Description

Summary:

We recommend buying NXST as a long, which currently trades at roughly 3.5x levered FCF / 8.5x TEV/unlevered FCF despite having a 3-year runway for ~20% growth in FCF per share and continued runway for double-digit FCF per share growth thereafter, driven by growing “net retrans” profits and capital deployment. The setup for 2020 looks particularly attractive, with the company likely to generate 31% of its market cap in FCF over the 2020 calendar year and another 24% of the current market cap in FCF in 2021, barring a significant recession.

In a normal economic outcome, we see almost 100% upside from today’s levels.

Detail:

Business description

NXST is a TV broadcasting company that owns 197 full-power stations in 115 DMAs in the US. 80-85% of those stations carry the BIg 4 broadcasting networks (ABC, CBS, FOX, NBC), with the remainder carrying CW or independent news-focused local stations. The company also owns a 31.3% stake in the Food Network and the WGNA cable network, both of which were acquired in the Tribune acquisition that was completed in September 2019. 

In terms of revenue breakdown, 35-40% of revenue is generated by traditional “core” advertising - dollars spent by companies on TV commercials - where 5-10% of revenue is generated by political advertising (campaigns and PACs spending on TV commercials), 5% is generated by digital advertising, and the remaining 45% comes from retransmission revenue - content fees paid by both traditional MVPDs (e.g. Comcast, AT&T/DirecTV, Dish, Charter) and virtual OTT MVPDs like Hulu Live, YouTube TV, CBS All-Access, etc. NXST pays the Big 4 networks “network fees” that are just under 50% of their retransmission revenue, and the Net Retrans profits have been an important driver of growth for the company in the last 10 years.

Growth profile going forward

Relative to 2019/2020 pro forma baseline (including synergies) revenue of $4.5B and EBITDA of $1.8B, we expect that over the next three years, revenue will grow M-HSD% p.a. and EBITDA will grow M-HSD% p.a., driven by a double-digit growth CAGR in Net Retrans profits, while HSD% growth in political and digital advertising offsets LSD% declines in core advertising dollars. 

The key driver of the company’s forward results is the growth in Net Retrans profits, for which we think there is a strong runway. Our framework for thinking about which TV content owners will see fee growth vs. fee declines in the coming years relates to following questions:

• What is content owner’s fee share in the bundle vs. its rating share - content owners that are undermonetized vs. their audience shares are likely to see growth.
• How intense is the viewer attachment to the content - higher viewer intensity means greater likelihood to switch providers over loss of the channel?
• How expensive is the underlying content of the content owner - owners with expensive content seeing growth in content costs have a better argument for increases going forward?

We believe on these metrics, the broadcasters have the strongest position in the bundle and are likely to see substantial continued fee growth over the next 3-6 years. Currently, the Big 4 networks account for ~35% of TV viewership, but are paid only 21% of PayTV fees, significantly undermonetized relative to their share of audience and despite the viewership intensity around the Big 4 TV stations (including the local news) and the high content costs (particularly sports costs) of the BIg 4 networks. While the overall TV bundle is “under stress,” we expect the gains of the TV stations to come at the expense of low-intensity lifestyle cable networks with low viewership, the scripted entertainment networks facing rampant competition from Netflix/Amazon/Apple,  and the overmonetized sports channels (ESPN and the RSNs).

While bears are concerned that, over time, the networks will take a higher % of the retransmission fees for themselves, we believe that for NXST the outlook is benign on the network fee side, for several reasons. 

• For all the station owners, the networks have less leverage in demanding extra fee share than one might imagine, because the threat to switch the network affiliation to a different station has lost significant amount of effectiveness in recent years, due to the audience loss that occurs with station switches. In the last 4-5 times the network has pulled its affiliation from a station in a network fee negotiation, the network has lost 30-40% of its primetime audience permanently (over and above the audience losses that are occurring from viewership declines), because the network has lost the “lead in” from the morning and evening news into the network morning shows and primetime shows. Because the networks have seen this play out, the threat of station switches has diminished in recent years.
• For the largest station owners like NXST, there is an extra degree of protection, for a few reasons. First, the audience loss described above is far less tolerable if it is occurring in 20-30% of the audience base (as NXST has with many of the Big 4 networks). Second, the largest station operators have enough leverage with MVPDs to demand fairly high “backup rates” for their stations if the stations lose their Big 4 affiliations, which mitigates the profit loss if an affiliation is lost, further diminishing the network’s leverage. As a result of these factors, we believe NXST has the most favorable network content costs of all the station operators at this time and has been able to achieve very small declines in their “net retrans margin” (likely going from 55% to 51-52% over the last five years) as a result. 

This growth in net retrans profits is responsible for essentially all of the EBITDA growth in our forecast over the next few years. We expect core advertising to decline slightly (though notably it has been remarkably flat in the last 4 years, adjusting for political displacement), but we expect this effect to be offset largely by HSD% growth in both the company’s digital revenue (largely advertising revenue from its station websites) and growth in political advertising, which we expect to be particularly pronounced in 2020, as a well-financed Trump campaign is likely to face off with a Biden campaign backed by the traditional Democratic donors + Mike Bloomberg’s PACs.

Capital Allocation

While the company’s leverage is currently in the mid-4s and likely holding back sentiment in the stock, the company will be comfortably below 4x leverage by 2020 year-end, and we think it can achieve this goal at the same time as using 30% of post-dividend FCF on share buybacks, which at the current depressed price would amount to a HSD% of the market cap. Having achieved its leverage reduction target by year-end, we expect almost all of cash flow to be directed toward capital returns starting in 2021, either via share buybacks or the creation of a very large dividend that could cause dividend investors to buy the stock (currently, 50% of guided FCF would represent a 16% yield on the stock!).

Recession risk

The stock is currently depressed due to macroeconomic concerns, and the stock’s advertising exposure does indeed expose it cyclically, but given a significant portion of the EBITDA is driven by net retrans profits, we think fears are overblown: in a recession, we might expect a 6-10% hit to advertising dollars, and even if that hit is permanent (which we wouldn’t expect), it still would amount to roughly a 6-10% hit to FCF.

Given this level of exposure, we think the shares are getting overly penalized at current prices.

We and our affiliates are long Nexstar (NXST) and may buy additional shares or sell some or all of our securities, at any time. We have no obligation to inform anybody of any changes in our views of SPSC. This is not a recommendation to buy or sell securities. Our research should not be taken for certainty. Please conduct your own research and reach your own conclusion.

Catalyst

FCF and this level of pessimism abating