Description

NXST, based in Irving, Texas is a television broadcaster that owns or operates 47 stations throughout 27 midsize markets (target 50-175 DMAs) in the states of Illinois, Indiana, Maryland, Missouri, Montana, Texas, Pennsylvania, Louisiana, Arkansas, Alabama and New York. Included in that number, are 16 stations owned by independent company Mission Broadcasting but with long-term service agreements with NXST. NXST reaches about 7.4% of the households in the US. About 60% of those households reached are served by multiple NXST stations, giving them a sizeable duopoly footprint. NXST’s affiliates include NBC (13 stations), CBS (8 stations), ABC (9 stations), FOX (13 stations), UPN (3 stations) and 1 independent station. By revenue, NBC makes up 37.5% of revenues, 27% for CBS, 21% for FOX and 14% for ABC. NXST has been highly acquisitive in the past, doing 21 acquisitions since inception and racking up a highly leveraged balance sheet in the process.

NXST represents an interesting opportunity in an out of favor sector. Clearly, the advertising environment through broadcast television and other traditional media such as newspapers has been experiencing deceleration and even declines, and a reallocation of advertising funds to new media (eg: the internet). Despite that, NXST represents an interesting value proposition that is not being fully appreciated by the street. The stock has seen its market cap drop by almost 50% during 2005 due to a mix of a generally difficult operating environment as well as some company specific events.

Generally, the market has been weak for television broadcasters. Industry top-line growth has stagnated for the past few years (averaging out political and Olympic years) as national advertising on broadcast TV has been weak due to lower ratings and other more effective ad mediums taking market share away. 2004 benefited from both Olympics and a presidential election, increasing broadcast ad revenue substantially; 2005 therefore faced difficult comps to 2004. NBC ratings, specifically in 2005 have been extremely weak, exposing NXST to additional national ad weakness. Auto advertising, in general, which makes up about 25% of NXST ad revenues, has had a terrible year.

Company specific issues NXST have faced have been significant as well. Broadcast retransmission disputes with various cable MSOs led to the voluntary removal of carriage for 7 NXST stations for the majority of 2005. I will explain this further below. NXST was essentially a busted IPO from the beginning, when it went public in November 2003 at $13.25 per share. It never made it above $15, and has trended south ever since, but appears to finally have found a bottom. NXST is 58.2% owned by Abry Partners, a private equity firm. This has added another overhang to the stock, as the street has constantly been speculating when Abry might sell their shares in a secondary offering. Abry has a 90.1% voting interest in the company through its ownership of Class B common shares. Other significant shareholders in the company are Neuberger Berman at 11.2 % and Banc of America Capital at 4.8%. Lastly, the company is highly leveraged (about 7.4x LTM), and until recently was within striking distance of leverage covenants. These covenants have since been renegotiated to 8.5x (decreasing every quarter in 2006), the leverage has been getting paid down, and the debt refinanced at lower rates. The CFO made comments on the Q3 conference call that leverage at the opco level ($95 million of 11.375% Senior Discount notes at Nexstar Finance Holdings and not factored into the leverage covenants) could approach 6.0x trailing EBITDA by YE 2006. In April, 2005, NXST refinanced $160 million of 12% senior subordinated notes, funded by issuance of $75 mm of 7% senior sub notes, and borrowings under senior secured facilities and the company’s term loan. This refinancing reduced annual cash interest expense by $8.5 million

Explaining retransmission

Television broadcasters, in their contracts with Cable MSOs, which typically last about 3 years, need to designate if they want “must carry” (guaranteed, uncompensated distribution of their channel) or retransmission consent for their broadcast signals. Under retransmission consent, the cable operator must negotiate with the broadcaster to get permission to carry its signal. While satellite providers and cable overbuilders in the past have always paid television broadcasters cash (on a per sub per month basis) for use of their signal, Cable MSOs have not, and have been extremely hesitant to set any precedent that would require them to do so in the future. They have in the past, used barter of advertising time or carriage of start-up cable channels (For example, ESPN Deportes for carriage of ABC affiliates in Disney’s case), but have not paid cash. NXST began informing its Cable partners last year that they would require the MSOs to pay cash retransmission fees for carriage. While early deals with extremely small rural cable operators were struck for undisclosed amounts, this request led to a standoff with larger cable operators, specifically Cox and Cable One over seven different channels. Cox and Cable One were not open to negotiating for pay for carriage, and NXST responded by taking their signals off in those markets.

While NXST itself was the little guy, standing up against the 2000 lb. monster, they are beginning to find themselves in company of some larger players. Because of the separation of Viacom’s assets into “New” Viacom and CBS, the cable channels will be located at Viacom, while the broadcast assets at CBS. Les Moonves, CEO of CBS has been quite up front about his desire to require cable operators located in owned and operated CBS markets to pay for retransmission. While CBS doesn’t currently have any station retransmission agreements up for negotiation, they will in the next few years, and his outspoken remarks have lent credence to NXST’s bold moves.

NXST took its signal off of Cox’s cable systems for KLST/CBS in San Angelo, Texas, KTAL/NBC in Bossier City and Minden, La., as well as Magnolia, Ark. and Mt. Pleasant, Texas and KRBC/NBC in Abilene, Sweetwater and Snyder, Texas on January 1, 2005, penalizing both NXST and the MSOs. In Cable One’s territories, NXST removed their signal for NBC affiliate KSNF and ABC affiliate KODE in Joplin, Mo.; NBC affiliate KTAL in Shreveport, La.; and NBC affiliate KAMR in Amarillo, Texas. NXST has commented that it has probably lost between $2 and $3 million of revenue as a result of these disputes. Additional expirations of contracts were scheduled to happen again December 31, 2005 in Cox and Cable One territories.

The retransmission overhang has finally been resolved (and is currently)for NXST with little fanfare from the market (and little disclosure from management). On October 20, 2005 the company announced they signed a retransmission consent agreement with Cox for 12 owned Nexstar stations and 9 owned Mission stations. The financial details of the deal are confidential, although industry sources have indicated and NXST has implied that the company is receiving cash, and has in fact won the standoff. The extent of the payment we don’t know, but we’ve been told that payments will begin to be seen significantly in Q4, 2005. CEO Perry Sook comments in the press release were : “As has been previously reported, Nexstar refused to grant retransmission consent without receiving adequate compensation. Although the confidentiality provisions limit Nexstar and Cox from discussing publicly the financial aspects of this agreement, we are pleased to have reached an economic agreement that is acceptable to both parties. This agreement encompasses all of the Nexstar and Mission stations carried on Cox cable systems. Going forward, we anticipate a mutually beneficial relationship between the companies.”

On November 4, 2005, NXST announced that it had reached deals with Insight Communications for retransmission, leaving the details as vague as in the Cox deal. The Insight deal covers nine NXST stations in Insight territories. The Insight deal also established a Video-on-Demand service for local news broadcasts in several of the markets.

And this past Friday, on December 16, 2005, Cable One Inc. and Nexstar settled on a handful of TV stations in three markets. The affected stations were back up in Cable One’s markets as of Monday December 19th. Again the companies declined to comment on whether the MSO had finally agreed to the broadcasters’ original demands -- being paid cash for carriage of its TV stations. Nexstar had originally sought a 30-cent monthly license fee per subscriber for these stations.

At a recent UBS conference, Perry Sook, the CEO discussed the 2 dozen retransmission deals signed so far. He went on to say that in 2006, they will begin breaking out retransmission revenue as a separate line item, and that it will be a “meaningful 7 figure number”. Most of the deals signed so far are 4 or 5 year deals. The company is still negotiating retransmission deals with about ½ of the 25 or so companies that make up 90% of revenue. The retransmission deals negotiated so far in addition to a cash component, have an advertising component where the Cable MSOs will have a minimum ad commitment on NXST stations which will show up in the local and national revenue line. All of the retransmission deals so far signed have annual escalators built into them, and all the deals are consistent with their aforementioned strategy. Management noted that several more deals need to be signed and hopefully will be by the end of 2005.

Now finally onto why NXST represents an interesting opportunity...

The market, as well as sell-side analysts, have been so sour on this company because of these issues that it has failed to see any of the progress the company has been making. Analyst estimates have not taken into consideration many of the balance sheet improvements, as well as revenue opportunities that will be in play in 2006. The valuation on a standalone basis has also become compelling, even if you discount any upside that could come out of recent developments. I see increasing value in the company as NXST delevers its balance sheet with the increased cash flow it will have in 2006, and shifts value from debt holders to equity holders. They will initially be paying off term loans, and some small amount of subordinated debt.

2006 looks to be a promising year for various reasons. 2004 was a heavily advertised political year with the presidential election, and 2005 lacked that revenue. 2006 is expected to be especially strong politically in NXST’s markets; including heated gubernatorial races in Texas, New York, Illinois and Arkansas, a contested Senate races in Missouri and Pennsylvania. In addition there are over 17 different statewide elections, and several competitive local elections. Management has discussed that it sees political revenue in 2006 likely to come in between the high watermark set in 2002 of $35 million, and 2004’s $27 million. I have conservatively assumed the low-end of this, but as more heated races emerge, this may prove to be low. In 2005, political was < $2 in revenue.

Next, the company already commented on its Q3 call, that it had already started receiving booking commitments for the 2006 Winter Olympics (on NBC) in excess of $2 mm. This number will surely ramp up as time gets closer to the Olympics. Management stated that it doesn’t see why they couldn’t have $5 million in revenues from the Olympics this year. The SuperBowl will also return to NBC this year, a benefit to NXST’s NBC dominated stations. Next, back in August, the company announced it had entered into a joint service agreement with Sinclair Broadcasting in Rochester, NY. Under the terms of this agreement, NXST’s CBS affiliate WROC-TV will provide sales and non-programming services to Sinclair’s Fox outlet. The potential for savings in this deal could increase operating income by up to $1 mm annually. The company will see a full year of benefit of this arrangement in 2006.

Finally, the retransmission agreements mentioned above have a twofold benefit to the company. NXST will see the benefit of a return in ratings for its Cox and Cable One stations which were off the air for 10 months. As mentioned above, the estimate of revenue lost on the advertising side is $2-$3 million over the course of 2005. In addition, the big wildcard, is what the retransmission revenue that NXST is receiving will be. Conservatively, I have looked at a case where they receive about $3 million in 2006 (along w/ his comments about a meaningful 7 figure number), and any value is upside to my estimates. They have already been receiving retransmission revenue from DTV and DISH for the past few years, around $2 -$3 million / year in aggregate.

On the expense side, NXST has one of the lowest cash programming costs as a percentage of net broadcast revenue among broadcasters, and prides itself on having declining operating expenses, SG&A expenses and cash program payments in each quarter of 2004 and YTD 2005. In Q3 2005, they completed the hubbing efforts of 4 stations in the Abiline market, which will lower operating expenses. Additionally, they are in the process of converting newsrooms from analog to digital which should also help to reduce costs. All in all, they have guided to low single digit declines in operating expenses in Q4 and 2006.

Lastly, the company is clearly in a cash generation mode, and is focused on paying down debt to more manageable levels. They have discussed that they are shopping around 5 stations in four markets that they consider non-strategic. This could raise $50 - $75 million, which will be immediately used to pay down debt. In the marketplace, private market multiples have been higher than public market multiples for television assets, with properties trading for around 12-14x normalized BCF. Recently, EMMS has been selling TV stations that an average multiple of about 12.6x EBITDA. Sook mentioned at the UBS conference, that these are roughly the multiples he is looking to sell the assets for, and he is being patient to get the right price. Proceeds from sales of any properties will be shielded by NXST’s $300 million NOL.

On the Abry overhang, the company recently had their board meeting, and Abry is pleased with the progress of the retransmission agreements and is under no fund wrap-up pressure to liquidate their holdings in NXST. Management mentioned that both they and Abry are disappointed with the current equity valuation.

Here are my numbers:

Stock Price - $4.43
Shares Out – 28.4 mm
Equity Value - $125.8 mm
Net Debt - $638.7 mm
Less: NPV of NOL - $22 mm
Enterprise Value - $742.5 mm

2004 2005 2006 2007
Net Rev $246 $222 $253 $234
EBITDA $84 $60 $88 $66
FCF $31 $13 $34 $20

EV / EBITDA 8.8x 12.3x 8.4x 11.5x
P/FCF 4.1x 9.5x 3.7x 6.2x

Comps Television Broadcasters

EV / EBITDA 2005 2006
HTV 13.1x 10.1x
TVL 12.3x 10.3x
SBGI 11.4x 9.9x
GTN 10.9x 9.9x
Average 11.9 10.0x

From a comparative standpoint, the valuation on a FCF basis is quite compelling. 3.7x FCF during a political year, and 6.2x on a non—political year show the lack of enthusiasm the street has given this company. On an EBITDA basis, the company should show greater growth from 2005 because of many of the factors discussed above, which are company specific. At a valuation of 8.4x vs. the comparable universe at 10.0x 2006 EBITDA, there is room for multiple expansion. There are also inaccuracies in the models of some sell-side analysts, which show a much higher Cash Interest expense, therefore reducing FCF and increasing the multiple b/c of a PIK subordinated note that is outstanding, and will probably be refinanced in April, 2008 or after. Arguably, the 3.6x FCF multiple is not comparable to other broadcasters because of the PIK interest expense being excluded. However, from an actual cash generation standpoint, the street is not fully accepting the cash generation capacity of this company, and is not factoring this into their models.

More interesting, and more tangible, however, is taking a look at the debt paydown story. Looking at the average EBITDA multiple of a non political and political years (2006/2007) at 10.1x EBITDA, and applying this to average 2007/2008 EBITDA of about $78 mm, I looked at how much value is transferred from debt holders to equity holders, assuming that (as management has stated) available FCF after capex, and interest expense is used to pay down debt. This analysis does not assume any asset sales, or really much upside for retransmission, or any significant increases in the advertising environment. So assuming, by the end of 2006, they can pay down almost $30 million of debt, this implies a share price of $6.25 by the end of 2006. This is almost a 40% premium to the price today, simply looking at the company as utilizing the benefits of increased cash flow in 2006 to pay down debt. Looking out to 2007, another $5-$10 million of debt can be paid down, and in 2008 about $35 million (Senior Discount notes stop accreting). This exercise gets you to a price of $7.70, a premium of over 70% to the current. It is important to note that this does not make any sweeping assumptions about the broadcasting ad resurgence, but it does leverage the cash flow characteristics of this business to continue to refinance the balance sheet and shift value to equity holders. I have been conservative in my modeling of local and national ad growth, factoring in only 1-2% gains (organic excluding the above mentioned factors), even though management has guided to higher gains of 3-4%.

The valuation currently ascribed to NXST gives it a floor, and limits downside. If you begin to give the company credit for cost cutting initiatives, asset sales or look at any stabilization in the advertising environment, the upside potential increases similarly. Add on the leverage in the model, almost all of the incremental Revenue falls to bottom line.

I have attempted to give a range to quantify the impact of the discussed catalysts to 2006 FCF vs. 2005 FCF. My model falls on the conservative end of the range and assumes the following: $27 million of political revenue, $3 million of retransmission revenue, $5 million of Olympic revenue, $0 NFL revenue, no expense reductions, and nominal interest savings except what was previously done on the refinancing of the 12% notes. As far as Capex, the company is required to have its stations transitioned from analog to digital by 2008, and has been investing to do so. This year, they raised their capex guidance to $14 million, from an original $12 million to accelerate the digital rollout, which will also have expense reduction benefits. They have indicated that next year they will be in the $20 million range, much of that going towards Digital conversion. They typically will invest heavier in capex during even political years.

Current 2005 FCF: $0.46
Current (conservative case) 006 FCF: $1.16

Asset Dispositions of 5 stations: $50 - $75 million; impact on EBITDA could be nominal as the company has indicated the stations on the block are laggards in FCF generation

- Retransmission Revenue: $2 - $8 million vs. 2005 of $0
- Political Revenue: $27 - $35 million vs. 2005 of <$2
- Olympic Revenue: $2.5 - $6 million vs. 2005 of $0
- NFL Revenue: $1 - $3 million vs. 2005 of $0
- Rebound from Retransmission Dispute: $2 - $4 million
- Less: Higher Agency commissions on increased Ad revenue: $35 million 2006 vs. $30 mm in 2005
- Continued Expense Reduction from Hubbing and Rochester JSA: $0.5 - $2 million
- Interest Savings from Debt Paydown: $0 - $2.5 million from ’06 paydown, also 2005 only received ¾ of the impact of the refinancing of the 12% notes
- Offset by higher Capex: $20 mm in 2006 vs. $14 mm in 2005

Total Potential Impact to 2006 FCF vs. 2005 FCF: $22.0 - $42.5 million
Total Impact to Cash (includes asset dispositions): $72.0 - $117.5 million

Impact to FCF / Share: $0.77 - $1.49
Impact to Net Debt / Share (including asset dispositions): $2.53 - $4.14 / share

Implied 2006 CF Range: $1.23 - $1.95
FCF Yield: 28% - 44%
Equity Value/FCF Multiple Range: 3.7x – 2.3x

Lastly, if it is any indication of what is in the retransmission agreements that is not public, and where the market valuation currently stands, CEO Perry Sook has been a frequent buyer of his stock in November and December.

Catalyst

- Earnings releases going forward breaking out retransmission revenue
- 2006 cash flow benefiting from strong Olympic, NFL and Political revenue on NBC stations – all with little incremental costs
- Easy comps to 2005 as 2006 will see revenue for stations that were not broadcast for much of 2005 due to retransmission disputes.
- Asset dispositions of 5 stations in 4 markets
- Continued debt paydown and eventual refinancing of Senior Discount Notes
- Continued expense reduction through digital conversion, hubbing of stations, coupled with resurgence in national/local ad revenue