Description

New Nexstar Broadcasting (Ticker: NXST) Write up (aside: I almost wrote up CSTR again as the risk/reward is similar with better trading liquidity):

Old write up: http://www.valueinvestorsclub.com/value2/Idea/ViewIdea/60236

Please see my post 5/30 from the NXST board where I wrote:

"I think the main deal going forwards is to find a merger partner (strategic) and have a new PE sponsor either take the combined entity private (complex) or create a liquidity event for Abry. The latter deal would be deleveraging to the new company, would put "some" new capital on the balance sheet, and take NXST from a $200mm orphaned equity with a 30%++ FCF yield to a size that is as big as a $BLC or bigger (if $BLC was to be a partner)...

I think any deal being contemplated has to be accretive day 1 to FCF ex synergy (some redundant costs yes), deleverage by year 2, and get the stock to 10-13 range, which was the original LBO goal."

I wasn’t far off…

New Event Type: Transformational Merger / Levered Equity

Trade Recommendation: Buy NXST common stock (consider SBGI or other industry peer short to hedge); participate in upcoming Abry Partners secondary offerings at a discount

Entry Catalyst:

End to strategic alternatives process. Disappointed risk arbitrage investors who desired a cash exit and immediate payoff through an LBO at $10-$12/share.

Duration: 9-15 months

Upside: ~100% (see below)

Situation Overview:

On July 19^th NXST concluded its strategic review process and announced the acquisition of television stations owned by Newport Television, an entity controlled by private equity firm Providence Equity. This deal was the result of a thorough process run by Moelis & Company. I believe the LBO offers NXST received (as well as paying a special dividend) were less attractive than the Newport transaction over the intermediate term and more value could be created from a financial perspective.

Press Release Link: http://www.sec.gov/Archives/edgar/data/1142417/000114241712000035/newportpr.htm

The merger agreement can be read here:

http://www.sec.gov/Archives/edgar/data/1142417/000114241712000037/nexstarapa.htm

Deal Terms:

NXST is paying $285.5mm or 8.3x blended 2011/2012 EBITDA. Synergy is expected to be ~$19mm and EBITDA is $35mm so pro-forma EBITDA is ~$54mm. NXST is paying a buyer multiple of ~5.3x. After speaking with management several times as well as meeting with them in person, I believe the synergy figure will prove to be low and the buyers multiple will end up being closer to 5x EBITDA.

“The Newport stations represent an ideal complement to our existing station portfolio in terms of geographic fit, market size and duopoly presence. The purchase price for the stations is approximately 5.5 times the acquired stations’ average 2011/2012 pro-forma projected cash flow and approximately 5.0 times their 2012 pro-forma projected cash flow.” – Perry Sook

Deal Timeline / Milestones:

HSR filed and approved

FCC filed and pending. Approval most likely in late 2012

Financing: Term Loan and Bond Financing – October

Abry Exit via secondary offerings: October; February; May

Newport Deal Close: December 2012

New Investment thesis can best be described by CEO Perry Sook:

“With expectations for free cash flow accretion in the first year of ownership of the new stations approximately 45% over the levels expected to be generated by Nexstar’s and Mission’s existing operations, we are highly confident that the Company will be positioned to aggressively address outstanding debt while potentially deploying free cash flow for shareholder enhancing actions.”

Valuation Pre – Deal and Pro-Forma Post Newport Transaction Close:

NXST pre-deal blended FCF for 2013/2014 (for reference 2012 will be 75-80mm per management and at least 109mm for 2011/2012*): 

            2013 FCF: ~$50mm

            2014 FCF: ~90mm

            Total FCF: ~$140mm

            Blended: ~$70mm avg or 29% FCF Yield (using $8/share price for simplicity)

            FCF/Share: $2.33 or 3.4x

*After my last few interactions with management I believe, 2012 FCF could very well exceed 75-80mm and be in the low 80’s which would be ~$2.70 in 2012 FCF.

*NXST 2011/2012 Blended FCF Pre-deal will be ~$109mm or $1.82/share (4.4x)

NXST post Newport deal blended FCF for 2013/2014:

            2013 FCF: $75mm (~$20mm synergy in year 1 - low hanging fruit / cost)

            2014 FCF: $125mm 

            Total FCF: $200mm (management confirmed this figure)

            Blended: $100mm avg or 42% FCF Yield ($100 divided by (30mm shares x $8/share)

            2013/2014 Blended FCF/Share: $3.33 or 2.4x (technically the company is now 1.0x cheaper on FCF basis post deal) 

The Newport deal is taking leverage up by 0.5x on the deal close as of 12/2012; no change to the share count. So effectively increasing blended FCF by $30m/year over 2 year period or $1/share. 

NXST will generate ~$7 in FCF over the next 2 years vs current share price of $8/share.

If you apply the NXST pro-forma for Newport deal FCF yield % to the BLC and SBGI FCF yield %, what valuation do you get? I have spoken with BLC and SBGI management in particular several times over the last year to get a better sense of consolidation in the industry, i.e. what happens next, but also to attempt to guesstimate what FCF looks like for the next 2 years.

BLC should generate $0.80-$0.90 in FCF in 2013 and (guess based on management commentary, model, etc) they will do $1.55/share in 2014 for a blended FCF/share of $1.23. - 6.1x FCF

SBGI should generate $1.75-1.85 in FCF in 2013 and (guess based on management commentary, model, etc) they will do $2.4/share (less confidence in this figure due to retrans) in 2014 for a blended FCF/share of $2.12. - 5.7x FCF

It’s clearly difficult to be spot on, but I will give each management the benefit since they are fairly conservative, especially in the case of BLC. As a sanity check, Wells Fargo has been decent on modeling ex acquisitions.

NXST Valuation utilizing BLC forward FCF yield:

BLC is trading at a blended FCF yield of ~16.3%.

Applying this yield to NXST pre Newport deal = $13.40/share

Applying this yield to NXST post Newport deal = $19.10/share

NXST Valuation utilizing SBGI forward FCF yield:

SBGI is trading at a blended FCF yield of ~17.6%.

Applying this yield to NXST pre Newport deal = $19.86/share

Applying this yield to NXST post Newport deal = $28.37/share

Upside / Pre-deal: $13.40 - $19.86/share or 67% - 148% 

Upside / Post Newport Pro-forma: $19.10 - $28.37 or 139% - 254% 

Downside:

The shares traded 2-3x average volume leading up to the Newport announcement on a few occasions, on various deal leaks (i.e. no LBO) as well 2-3x, on the deal announcement and days following. From early May until the announcement NXST traded down from ~$7/share to as low as $6.10 on July 17^th. I believe this was mainly due to selling pressure from risk arbitrageurs not willing to do the work on the pro-forma transaction.

Why is NXST trading at such a material discount?

• Abry Partners Overhang:

The main overhang for NXST shareholders has been the strategic alternatives process, which has kept the shares in limbo, but the bigger overhang is the float. Abry owns ~53% of NXST and management owns ~8% of the shares as well so there is limited float (~39% trades) and limited trading volume. Abry has been invested in NXST for some time, and is no longer in it to realize full value. They want to exit. I believe they will exit in a series of secondary offerings over the next 9 months and liquidity will improve.

• Leverage:

NXST is a levered equity, and is more levered than BLC and SBGI in particular. SBGI will probably maintain leverage of ~4x in order to continue their M&A strategy, and BLC is probably going to continue to de-lever below 3x and has not been active in consolidation thus far. NXST should generate substantial FCF over the next 12-24 months and leverage will be closer to 3.25x in mid CY 2014.

• Dividend:

BLC and SBGI both pay dividends. NXST currently does not have the ability to pay a dividend or repurchase shares. As part of the Newport acquisition and the associated refinancing, NXST will be able to initiate a dividend after the deal closes. BLC currently has a 4.3% dividend yield and a 40% payout. SBGI has a 5.10% dividend yield. I believe NXST will initiate a quarterly dividend in early 2013. The distribution will be ~15-20% of FCF. This should equate to a 6-7% dividend yield, and worth noting the payout will be less than BLC and SBGI, but I expect it to stair-step higher over time. Dividend yield will be another metric for investors to benchmark vs BLC and SBGI, but also serve as a potential catalyst to introduce income-oriented investors to the NXST story.

The above demonstrates why NXST has traded at a discount, but should also illustrate that the event path and series of catalysts are becoming very transparent to unlock value for the shares to re-rate to either inline with BLC and SBGI or a more appropriate discount.

Net/Net: if we use the average trading price over the last few months of $6-7/share as a reasonable downside, and upside ranging from $19-$28 (utilizing BLC and SBGI relative valuation), the result is an asymmetric risk/reward of down $1-2 up $10-$20.

However, due to NXST trading constraints, lack of sell-side coverage, current leverage, and the “show-me” Newport M&A story…

A ~30% discount is appropriate = $16.60/share or 100% higher.

I believe a full re-rate could very well transpire, but management clearly needs to execute. As an aside, I think an SBGI short as part of a position bundle could have some merit. Once the Newport transaction closes, an expanded position bundle hedge will be more straight forward if appropriate. 

Catalysts:

• Newport Deal Close: December
• Abry Partners: share overhang limiting the float, but also investors are wary to purchase ahead of their exit. I expect Abry will exit in 3 secondary offerings.
  • Nexstar board member Jay Grossman, Managing Partner of ABRY Partners, which funded Nexstar’s formation in 1996 and remains the Company’s largest shareholder with a 52.9% equity interest added, “Over the past year Nexstar conducted an exhaustive review of its assets, operations and the M&A options and strategic alternatives available to maximize shareholder value.  ABRY is a strong advocate of the value the transaction announced today creates for all shareholders.  While we have an intention over time to monetize the value of our Nexstar holdings for our investors, we will be highly disciplined in this regard and sensitive to the interests of other shareholders by pursuing any such monetization strategies in an orderly manner.”
• Bond Offering: October – NXST announced as part of the Newport transaction a term loan financing of $570. I expect them to issue ~$200mm of bonds instead of the full term loan to provide additional flexibility as it relates to capital return
• Dividend initiation: early 2013 should create some shareholder rotation
• Share repurchase: I don’t expect a material share repurchase, as improving the float is currently management’s main objective. However, I would not be surprised to see a token share repurchases as part of the Abry exit, more likely as part of later secondary offerings.
• Insiders eat their own cooking: since the deal was announced, Perry Sook / CEO and Tom Carter / CFO have made very small purchases during a very small window to buy stock (due to FCC notifications; HSR; debt offering; other blackouts). I expect additional open market purchases subject to trading liquidity and blackouts over the next 2-3 quarters.
• Further M&A: NXST intends to be acquisitive with a continued focus on FCF accretion. Other deals have already been identified, but management is laser focused on price.
• Non-core divestments: this process has already started with the recent announcement that NXST has definitive agreement to sell the net assets of KBTV, its FOX and Bounce TV affiliate in Beaumont-Port Arthur, TX, to Deerfield Media (Port Arthur), Inc. for $14.0 million. Proceeds will be used to pay down debt.
• Sell-side coverage: I doubt we see many initiations, but I wouldn’t be surprised to see existing coverage re-initiate and perhaps 1-2 new analysts launch coverage. The Newport financing banks are UBS, RBC, and Bank of America. BofA already covers NXST on the credit side, and unlikely to pick up coverage of the equity.
• Further Rating Agency Upgrades:
  • From Moody’s: “transaction does not impact Nexstar's B3 corporate family rating or positive outlook, because Moody's believes the company could achieve the credit profile necessary for a B2 corporate family rating.”
• Industry Consolidation: I believe we are in the midst of the industry roll-up, but the big kicker is when we start to see the larger cap players merge. I believe this is inevitable at some point, and if ego’s can align with valuations we could see some very interesting transactions. I would not be surprised to see NXST merge with Lin TV (TVL), or SBGI buy NXST; NXST merge with BLC; CBS may/may not have some involvement; etc. I believe all of the boards and management teams have had these conversations over the last decade, but for the first time during this timeline my sense is the interest level is rising. I don’t believe this process will begin in the very near term, but I wouldn’t be surprised to see a deal 12 months from now, which could set off various transactions, and the industry will be left with 2-3 players.

In summary, NXST is trading at an undemanding valuation on an absolute and relative basis. Shares should re-rate over the next 2-3 quarters to a valuation more in-line with peers and narrow the discount. In addition, I expect to see further industry consolidation, which should lift all boats.

Catalyst

• Hard Catalyst: Newport Deal Close in late 2012 / early 2013
• Float overhang: Abry Partners exit
• Soft Catalyst: Capital return in form of quarterly dividend
• Insider purchases
• Accretive buy-side M&A
• Sell-side coverage initiations
• Rating agency upgrades
• Optionality Event(s): Larger scale industry consolidation