / Ticker / Stock Price / Market Cap / EV /Net Leverage / FCF Yield / PF 13-14E EBITDA Multiple
Sinclair / SBGI / $24.00 / $2,400 / $6,150 / 4.8x / 15.3% / 8.0x
Nexstar / NXST / $30.40 / $950 / $2,150 / 4.7x / 15.2% / 8.5x*
Media General / MEG / $10.00 / $890 / $1,780 / 4.7x / 11.6% / 9.6x
Gray / GTN / $6.75 / $390 / $1,200 / 6.2x / 15.3% / 9.2x
AVERAGE (ex LIN): 5.1x / 14.4% / 8.8x 

Lin Media / LIN / $15.00 / $815 / $1,770 / 3.8x / 14.3% / 7.1x**

*NXST FCF yield reflects NOLs.  Fully taxed FCF yield closer to 12.7%
**LIN FCF yield fully taxed, as NOLs were used up in the LLC-conversion 

TV broadcaster stocks have been on a relentless climb over the last year, driven by M&A, rapid revenue growth from retransmission revenue, and robust cash flow yields.  SBGI and NXST have led consolidation in the space, but other new players have recently become acquisitive as well – like Tribune (TRBAA) and Gannett (GCI).  The ‘rolling thunder’ of M&A in the space is going to continue for years to come, given the many benefits of consolidation and scale and the acquisitive appetites of the sector’s largest players.  Below is a summary of recent transaction multiples for TV broadcast assets:

Target / Ticker / Acquiror / Date Announced / Purchase Price / Buyer’s Multiple / Seller’s Multiple
Fisher / FSCI / SBGI / Apr-13 / $373 / 6.4x / 12.4x
Allbritton / Private / SBGI / Jul-13 / $985 / 8.7x / 10.7x
LocalTV-FoxCo / Private / TRBAA / Jul-13 / $2,725 / 7.0x / >10.0x*
New Vision / Private / LIN / May-12 / $342 / 5.9x / ~10.4x
Newport / Private / Jul-12 / $413 / 7.2x / 9.8x
Belo / BLC / GCI / Jun-13 / $2,215 / 5.4x / 9.4x
Freedom / Private / SBGI / Nov-11 / $385 / 6.6x / 9.0x
AVERAGE (ex LIN): 6.7x / 10.2x

*Seller multiple of 9.4x including PV of tax assets

To see other small and lower-end market transaction comps, see slide 7 here: SBGI Slide Deck

The spread between public multiples and transaction seller multiples is due to the exceptionally high synergies that can be realized through consolidation of broadcaster assets.  These synergies are driven by basic corporate cost cuts and formation of duopolies (two stations in one market), but also in large part through retransmission consent (“retrans”) agreements with MVPDs.  Since larger operators have greater scale and leverage to negotiate retrans agreements with the MVPDs, they are typically much more lucrative than those negotiated by their smaller peers.  So while the seller’s multiple may be greater than 10x, the buyer is still getting an accretive deal, as the buyer’s multiple is significantly lower.  Given this dynamic, a buyer could pay north of 10x for LIN, and the transaction would still be highly accretive to the buyer’s earnings and cash flow.

Risks to Thesis

-Local advertising spend is highly correlated to GDP, and LIN is sensitive to the macro environment
-TV broadcasters operate against a regulatory (FCC) backdrop that, albeit stable, could evolve and impact LIN’s business 
-HM Capital, a private equity fund has held a controlling interest in LIN since the 90s
-While TV, especially local, holds a dominant and defensible position in the advertising ecosystem, competition from new digital technologies will increase over time.  

Conclusion

There is no rationale for LIN’s current discount to its peers.  In fact, LIN should trade at a premium to its larger peers (SBGI/NXST), given its high potential to be a near-term takeover target.  I believe there are multiple near-term catalysts for the stock’s re-rating, which could include buyside M&A and/or a sale of LIN.  LIN’s assets are highly attractive, and the Company is in a great position to outperform expectations in the second half of 2013. 

DISCLAIMER:  THE AUTHOR AND HIS FAMILY, FRIENDS, EMPLOYER, AND/OR FUNDS IN WHICH HE IS INVESTED MAY HOLD POSITIONS IN AND/OR TRADE, FROM TIME TO TIME, ANY OF THE SECURITIES MENTIONED IN THIS WRITE-UP.  HE TAKES NO RESPONSIBILITY TO UPDATE THIS WRITE-UP IN THE FUTURE.  PLEASE DO YOUR OWN WORK.  

Catalyst