Description

Outdoor Channel Holdings (OUTD) is a national cable television channel with approximately 30 million subscribers and a pure play focus on hunting, fishing, and outdoor life. The company has a number of attractive attributes: a) strong balance sheet with about 30% of the market cap in net cash b) solid growth potential with a penetration of 30mn out of nearly 85mn potential subs c) excellent CEO who was formerly the COO/CEO of ESPN and who sold the competitor to OUTD (the Outdoor Life Channel) to Comcast for $16.67 per subscriber in 2001, and finally d) we believe the company is very cheap on a per subscriber basis @ $4 vs. a mid teens valuation for a number of comps. The mean sale price for 16 similar transactions over the last 10 years was $15.22. Using a conservative $10 per subscriber valuation, we get a stock price of $14 (a 99% premium to the current price) and using a $15 per sub valuation we get a stock price of $20.  We believe catalysts include: resuming subscriber growth (see pr's since Sept 2009) and strong cash generation in 2H09. As an interesting aside, in April 2009 Warren Kanders, (no stranger to VIC as CEO of CLRS, and chariman/ceo Armor Holdings which sold to BAE for $4bn ), filed a 13g that he personally has a 5.2% position in OUTD.

Our downside analysis indicates that even in a disaster scenario, where ad rates continue to fall and the company loses one-third of its subscribers, the stock should still be worth $5.75 (please see analysis below).

In 2008, OUTD repurchased slightly under 10% of their outstanding shares at an average price of $7.50 per share.

Brief Company Overview

Outdoor Channel was founded in 1984 and has run 24/7 programming since 1994.

The Outdoor Channel is the only pure play outdoor living channel which is Nielsen rated (31.2mn households as of Sept 2009), while overall ratings were up 24% in 2008.

According to a recent survey, when outdoor enthusiasts were asked "What is your favorite television network for Outdoor Programming?", OUTD scored 83.9%, far above competitors such as Versus 4.5%, ESPN2 3.5%, Sportsman Channel 3.0%.

OUTD earns fees from advertisements aired on the Outdoor Channel and subscriber fees paid by cable and satellite service providers that air Outdoor Channel. In addition, OUTD owns a production services company (Winnercomm) that earns revenue from advertising fees, production services for customer-owned telecasts, camera services for customer-owned telecasts and web page design and marketing.

Management

As we mentioned in the introduction, CEO Roger Werner is the former COO/CEO of ESPN (1982-1990) and the former founder of Outdoor Life (currently called Versus), a major competitor of OUTD which he sold in 2001. Werner is just about to start his third year at OUTD, and we believe that while it has taken time, he has successfully positioned the company for future growth.  In recent quarters he has guided the creation of a number of new shows, expanded distribution, and acquired Winnercomm, a production services company can produce more in-house content with lower costs.  By virtue of his compensation package Werner has significant incentive to grow the two profit centers of the business, subscribers and ad dollars. First, Werner earns a bonus based on the number of subscribers added. Second, he gets 5% of the yr/yr increase in advertising revenue. While this is undoubtedly a lucrative contract for Werner, we find it reasonable given Werner's track record of success and the alignment of incentives.

Here is an 11 minute interview with the CEO Roger Werner http://www.youtube.com/watch?v=yiIZRQYWbGE. 

Winnercomm Acquisition

Outdoor Channel recently acquired production services company Winnercomm for $5.9mn cash. The OUTD CEO knew the CEO of Winnercomm from his ESPN days. Winnercomm focuses on marketing, design, programming, live event coverage, and Web and interactive design for 14 TV networks. Additionally the company designs and deploys Skycam for sporting events (NFL/College Football). Winnercomm has won 13 Emmy's. OUTD management is guiding Winnercomm revenue to just under $30mn for 2009.

OUTD is aggressively pushing creating new innovative content (through Winnercomm) and new media platforms, such as broadband (outdoorchannel.tv). According to the site, the average viewer stays on the site 10 minutes, and total viewership saw several hundred percent yr/yr growth in 2008.

We think tying the web traffic to cable channels is an important development. In July 2008, Blackstone, Bain, and NBC paid what appears to be a rich valuation of $35 per subscriber for The Weather Channel due to its extremely well developed weather.com. Clearly, The Outdoor Channel web property is nothing like weather.com, but it appears that OUTD is on the right track with a sticky (avg. stay 10 minutes) and growing site vs. an overall industry low valuation of  $4.20 value per subscriber.

Valuation

Cable channels are usually valued on an enterprise value per subscriber basis, and the most common metric used is revenue per subscriber per month.  Standalone earnings are typically not emphasized given the scalability of the business and the value of an additional channel to an acquirer. 

Despite strong management and a nice niche business, OUTD currently is valued at an enterprise value of only $4.20 per subscriber (assuming 30.1mn subs as of 6/30/09), which is a fraction of current public market valuations and comparable acquisition valuations.   Below, the valuation of OUTD is compared to its two closest pure play competitors, Crown Media (Hallmark Channel) and Scripps Networks (HGTV, Food Network, DIY Network).

Note: Scripps enterprise value is adjusted for the value of its interactive services segment.

Using a regression analysis (EV/Sub vs. Rev/Month) based on the valuations of CRWN and SNI, OUTD should trade at an EV/sub valuation of $8.79, which implies a stock price of $12.77 (a 79% premium to today's stock price), assuming Winnercomm is valued at the cost of the acquisition.    

On a comparable acquisition valuation basis, OUTD looks even more undervalued.  Below is a list of comparable transactions since 2001 sorted by transaction size.

Using the same regression analysis, OUTD should be valued at an EV/sub valuation of $12.57, which implies a stock price of $17.21 (a 141% premium to today's stock price).

Both of the valuation analyses assume no growth in subscribers or revenue/sub/month, which we believe is a highly conservation assumption.

Downside Analysis

While we believe that OUTD is poised for growth going forward, we have produced a downside analysis that looks at the value of the company in a down scenario where it loses a major distribution partner.  Our downside analysis assumes that OUTD loses 33% of its subscribers, has a 50% reduction in both advertising fees and subscriber fees, and it maintains its current EV/Sub valuation of $4.20.

Under this scenario (which we feel is extremely unlikely), we believe the shares would still be worth $5.75, 19% below the current price.

Investment Highlights

We believe that OUTD is cheap for a couple of reasons:

a)       Lack of growth in subscribers over the past three years

b)       Lower EBITDA margins than the above comps, so it doesn't screen well

c)       It is a small company relative to other publicly traded cable television channels, and it has no prominent research coverage

d)       Seasonal nature of OUTD's cash flows are potentially exacerbated by the addition of Winnercomm

e)       The advertising market is currently soft, which has caused a decline in advertising revenue for OUTD in recent quarters

Why should that change?

a)       OUTD is currently in discussions with Comcast and Time Warner Cable to move the Outdoor Channel to more broadly subscribed tiers in many areas of the country, and they have announced several successes in this initiative recently. Since early September 2009, OUTD has announced nearly 700,000+ new subscribers.

b)       On the August 2009 conference call guided to approximately $15mn in OCF in the back half of 2009, due to a general strengthening of the business and as a result of the cyclical nature of their cash flows (3Q and 4Q tend to have much stronger cash flows than 1Q and 2Q).

c)       Winnercomm has the potential contribute meaningfully to OUTD's results and broaden its revenue base to both production services and web design services

d)       Under Werner's leadership, OUTD has greatly improved its new lineup of shows

e)       OUTD subscribers could get higher valuation given strong website and user engagement (500,000 visits a month with 10 minute avg. stay), Video on Demand/ HDTV are growth areas for OUTD

We believe growth in subscribers combined with increased revenue opportunities through its production and internet offerings have the potential to boost the valuation of the company from $4.20 per subscriber to something closer to $10-15 which translates into $13-18 per share.

Shareholders

The Massie family, the founders of OUTD, currently hold approximately 39% of outstanding shares.  In addition, investor Warren Kanders filed a 13g in April announcing a 5.1% position in OUTD. While his intentions are not clear, Kanders is a noted activist investor who also holds a 3.7% position in Johnson Outdoors and is a co-owner of Gregory Mountain Products, which are both outdoor recreational equipment manufacturers.

Disclaimer: This does not constitute a recommendation to buy or sell this stock. We own shares in this company, and we may buy or sell shares at any time without updating the board

Catalysts:

OUTD should generate $15mn of OCF over the next two quarters per August 2009 guidance

OUTD is adding subscribers over the last 8 weeks see PR's

OUTD is current valued at $4.20 per subscriber, substantially below comparable valuations

OUTD should generate .60 in OCF on what should be near a $3.50 year end EV (fairly cheap)

OUTD will benefit from any economic recovery through the hardening of advertising rates

OUTD could potentially use its excess cash to make further acquisitions or buyback a meaningful percentage of the company

Catalyst

see above