Value Investors Club / MEDIA GENERAL INC (MEG)

Description

**** I first published on Media General the week before the Nexstar offer and while I appreciate the strategic logic behind the combination, I believe the offer significantly undervalues Media General. As can be seen below, the cash generating capabilities, NOLs and surplus spectrum yield value well in excess of $14.50. ****

“Seeking Understanding Through the Noise”

Media General

September 2015

Noise surrounding the media space allows for an investment in leading broadcaster

Media General at a 21% free cash flow yield with further upside potential from continued

industry consolidation and the upcoming spectrum auction.

Our best investment opportunities often arise when we can find a deeper understanding through

the noise of the day. The media space has come under great pressure in recent months. There

are countless questions about the long term viability of many business models in the media

landscape. But amidst this noise and uncertainty comes a compelling opportunity to purchase

an enduring broadcasting business at an incredibly high free cash flow yield.

To set the perspective of our approach to investing, we aim to acquire stakes in world class

businesses at a discount to an increasing intrinsic value, allowing for strong future returns with

limited risk of permanent capital loss.

Media General is a nationally leading broadcasting company that owns, operates or services 71

network-affiliated stations in 48 markets and, when combined with its leading digital media

businesses, is one of the largest connected-screen media companies in the country. The

Company’s portfolio of broadcast, digital and mobile products covers 23% of U.S. TV

households and more than two-thirds of the U.S. Internet audience.

The majority of the Company’s stations are with the four major networks: 22 with CBS, 14 with

NBC, 12 with ABC and eight with FOX. The Company also has seven MyNetworkTV stations,

seven CW stations and one Telemundo station.

Media General in its current form came together through the combination of three broadcasters

in recent years. On November 12, 2013 Media General and Young Broadcasting were

combined in a tax-free, all-stock merger and on December 19, 2014 Media General (then

encompassing the Young Broadcasting business as well) merged with LIN Media creating what

is now the current Media General.

The original Media General became a public company in 1969 and has grown through

acquisition purchasing high-quality, privately owned local media entities in the Southeast. The

Company sold all of its newspapers in 2012 to in a deal with Berkshire Hathaway which also

made Berkshire a shareholder in the remaining broadcasting company. Berkshire remains a

shareholder today and has not sold any of its shares in Media General.

The Company also just announced on September 8

anothertransformative merger with

Meredith that will bring total local station count to 88 while enabling the combined entity to cover

30% of US households with free cash flow per share accretion of roughly $0.30 per year, which

is quite material given a roughly $10 current stock price. The proposed merger will also bring

greater heft in the digital arena as Meredith has a portfolio of brands historically tied to

magazines but which in recent years have been used to grow a substantial digital footprint along

with new revenue streams from brand licensing.

Broadcasting is a high returns business that generates large amounts of free cash flow. Local

broadcasters are the preeminent purveyor of highly demanded local news. The dramatic

consolidation in recent years has brought scale to a handful of companies while rendering their

historical financials largely meaningless when considering their current free cash generating

capabilities.

It is important to consider broadcasting results over two years as there are even year spikes in

revenue and cash flow largely attributable to political campaigns. While historical financials

provide an understanding of how the business has performed, it is necessary to value current

pro forma free cash flow given the significance of the Company’s recent acquisitions. Pro forma

for all completed acquisitions and station dispositions, Media General will generate cumulative

free cash flow of $570 million in 2015 and 2016, representing annual average free cash of $285

million. At today’s share count, this equates to average free cash flow per share per year of

$2.20.

Opportunity Summary

With Media General generating an average of $2.20 per share of free cash flow per year on

average in 2015 and 2016 (before the impact of the Meredith merger which would add about

$0.30 per year to that number), a purchase at today’s price around $10.30 equates to an

astounding 21% free cash yield. Moving to a much more reasonable free cash flow yield

of 10% would create a more than doubling in share price. Further upside potential comes

from monetizing its surplus wireless spectrum (conservatively $2 to $4 per share) along with

accretive capital deployment and additional acquisition opportunities (such as the Meredith

merger) given the Company remains well below the FCC ownership cap.

What is Creating the Opportunity?

There is tremendous noise surrounding the media industry and in particular those companies

deriving revenue and earnings from TV-focused business models.

Talk of cord cutting, cord shaving and cord nevers has been a constant topic in recent years but

the airwaves were filled with increasing veracity through the summer after comments by Disney

CEO Bob Iger. Mind you, he actually referenced slower than expected growth from pay TV fees

rather than actual declines, but in a world of severe overreactions to the headlines of the day, a

whirlwind was created and stock prices declined dramatically.

What else happened that week? Discovery disclosed an accelerating high single digit affiliate

fee outlook. CBS revealed a faster ramp to $1 billion in retransmission fee revenues and many

media companies reported a stronger second half advertising environment.

Beyond the news of that week, there has recently been a lot of discussion about declining

ratings across the cable and broadcast TV footprint due in large part to a disaggregation of

linear viewers as viewing is time shifted and moved online.

But what does all this mean for the media industry and specifically Media General? We will

spend considerable time below debunking myths that have plagued the minds of investors. In

short, those companies with must have content will find their video content in continued

demand. How they get paid for this content may change but consumers will retain a desire to

watch great shows, great movies and important news. It is possible that niche audience

oriented content will lose value as skinnier bundles take away some of today’s revenue from

such offerings. But those with the most in demand content will continue to get paid.

What will be the impact on Media General? We already have a good idea of the cash flow

Media General will produce in 2015 and 2016. As we look past these two years, continued

growth in retransmission fees, digital revenue, and political ad spending combined with

enhanced cost controls and merger synergies will driver higher free cash flow above and

beyond 2015/2016 levels. Much of the growth coming from retransmission fees is already

under contract and expense control and synergy plans simply need execution. So we can look

forward and have comfort about continued growth in free cash flow for Media General.

More fundamentally, what provides comfort about the longer term viability of Media General? It

largely comes down to the content of its stations. The big four networks and their local affiliates

will play prominent roles in even the skinniest bundles. ABC, CBS, NBC and FOX are not

niche, small audience cable channels.

Live local programming is a primary revenue driver for Media General and other broadcasters

and has shown to be resilient in the midst of challenges facing media companies more broadly.

In fact, ratings for most local news are actually increasing whereas the declines across cable

have been pronounced and much better documented.

In summary, Media General has a solid and enduring business that generates

tremendous levels of free cash flow and is available today at a wildly attractive valuation.

Before going further, I want to point out three key tenets to the investment thesis with local

broadcasters generally and Media General more specifically:

1. Broadcasters deliver by far the largest audiences across the TV landscape.

2. Local broadcasters in particular have a preponderance of live programming throughout

the day including three large chunks of local news, sports and weather, morning and

daytime talk shows, live sports, live events and late night talk, amongst other

programming viewed in real time. This makes them less reliant on any continued

declines in the linear viewing of scripted primetime programming.

3. Many local broadcasters including Media General trade at by far the best valuations in a

media industry that is already attractive in many other areas. Media General is available

at a greater than 20% free cash flow yield and that, paired with some of the best

underlying business dynamics with continued growth coming from increasing retrans

fees, growing digital revenue streams, accretive M&A and effective capital allocation,

makes for an unusually attractive investment.

TV is Dead, Long Live TV (or at least the local news, sports and programming of the

broadcast networks…)

The decline, even death, of TV has been one of the most discussed topics amongst investors

with the intensity of the discussion gaining yet more steam this summer. But let’s peel back the

headlines and see what is happening with the business of TV.

People are still watching a lot of TV. While that statement may seem benign and even

obvious, sometimes simple statements of truth are needed to gain perspective. As the chart

below illustrates, we are actually watching slightly more hours of TV per day than we were five

years ago. That is a somewhat startling fact given recent headlines.

It should be noted we are also spending much more time on digital devices which is terribly

obvious to all of us. But that does not mean we are watching less TV. Our digital time has

taken from other places including our time conversing face to face.

It also is important to note that local broadcasters, particularly Media General, have strong and

growing digital businesses. In fact, the stability of local news and the big four network TV

business paired with the growth in retrans fees and digital businesses portends continued

growth ahead for Media General.

TV remains the most effective way to reach mass audiences. This is another seemingly

simple and obvious statement that needs to be restated. The broadcast networks in particular

have retained the singular ability to garner large audiences at one time, in one place.

In the eyes of advertisers, TV remains the most influential medium to influence purchase

decisions. As important, the broadcast networks remain the only place to reach mass

audiences. Broadcast networks dominate household ratings and total viewing times. They

house the vast majority of must see viewing including sports, primetime shows, national and

local news and other event based shows drawing massive, real time audiences.

Broadcast network viewing trounces cable viewing. The dominance of broadcast networks

relative to cable holds across day parts and across programming.

The following chart paints two very interesting pictures. The bottom half of this slide from a

recent Sinclair Broadcast presentation starkly reveals how the broadcast networks post

dramatically higher ratings than even the best cable networks. The top half of the slide is even

more compelling for the business side of a broadcasting business. As can be seen, even

though the broadcast networks have substantiallymore viewership, they lag in compensation

received per subscriber. So while they capture more eyeballs, they get paid much less per

subscriber. This is one reason we see secular growth coming from the broadcasters. They can

expect to see higher retrans fees in coming years as they capture more of the value they

deliver.

			2015	2016
Price:	13.93	EPS	0	0
Shares Out. (in M):	130	P/E	0	0
Market Cap (in $M):	1,810	P/FCF	0	0
Net Debt (in $M):	2,220	EBIT	0	0
TEV (in $M):	4,030	TEV/EBIT	0	0