Description

In Aug-15, I wrote up SBGI (here: SBGI Writeup) with a comprehensive discussion of the risks, opportunities, and misunderstandings facing TV broadcast stocks.  Subsequently, SBGI traded up into the mid-$30s and I have exited SBGI in favor of Nexstar Broadcast Group (“NXST”), as it has meaningfully underperformed SBGI and its relative attractiveness has improved for a number of reasons.  Given the persistent misunderstandings around this situation and, frankly, the silliness apparent in NXST’s volatility YTD, I am writing up NXST here.  Please see the SBGI write-up for a discussion of the business/risks/opportunities facing broadcasters broadly, as the picture is largely unchanged since then.  Herein, I will focus on the opportunities that differentiate NXST from its peers, given what I see as exceptional upside over the next 12 months.  The path to close its merger with Media General (“MEG”) is clear, and any deal overhang will be removed by year-end.  Based on a 13% fully-taxed FCF yield, NXST stock is worth over $65/sh today.  Add $14/sh of FCF to be generated this year, and NXST has upside to $80/sh (+80%) by year-end.  Any spectrum value that NXST might realize in the incentive auction this year is incremental upside optionality, and there is likely upside to mgmt’s 2016/17 FCF and synergy guidance.  

 Absolute Valuation: NXST is trading like it’s going out of business – period.  There is no other scenario that justifies its current >25% FCF yield, unless we are about to enter a deep 2008/09-esque recession.  However, NXST is a stable and growing business, with growth in revenue, EBITDA, and FCF, a substantial portion of which is contractually locked-in.  NXST mgmt are excellent allocators of capital, and I am confident that 100% of this FCF will accrue to the equity in the form of debt paydown, capital returns (dividend and share buybacks), and/or accretive tuck-in acquisitions.  With Perry and Tom, there are no concerns about whether their incentives are aligned with investors' when it comes to deploying their cash.  Below is a summary of NXST's cash flow statements for the past two years:

Free Cash Flow: In 2016, NXST and MEG will each generate significant FCF that will build on their respective balance sheets and reduce debt financing for the acquisition.  The magnitude of this cash generation is astounding: over $650mm, relative to NXST’s PF market cap of $2.1bn.  In other words, FCF equal to over 30% of NXST’s market cap will be generated in the next 12 months alone.  Even in declining industries, stocks do not trade at these depressed levels, and NXST’s revenue and FCF are growing!    

Relative Valuation: NXST has historically traded at a premium to its closest comp, SBGI, due to its mgmt team and their approach to capital allocation.  Today, it trades at a meaningful discount on both FCF yield and EBITDA multiple.  Based on net debt at the end of this year, NXST trades at just 7.1x EBITDA.  Its significant NOLs mean the stock trades at a 25% FCF yield on 2016/17 PF FCF.  Even ignoring the ~$7/sh of PF NOL value, the stock still yields >19% fully taxed.  I view the broadcaster stocks as broadly undervalued, but no stock is more irrationally priced than NXST.  Even on a standalone basis (assuming the MEG deal never happened), NXST is still cheap to SBGI.  In other words, NXST is cheap standalone, and is getting no credit for the >35% FCF/sh accretion it will realize through the merger with MEG.   

Financing: The market is misunderstanding and over-estimating risks related to financing the MEG deal.  Volatility in the high yield market has caused levered equities and ‘deal’ stocks to underperform.  However, NXST is a darling of the high yield market, and credit investors are hungry for high quality new deals.  With its increased diversity, scale and robust FCF, NXST will benefit from strong demand for its paper in the high yield and leveraged loan markets.  On Monday, NXST’s committed bridge loan allocated to strong demand and a diverse bank group.  All indications are that NXST will be able to continue to tap the deep pool of low cost debt financing that has always been available to it, and the value created by this low cost financing accrues directly to the equity.  Below is NXST’s PF capital structure.

BACKGROUND

In 3Q’15, Meredith Corp (MDP) and MEG entered into an agreement, whereby MEG would acquire MDP and MDP’s mgmt team would run the combined Company.  This prompted NXST (which had been interested in acquiring MEG for some time) to make public its unsolicited bid for MEG, beginning what would be a multi-month negotiation process between NXST and MEG that ultimately resulted in a definitive merger agreement at the end of Jan 2016.  There were a lot of twists and turns throughout this process that are now irrelevant, but they are well documented in NXST’s S-4 for those interested in the detailed history (here: http://www.sec.gov/Archives/edgar/data/1142417/000119312516513634/d119732ds4.htm).  Ultimately, MEG's BOD found NXST’s deal to be superior to MDPs, and they dropped the MDP deal in favor of NXST.

The deal terms were for $10.55/sh in cash and 0.1249 shares of NXST per MEG share.  MEG shareholders will also receive a contingent value right ("CVR") which effectively transmits to the MEG holder the net incremental spectrum value from MEG stations (over and above their operating value), if any, from the broadcast incentive auction.  This mechansim is dicussed in detail in the S-4, but basically if MEG sells a station into the auction, MEG holders will get the net cash proceeds less the going concern value of the station (based on 10.5x cash flow), net of taxes (at a 40% rate) and fees.  CVR proceeds paid to MEG holders will also be reduced by the amount of net incremental value from any NXST stations sold into the auction.  So the CVR could be worth nothing or it could be worth a few bucks.  I value the optionality at ~$1-1.50/share for MEG.  In any case, the CVR doesn't really impact the value of NXST - it only impacts the value of MEG's stock.   

Concurrently with the definitive agreement, NXST obtained committed debt financing from a syndicate of banks.  The number of banks in this syndicate has since grown, as appetite for this high quality deal has been robust.     

Against the backdrop of broader equity market turmoil in February, NXST stock saw no boost from the deal announcement and traded horribly.  The technical pressure from arbs (buy MEG, sell NXST) had a particularly negative impact, given risk aversion in the market and the unwillingness of fundamental investors to step in.  While the time to close the deal will be delayed by a couple months due to the ongoing broadcast incentive auction (the FCC is focused on conducting its auction, and so as a general rule it is not approving any deals until the auction concludes), the path to a close is clear.  NXST is divesting stations in all markets that it overlaps with MEG, and there is no reason that this deal should be any different than the dozens of other mergers and acquisitions that the FCC has approved over the past few years.  There is also the chance that the FCC might grant a waiver to NXST to close the merger before the spectrum auction ends (expected late 3Q / early 4Q).  

In February, mgmt reported a beat-and-raise quarter, providing 2016/17 FCF guidance above Street on both a standalone and PF basis.  This positive fundamental news and the recovery in the broader market has moved NXST off its February lows, but the stock is still down -25% YTD and trading at a depressed valuation.      

COMPANY (BRIEF)

NXST will operate 171 stations in 100 markets, with broad geographic exposure and a focus on mid-sized and smaller DMAs.  Its reach will be at the ~39% FCC mandated cap, but a divestiture or swap of MEG’s San Francisco station would reduce reach to below 37%, freeing up room for tuck-in acquisitions.  NXST can also execute acquisitions and swaps of stations that form duopolies or otherwise do not push it over the 39% cap. 

NXST is currently the 7^th largest broadcast affiliate, and the MEG merger will make it one of the largest.  NXST has diversified affiliate relationships with the Big 4 and other networks.  PF for the MEG merger, NXST’s affiliations will be 17% ABC, 19% Fox, 20% NBC, 28% CBS, and 16% other.  Its next CBS affiliation expiration isn’t until 2018 for NXST stations and 2019 for MEG stations.  Its only affiliation agreement expiring this year is Fox for Nexstar stations.

CEO Perry Sook has been with NXST since its founding and continues to be one of its largest holders.  Both Perry and Tom (CFO) have recently added to their holdings.

CONCLUSION

Broadcast stocks have historically been susceptible to periods of deep dislocation, which time and time again have proven to be exceptional buying opportunities; and I believe this is the case for NXST currently.  There is no reasonable explanation for why a 25% FCF yield might be an appropriate valuation for NXST.  While leverage will increase following the MEG merger, it will be quickly reduced through robust FCF generation and EBITDA growth.  Broadcasters’ high margins, low capex, hard assets, and substantial FCF have always allowed for relatively higher leverage, and this efficient use of the balance sheet has created exceptional value for equity holders over the years.  Investors seem to either be completely missing this or have left NXST in the penalty box until the merger closes.  But we’re talking about a catalyst just several months away!  Sometime between now and then, the market is going to wake up to the fact that NXST is generating 25% of its market cap per year in FCF alone, and this will get re-rated, in what is likely to be a violent move higher.  Based on a 13% fully-taxed FCF yield, NXST stock is worth over $65/sh today.  Add $14/sh of FCF to be generated this year, and NXST has upside to $80/sh (+80%) by year-end.     

 DISCLAIMER:  DO NOT RELY ON THE INFORMATION SET FORTH IN THIS WRITE-UP AS THE BASIS UPON WHICH YOU MAKE AN INVESTMENT DECISION - PLEASE DO YOUR OWN WORK.  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.  THIS WRITE-UP DOES NOT PURPORT TO BE COMPLETE ON THE TOPICS ADDRESSED, AND THE AUTHOR TAKES NO RESPONSIBILITY TO UPDATE THIS WRITE-UP IN THE FUTURE.

Catalyst

MEG deal close in late-3Q/early-4Q
Earnings beats as core/political/retrans drive outsized FCF growth in 2016
The pendulum of investor sentiment on broadcast stocks swings back from its extreme bearishness to a more reasonable state