Nexstar Media Group, Inc. (NXST) is the second largest owner of local television stations in the US. The company owns, operates or provides services to 170 television stations which reach 100 separate markets (out of a total of 210 generally recognized television markets). Its stations cover 39% of all US households reaching nearly 44 million people. Of Nexstar’s portfolio of local stations, 82% are affiliated with the “big four” of CBS, ABC, NBC, and Fox. Other affiliations include stations broadcasting the CW or MeTV. Nexstar is the #1 CBS affiliate group, #2 NBC, and #3 ABC, FOX, and CW. These affiliate relationships give Nexstar the exclusive right to broadcast primetime network content in its markets. Some of its largest stations include:
ABC in Salt Lake City, Utah
CBS in Las Vegas, Nevada
NBC in Tampa, Florida
CBS in Portland, Oregon
ABC in Nashville, Tennessee
CBS in Raleigh, North Carolina
NBC in Austin, Texas
The CW in Phoenix, Arizona
Nexstar’s core competency is the production of local news, sports, and lifestyle programming which is broadcasted in its local markets. Currently Nexstar produces and delivers over 3,500 hours per week of wholly-owned news and content such as morning, midday, evening and late-night local news. During these broadcasts, Nexstar has the exclusive right to sell advertising to both local and national ad buyers. For commercial advertisers, local news provides an avenue to reach a large audience in key demographic and regional areas. During prime-time hours, the network provides its programming exclusively to its local affiliate in each market. The local broadcasters also purchase the rights to broadcast first-run (e.g. Jeopardy, Judge Judy, Dr. Phil, Wheel-of-Fortune, etc.) or rerun (That 70’s Show, Seinfeld, King of Queens, etc.) syndicated programming during which they can sell ad space or let the content owner retain some ad time in exchange for reduced syndicate fees. Local ads are sold by local sales teams and national are typically sold by advertising agencies, to which the local broadcasters pays a commission. In markets where Nexstar owns or provides services to more than one station, there are significant cost and negotiating advantages to utilizing the same sales team.
In the past, the vast majority of revenue has come from selling ad space. Many of the largest national advertisers include automobile manufacturers, telecom companies, QSRs, and national retailers. Ten years ago, 90% of Nexstar’s revenue was derived from local (63%) and national (27%) ad selling. National ad revenue has been sensitive to the national economy. For example, national ad revenue on a per station basis declined 33% between 2007 and 2009. Local revenue has also been levered to the economy, but to a smaller extent than national. During the same period during the financial crisis, local ad revenue declined approximately 20%. Given the high proportion of ad revenue relative to total revenue, changes in revenue have been somewhat volatile which has led to volatile stock prices as broadcast expenses have a high proportion of fixed costs. Even in a poor economy, the news still has to be produced and payments to the affiliate networks must be made. Somewhat as an offset to the more volatile nature of ad revenue, the broadcasters have been able to depend on a steady stream of political ad revenue every even-numbered year. This ranges from a low of 1% during off years to 10% during election years. The growing political divide and partisan nature of American politics has been a benefit to the broadcasters, especially those with assets in battleground states.
However, the industry has undergone significant changes in recent years. First, a new and stable stream of revenue has grown in importance. While the broadcasters have historically relied on advertising revenue, retransmission revenue has grown very significantly in recent years and has transformed the broadcasting business model. Beginning a few years ago, the broadcasters began to push back on the fact that they were receiving significantly less compensation (on a per subscriber basis) from the cable and satellite companies (multichannel video programming distributor, or MVPDs) for their content compared to the cable channels (i.e. Disney, Viacom, Discovery, Scripps, etc.) The following slide is from Sinclair Broadcasting from June 2015 so the numbers have changed somewhat since then, but the basic idea remains the same: the big four networks are by far the most popular channels in the cable bundle, yet, they receive significantly less in retransmission fees (i.e. the fees paid by the MVPDs for the right to transmit the content owned by others). It is important to note that the broadcasters negotiate on behalf of themselves and the networks with the MVPDs regarding retransmission rates and the broadcasters then pay the networks a portion of the retrans to the network. The net retransmission profit for the broadcasters is referred to as net retrans and the payment from the broadcaster to the network for their portion of the retrans revenue is referred to as reverse retrans. The following two slides tell the story:
By a wide margin, the big four networks are the most watched and highest rated channels in the cable bundle yet the retrans fees are not indicative of viewership. Though the broadcasters have made progress in receiving a higher proportion of the MVPD’s programming fees relative to cable channels, a disconnect remains. As the broadcasters have negotiated for higher rates, retrans revenues have grown at double digit rates in the past few years and Nexstar believes that growth will continue for the next few years as the gap between viewership and retrans rates narrows. The retrans agreements negotiated between the MVPDs and the broadcasters typically last for three years and are comprised of a fixed payment per subscriber. The following table reflects Nexstar’s revenue mix over the past decade.
As the chart shows, retrans revenue has gone from less than 10% of total revenue as recently as 2010 to nearly 35% in 2016. In fact, in 2016, retransmission surpassed local advertising as the largest source of revenue. It is also important to keep in mind that although retrans revenue has grown as a percent of the total, this has not been exacerbated by a decline in other sources of revenue. National ad revenue has been flattish on a per station basis but comparable local and political revenue has increased slightly. The following chart reflects revenue on a per station basis. Keep in mind that the fluctuating two-year political cycle impacts local and national ad revenue.
This changing composition of revenue has reduced operating leverage for the broadcasters and thus reduced overall risk. There will likely be less fluctuation in total revenue during the next economic contraction compared to 2008-2009 due to the fixed nature of retrans revenue even with a moderation in the rate of growth going forward.
As mentioned previously, there has been another significant development in the broadcast industry in recent years which can be seen in the Revenue per Station chart. One of the biggest criticisms of the broadcast stocks is that advertising is moving from traditional advertising mediums such as print and TV to online/mobile and the broadcasters will see a continual and accelerating decline in their broadcast ad revenue as a result. While the outlook is far from perfect, it’s likely not as bleak as some predict. For Nexstar, over the past few years, national ad revenue per station has been flattish but local and political ad revenue has increased. In addition, digital ad revenue per station has been growing at compound annual rates of 25%, 29%, and 31% over the previous seven, five, and three years, respectively, albeit this includes acquisitions. Nexstar’s digital advertising revenue in 2016 comprised 9% of the total and the company anticipates digital revenue to double within five years.