Description

Nexstar may be the greatest unloved, under-the-radar stock performer and business I have ever seen. (As distinguished from, say, POOL, which is under-the-radar but has long been high-multiple and well-loved by those who know it.) “Extreme value with no catalyst” can work extremely well over time; multiples don’t need to rise for a stock to do well.  Nexstar’s per-share earnings power has grown by more than 30x in the last 10 years.  Its stock price has risen “only” 20-25x, which leaves it at a cheaper earnings multiple today than it was back then, 5x versus 7x.  The business’s best growth days are behind it, but the stock should remain a great long-term performer for years to come.

Nexstar’s key to success has been operating in an industry where everyone’s equity has a perpetually cheap valuation.  Valuations are cheap because the companies all (rationally) use a lot of debt, because GAAP earnings are always far below cash earnings thanks to depreciation and amortization charges, and -- probably the key reason -- because most investors have assumed and still assume that local broadcast TV stations are dying.  That assumption has been dead wrong for twenty years and will remain wrong for at least the next several years and possibly forever.

Founder and CEO Perry Sook built Nexstar over 24 years from a few TV stations into the nation’s largest station chain, along with CFO Tom Carter for the last 12 years.  Tom just became President & COO.  I have never seen them make a wrong move in my 14 years of watching them.  First and foremost, they have been fantastic capital allocators.  Nexstar is also clearly an excellent operator of its stations.  They always under-promise and over-deliver.  They always meet or exceed their guidance.  They are forthright with investors.  They follow the rules and play fair, which meant that, when the FCC killed Sinclair’s Tribune acquisition after Sinclair finally went too far in flaunting the rules, concocting sham transactions, and hard-balling the regulators, Nexstar could step in as the white knight.

Nexstar’s primary capital-allocation playbook has been to buy more and more TV stations at cheap earnings multiples, using cheap debt to pay for them.  Borrow at 2%-6% to buy assets with 10%-15% unlevered yields, higher with synergies; use the strong cash flows to pay down the debt; then do it again, and again.  The purchases have been a mix of many small deals for a few stations each and two huge transformative deals.  The January 2017 acquisition of Media General doubled Nexstar’s revenues, and the September 2019 purchase of Tribune’s stations grew revenues by another 50%.

Nexstar’s station-acquiring days are now largely behind it because the Tribune deal increased its total station count up to the FCC’s regulatory cap.  Now Nexstar will use those cash flows for value-creating stock buybacks, non-station acquisitions, and, if management ever feels the need, further debt paydown.  I continue to hold Nexstar stock because the earnings yield remains 20% ($30 per diluted share on a $145 stock), TV stations will continue growing earnings rather than dying, and management will continue to use the cash flows to create significant shareholder value on top of the 20% yield.

LOCAL TELEVISION ISN’T DYING

We got to know Nexstar in 2007 when we shorted every public TV station stock on the thesis that local broadcast TV was dying.  That was the most egregious better-lucky-than-good trade of our investing careers.  We made ~80% on all those shorts when the global financial crisis decimated everyone’s advertising revenues.  We covered them all and only later, as we continued to follow these businesses, realized that our initial thesis had been not merely wrong, but 180-degrees wrong.  Local TV stations were and still are growing revenues and profits rather than dying because (1) they produce and distribute plenty of content that plenty of people still want to watch; (2) they have successfully navigated the technological shifts from over-the-air to cable to online text and video streaming and, partially, back to over-the-air; and (3) their product continues to become substantially more valuable on a per-viewer basis.

1. Content

For decades, local station content has split conceptually into locally-produced news and local talk shows, live sports, and “everything else” produced by the national networks (primetime dramas/comedies, reality shows, game shows, soap operas, national talk shows, network news, etc.).  The “everything else” category is the one that has most obviously migrated from broadcast TV to cable networks and then to streaming.  Today a bunch of splintered-interest shows broadcast or stream to a few million viewers each (at best), instead of NBC’s Thursday night lineup routinely pulling 30-40 million viewers from a materially smaller U.S. population.  The crown jewels for a local station, though, have always been news and sports.  The station sells  and keeps the revenue from all of its local-news ad slots, while most of the ad slots on network-produced content go to the network.  Although most national sports ad slots also go to the networks, each of those slots is worth multiples of those for other programming.  Viewership is higher, and ad prices per viewer (CPMs) are much higher, because almost everyone wants to watch their sports live and it reaches the otherwise hard-to-reach younger male demographic.

Both of the two key content buckets have stayed surprisingly robust for local stations. Viewership of local TV news remains strong, and competition from other sources may have actually decreased rather than increased, as local newspapers have vanished or become shells of their former selves.  The big sporting events have had only a modest migration to pay-TV and streaming in recent years and don’t show much signs of further migration.  One of my largest longer-term risk factors for Nexstar a few years ago was the scenario that the FANGs would make a big move to outbid traditional TV for sports rights.  That risk looks much lower today.  The bellwether is the NFL.  Amazon began dabbling in non-exclusive streams of Thursday NFL games in 2017, and people were worried that significantly more games might go to the FANGs when new deals were signed in 2021.  Instead, the only NFL right moving to streaming is more Thursday night games going exclusively to Amazon.  In numerical terms, only 1/16th of weekly regular-season games shifted to a FANG; the other 15/16ths of the regular season and 100% of the playoffs stayed where they were.  The new deals all take effect in 2022 or 2023 and run for 11 years, so the next potential shift in America’s dominant sports television property won’t come until 2033.

2. Technology shifts

Everyone is familiar with the steady pace of cable (and satellite TV) cord-cutting.  But some people who end their cable/satellite TV subscription, or new households who never get one in the first place, still want the local station’s content and still pay for it via a streaming package.  Nexstar gets retransmission fees either way.  Recently Nexstar’s subscriber counts have been falling ~5% YoY, likely worsened by the initial Covid panic.

More of the cord-cutters are becoming over-the-air (OTA) TV watchers by connecting an antenna to their TVs.  Traditionally OTA has been about 15% of Nexstar stations’ viewership.  OTA viewership has been slowly but steadily increasing ever since broadcasts switched from analog to digital ~15 years ago, especially among the younger viewers who have the reputation of abandoning linear TV altogether.  I’ll steal from a recent Seeking Alpha article a nice chart of recent OTA usage growth for various demographic groups:

The coming upgrade of TV broadcast standards to ASTC 3.0 may provide another boost to OTA usage by allowing signals to travel greater distances, penetrate building walls better, and provide improved sound and video definition.

Local stations have also become multi-platform media providers just like everyone else, particularly with their local-news content.  Nexstar has 120 local web sites, 284 local news and weather mobile apps, and other online properties.  Management likes to highlight that, if the company’s local websites were combined into one unit, they would be a top-10 site on ComScore.   In 2020 Nexstar had 91 million average monthly online users, 7.8 billion page views, and 1.6 billion online video views.  That business is still growing nicely; Nexstar’s online revenues have grown from 2% of the total in 2007 to 7% today.  2Q digital revenues grew 57% YoY, versus “only” +42% or core ad revenues.  (Some of the outperformance comes from the BestReviews acquisition in December 2020.)

3. Increasing value

Stations have consistently grown the revenue and profits they can achieve per viewer and will continue doing so for years to come.  The primary growth source is retransmission fees, which Nexstar has renamed “distribution revenues” to encompass its cut of revenues from streaming packages.  No matter what technology is used, pay-TV providers must pay the local stations to include stations’ content in a subscription bundle.  In the old days, stations would almost give away this content to the retransmitters for next-to-nothing; they were content to get the added viewership and boost their ad revenues.  Starting ~15 years ago, everyone began to realize that the OTA content was far more valuable to the pay-TV providers than it was priced; the per-viewer fees were a fraction of what providers paid cable networks for their content. The station chains have demanded higher and higher prices as each retransmission deal comes up for renewal.

Same-station revenues from retransmission fees have been growing by double-digits every quarter, despite the 1% decline in subscriber counts.  Every so often a pay-TV provider tries to play hardball in negotiations, lets its retransmission right lapse temporarily, and lets those channels go dark on its platform.  The viewers complain, the provider tries to blame the station chain, and then after not too long, the provider relents.  This repricing process is not done; Nexstar management is still saying, as it has for years, that fee growth will remain in the double digits for at least another few years.  Recently Perry said he had thought a few years ago that the retrans growth runway would have lessened by now but that the fall-off continues to get pushed farther and farther out, helped by both continued price increases and by an expectation that subscriber attrition will level out.

Retransmission revenue has grown from 4% of Nextar’s total revenues in 2007 to 48% last year (a presidential election year with significant political ad revenues) and 55% in the last two quarters (with almost no political ads).  At this point “double digit” growth on roughly half the company’s revenues implies at least a 5% annual boost to total revenues.  Growth will slow to mid/high single digits in 2022 because only 8% of the subscriber base is up for renewal this year, but growth should reaccelerate strongly in 2023 because 65% of the subscription base is up for renewal in 2022.

The second value boost comes from political advertising.  The media dollars spent on U.S. elections have exploded, and the growth is not slowing down.  Although the spending mix keeps shifting from TV to online, the growth in the total is high to keep local TV’s absolute share rising nicely.  It is still hard to beat local TV stations for targeting specific geographic locations, and linear TV remains the best format to convey effective political messages to the average voter (i.e., the mildly engaged voter) and particularly the average undecided voter.  Nexstar’s political ad revenue has consistently been 10-12% of total revenues during election years, which means it is growing almost as fast as retransmission revenues on a same-station basis.  All signs point towards a continuation of this political ad growth.  Management’s 2021-2022 guidance includes political ad revenues in 2022 (a non-presidential year) coming “close to” those from 2020 (a presidential year).  Given how conservatively management guides, I infer from that comment that 2022 revenues have a good chance of exceeding those from 2020.  (Political ad revenues have routinely beaten management’s public forecasts over the years.)

4. “But what about XXX?”

I can hear it in my head, or rather envision the coming comment-board post.  “Sure, TV stations have gotten lucky and survived this long.  But isn’t the coming trend of XXX going to finally cause the inevitable decline?”  That’s what people have been saying for 20 years, including me for 10 of them.  With the caveat that the future is always uncertain, I don’t see those worries being any more accurate in the future than they have been up until now.  The local content has enduring value that people are willing to pay for.  The local platforms and localized ads have enduring B2B value.  The broadcast networks’ ability to aggregate the most users in one place has value.  The streaming giants do not look like they want to take it away.  The most certain negative change is that retransmission fee growth will slow materially.  That’s an acceptable outcome.

LOCAL TV IS NOW MUCH LESS CYCLICAL

We made 80% shorting TV stations into the global financial crisis because ~85% of their revenue came from commercial advertising and the collapse in ad spending was enough to make them all bankruptcy risks.  That is no longer remotely true.  In 2020 Nexstar’s revenue makeup was 48% retransmission fees, 35% core advertising, 11% political ads, and 5% digital.  (Digital dipped in 2020 because the company was going through a planned retrenchment of its digital portfolio to weed out the unprofitable bits.)  The retransmission fees and political advertising are cyclically immune.  Below the revenue line, Nexstar also now owns, via its Tribune acquisition, a 31% stake in the TV Food Network (with Discover as the majority partner.)  That stake generated $223m of cash distributions to Nexstar in 2020 and will produce a similar amount in 2021 -- a substantial share of Nexstar’s total annual cash flows of $1.3 billion.  The Food Network’s economics are partially subscription-based and therefore more cyclically immune.

The Covid pandemic provided a perfect test case for the new cyclical reality.  When commercial ad revenues started collapsing, Nexstar’s management withdrew its $1,175m average annual cash earnings guidance for the 2020-2021 cycle.  Commercial revenues ended up falling -5% YoY in 1Q, -35% in 2Q, -19% in 3Q, and -10% in 4Q -- and it didn’t matter.  2020 cash earnings came in at $1,280m (=$27.40 per share), barely below prior expectations, because retransmission fees and political ads both outperformed and interest expenses were lower.  (That’s worth restating for emphasis: In the pandemic-collapse year of 2020, Nexstar earned ~20% of its current market cap and ~40% of the market cap as of mid-2020.)  Commercial ad revenues have now regained their 2019 levels.  Based on 2021’s results so far, the company is on pace to meet or exceed the original 2020-2021 guidance given before Covid.

Looking ahead, in February management guided for an average $1,270m cash earnings during 2021-2022.  In August they raised guidance to $1,330m.  Using the August 3 10Q’s share count data (= basic shares as of that date + the 2Q diluted-shares increment), that’s $30.39 per diluted share.  The eventual per-share number will be materially higher, thanks to prodigious buybacks.  Let’s turn to that factor.

CAPITAL DEPLOYMENT AND GROWTH GOING FORWARD -- BUYBACKS, NON-STATION ACQUISITIONS, QUASI-NATIONAL PLATFORM

As of the September 2019 Tribune acquisition, Nexstar is essentially done with buying more stations.  As of mid-2021, Nexstar is essentially done paying down debt from that acquisition; management has been clear that they feel no need to reduce leverage much further and have better uses for their cash flows.  Net leverage is currently only 3.3x EBITDA, maybe 3.6x if you strip out the 4Q20 political-ad boost, and EBITDA margins across a full two-year election cycle are around 40%.  Covid was about as good of a leverage stress test as one would want, Nexstar’s debt leverage is materially lower now than it was in mid-2020, and the lower rates on recently-refinanced debt have reduced its interest burden even more.  Why would you pay down more debt if it presents little risk and costs you this little (as of 12/31/20 for the term loans’ variable rates):

• $485m Term Loan A due 2023 -- 1.89%

• $615m Term Loan A due 2024 -- 1.89%

• $800m Term Loan B due 2024 -- 2.39%

• $2644m Term Loan B due 2026 -- 2.89%

• $1785m Senior Notes due 2027 -- 5.625%

• $1000m Senior Notes due 2028 -- 4.75%

• Blended interest rate -- 3.61%

Side note #1: The 2028 notes were issued a full year ago; Nextsar sold an eight-year maturity for 4.75% fixed.  I haven’t looked to see if the 2027s have any provision that makes refinancing too difficult or expensive.  Assuming not, the obvious next move is to refinance those notes out to a 2030 maturity and save another 87bps = $16m of interest expense.

Side note #2: Even with 60% of Nexstar’s debt at variable rates, the interest rate risk is minimal.  If the unthinkable happens and LIBOR quickly jumps 200bps, interest expense would rise $91m against $1330m in ex-ante cash flows.  And if that happened, the equity discount rate on growth stocks would skyrocket, growth earnings multiples would collapse, and global financial markets would probably crater.  The hit to Nexstar’s value would probably look good in comparison.  Also, it’s difficult to see interest rates rising materially unless there is sustained above-target inflation.  In that scenario, Nextar’s revenues and operating profits will also be inflating.

So without more stations or debt paydown, what will Nexstar do with all that cash flow?  That was the lead Q&A topic in February’s 4Q earnings call.  The answer then was simple:  Double the pace of stock buybacks to $500-600m per year, or roughly 9% of today’s market cap, and raise the dividend 25%.  The dividend raise is a throw-away; the yield is still only 1.8%, and they raise the payout at least 20% every year.  The buybacks are a big hairy deal.  Buying back gobs of stock at 5x earnings is similar, from an owner’s perspective, to acquiring more stations at the prices Nexstar typically achieved.  On the one hand, Nexstar won’t get some of the operating cost synergies, increased retransmission fee leverage, operational improvements, and (sometimes) reduced ad-sales price competition it used to achieve from station acquisitions.  On the other hand, buybacks are easier to execute, can be more opportunistic during market dips, require no control premium in the purchase price, and have no regulatory restraints.  From a long-term owner’s perspective, I don’t know how fair value for Nexstar’s stock could be less than 10x earnings.  Buying stock at 5x adds 100% value on every purchase.  Buying 9% of market cap per year adds 9% value-creation to the 20% earnings yield.  Now you’re effectively yielding 29% per year, and the buybacks-value piece of that is compounding.  As a long-term owner, I kind-of hope that Nexstar’s stock stays at 5x forever and I can just ride the higher per-share earnings stream to a higher stock price.

The rest of the capital-allocation answer can be seen in Nexstar’s actions during 2021:  It is transitioning from being a collection of local stations producing local content and transmitting network content, to a quasi-national platform that owns and creates its own national content and offers some quasi-national advertising platforms.  This transition includes spending capital on acquisitions of national online content rather than TV stations, as well as spending organically to grow the content generation and platform capabilities.  Here are the announced moves during the past year, in reverse-chron order, for lack of a better organizing principle:

• Along with local stations and its TV Food Network minority stake, the Tribune acquisition also brought WGN America, the national pay-TV feed of WGN-TV in
  Chicago.  Starting back in cable’s early days, WGN’s local feed was retransmitted to cable networks all over America, and that pay-TV feed still reaches 75 million households.  Over time Tribune transitioned the national feed from a straight retransmission of the WGN local feed to essentially Cubs games plus fully non-local content, a mix of self-produced comedies and dramas, movie reruns, etc.  The Cubs are now broadcast elsewhere.  Nexstar is now in a multi-year process of transforming WGN America into a renamed NewsNation, which will eventually be a 24/7 news network.  They started a year ago with 19 hours per week of programming on weekday mornings and evenings.  This month they expanded to 55 hours per week of programming, with a new three-hour morning show and a prime time news show hosted by Don Abrams, who was ABC’s chief legal correspondent and a SiriusXM host.  They also launched a NewsNation promo campaign on all their local stations.  They will next build out the 10am-5pm weekday content throughout 2022 and will add weekends in 2023.  Perry said that NewsNation is already commanding the same ad pricing per viewing as CNN and has full distribution on all the over-the-top (streaming) platforms, both achievements he “thought would take years to achieve.”  I also like this comment from him:  “I'm not embarrassed by anything we put on the air, and I'm not sure that CNN in its infancy or Fox in its infancy could have said that about their news networks.”

• Launched STELLAR, an omni-channel ad-selling platform that allows purchases across all of Nexstar’s local stations, web sites, and mobile apps.  It uses “proprietary predictive technology to determine where a brand’s advertising will perform best against campaign goals, based on context and content signals.”

• Launched Rewind TV, which will show sitcoms from the the 1980s and 1990s, on newly-available digital subchannels for many of its TV stations.  (E.g., if your Nextar-owned local NBC affiliate primarily broadcasts on digital channel 4.1, Rewind TV might broadcast on channel 4.3.)

• Used other digital subchannels to make an initial test nine-station launch of SportGrid Network, which will produce and air original content entirely devoted to sports betting.  (Sports betting is becoming huge for television as more and more states legalize it.  On top of the traditional bets on the game outcome, “in-game” bets on various otherwise-trivial in-game event outcomes are exploding.  The combination of more states and more types of bets is significantly increasing demand for and engagement with sports TV viewing.  Also, advertising for sports betting has grown from a not-worth-mentioning local TV ad category to 5% of ad revenues in just the past year, +282% YoY in 2Q.)

• Acquired The Hill, a producer of top-flight, non-partisan political news and analysis, for $130 million.  Although the purchase price is only 1% of Nexstar’s EV, I really like this one.  The Hill perfectly fits Nexstar’s image of straight-shooting, non-partisan content, and Nexstar should be able to integrate its content into both their local-station content and NewsNation.

• Acquired BestReviews, a consumer products recommendation site.  Since the December 2020 acquisition, BestReviews has been showing “double-digit revenue growth and improved EBITDA margins.”

SUMMARY

5x earnings and 8x EV/EBITDA for a high-margin business that is still growing (albeit slowly), might never decline and would probably do so slowly and gracefully if it did, is exceptionally well operated, and is run by A+ capital allocators who will find great uses for all that cash flow.

Catalyst

Large buybacks, adjascent acquisitions, and other value-creating uses of that gusher of cash flow.