Description

Company Overview: Saga Communications, Inc. (“Saga”, “SGA”, or the “Company owns 79 FM stations and 35 AM radio stations in 27 markets across the United States.  Saga operates in several large markets including Charleston, SC, Columbus, OH, Des Moines, IA, Portland, ME, Manchester, NH; Milwaukee, WI, and Norfolk, VA.  Saga was founded in 1986 and is headquartered in Gross Pointe Farms, Michigan and has over 800 employees.  Saga has Class A and Class B shares with Edward Christian (the founder, Chairman, and CEO) owning all Class B shares, giving Mr. Christian control of Saga.

Investment Thesis: 

• Saga Communications is a well-managed radio broadcaster with strong market share in their communities.

• Saga remained profitable and cash flow positive through the COVID-19 pandemic, and additional cost-cutting measures taken during the pandemic should lead to improved profitability going forward. 

• Robust political spending, growing digital revenues, and an increase in non-traditional revenues should insulate Saga from a potential economic recession in 2022.   

• Saga owns land, buildings, and towers with a gross book value of $78.1 million which nearly exceeds the enterprise value of the entire Company.  

• Unlike its competitors, Saga has a pristine balance sheet consisting of $55 million of cash and no debt 

• Saga recently increased their quarterly dividend to $0.20/share (3.5% yield) and further returns of capital could be forthcoming.  

• With a market capitalization of $136 million and an enterprise value of just $81 million, valuation is attractive. We expect Saga to generate $15-20 million annually in free cash flow, resulting in an unlevered FCF yield of almost 20%.  

Station Overview: Saga owns and operates 114 radio stations in 27 markets across the United States.  The Company’s seeks to be the number one or two radio broadcaster in each market they operate.  Saga has historically focused on cities that are home to colleges, state capitals, and military bases due to the consistent levels of employment of these areas.  The Company’s largest market areas include Milwaukee (11% of revenue), Columbus (10% of revenues), Des Moines (6% of revenue), Charleston (6% of revenue), Norfolk (6% of revenue) and Portland, Maine (6% of revenues).  Unlike larger competitors including iHeart, Cumulus, and Audacy, Saga has avoided national branding and instead focuses on being a local radio station with close ties to their local community.  Saga generates 85-90% of its advertising revenue through local advertising.   Saga also takes pride in its local salesforce which works closely with area businesses to highlight the effectiveness of radio advertising and collaborates with these businesses to produce effective radio campaigns.  This focus is a key competitive advantage for Saga as it reduces competitive pressures and makes the Company less susceptible to changes in national advertising dollars.  

Saga has also made it a priority to own the real estate and towers in each of their markets.  Saga owns the real estate in all but one of their markets and the majority of its towers.  This represents another important differentiator for the Company as many competitors have monetized real assets through sale and leaseback agreements.  In addition to broadcast radio, Saga also generates revenue from digital advertising from its websites and audio streams.  Saga’s stations also generate non-traditional revenue from concerts, promotional events, renting tower space, and operating local digital newspapers.  

Pandemic Impact: COVID-19 represented a worst-case scenario for the radio industry.  Businesses that were forced to close found little reason to advertise while radio listening hours fell dramatically as commuters stayed home.  Saga revenues fell 22% in 2020 with Q2 2020 revenues down almost 50%.  Despite the sharp drop in revenues in a terrible operating environment, Saga generated positive operating profit in 2020 and almost $10 million in free cash flow.  In 2021, Company revenues rose 13% to $108 million and operating profit surpassed $15 million (14% operating margin). In Q1 2022, Saga revenues rose an additional 12% versus 2021.  Revenues remain about 10% below 2019 levels but operating profit has almost returned to pre-pandemic levels.  We attribute the improved profitability metrics to cost-cutting actions taken by Saga during the pandemic.  The Company has reduced headcount (800 employees today versus 1,000 at the end of 2019) while maintaining its ability to serve its local markets with local talent.  While meaningful, these reductions in workforce were much less severe than many of the Company’s competitors, and we believe Saga has actively added industry talent from competitors.  

Station Economics: Saga generates most of its revenues from local and national advertising.  In 2021, Saga generated 89% of its gross revenue from local advertising and the remaining 11% from national advertising.  While Saga has always focused on local advertising, national advertising has decreased as a percentage of gross revenue as iHeart, Cumulus, and Audacy have attempted to control national ad dollars.  Saga further subdivides its local advertising revenues into direct revenue and agency revenue.  Over half of the Saga’s local advertising gross revenues are generated directly from its internal salesforce.  Agency revenue (both national and local) is generally subject to a 15% commission which is deducted from gross advertising revenues to obtain net advertising revenues.  Station operating expense consists of employee expenses including on-air talent, Nielsen ratings data, internal commissions, and advertising.  Station operating expenses (except for commissions) are typically considered fixed, but Saga was able to significantly reduce these costs during the pandemic, with most of those costs being permanent in nature.  Station operating profit has historically ranged between 25-28% of sales, resulting in $25-30 million annually in station operating profit.  Saga’s SG&A has historically been between $10-11 million annually, and we expect similar levels of SG&A spending to continue going forward.  Saga has no meaningful interest expense and has a GAAP tax rate of 29% and a cash tax rate that is 5-10% lower.  

Political Spending, Digital Revenue, and Non-traditional Revenue: Even as the broader economy is showing signs of weakness, Saga has several positive developments in 2022 and beyond that should insulate the Company from an economic downturn or recession.  Political spending is again expected to set mid-term records in 2022.  In 2018, political revenue represented 2.3% of Saga’s overall revenue and we expect that percentage to increase in 2022 with the most of this spending occurring in the second half of the year.  In addition, while political ad spending tends to be focused on broadcast television, the additional demand for advertising during election years tends to increase advertising rates and benefit all types of media.  Digital revenue has also been a growth driver for the Company, with digital revenues increasing 86% in 2021 and 75% y/y in Q1 2022.  Saga has been slower to capitalize on the digital opportunity than their competitors and still has several markets to fully roll-out their digital product offerings.  Saga is also operating online newspapers in several of their smaller markets which has contributed to profitability.  Our conversations with management suggest these incremental revenues have similar margins as traditional broadcasting.  Saga expects their digital revenue to grow from 6% of sales today to 10%+ in the future.  Non-traditional revenue (6% of total) represents another growth driver for the Saga.  Saga is very active in its local communities in producing concerts and other events.  Many of these events were put on hold during the pandemic, and we expect this revenue base to continue to rebound in 2022 and beyond.  Finally, the auto market has historically been the largest contributor to ads revenues for the Company but has fallen to a distant 3rd as supply-chain challenges have reduced the supply of new cars on dealers’ lots.  We expect this headwind to diminish over time which should benefit Saga.  

Dual-Share Class Structure and Corporate Governance: Saga has a dual share class structure with 5,087,693 Class A shares and 965,149 Class B shares.  Class A shares are entitled to one vote while Class B shares receive 10 votes.  Ed Christian (age 77) founded the Company in 1986 and is currently the Chairman and CEO.  Mr. Christian owns all of the Class B shares, giving him effective control of the Company.  The Class B shares collapse into Class A shares upon Mr. Christian’s death.  We have met with Mr. Christian on several occasions and found him to be very knowledgeable about the radio industry and an honest individual.   Total compensation for Mr. Christian is higher than we would like ($3.2 million last year) but not egregious for the media industry.  TowerView LLC (the investment fund of the Tisch family) is the largest holder with 1.16 million shares (19.5% of total shares outstanding).  

Balance Sheet: Saga has an exceptionally strong balance sheet with $55 million in cash and no debt as of Q1 2022.  Nearly all of Saga’s competitors have highly-levered balance sheets with several going through bankruptcies and restructurings in recent years.  In addition to avoiding financial distress, the strong balance sheet has enabled the Company to attract and retain talent and maintain a long-term focus on operating the business.  Saga is likely one of the only companies in the industry with the capital available to pursue accretive acquisitions especially in the event of a market downturn.  In addition to the large net cash balance, Saga also owns almost all of its properties and towers.  The net book value of the company’s PP&E is $53.3 million.  We believe gross book value is likely a better way to value the land, buildings, and towers as these assets tend to appreciate over time.  The gross book value of the Company’s land, buildings, and towers is $14.6 million, $38.2 million, and $25.9 million, respectively.  The total gross book value of the land, buildings, and towers is $78.1 million, just shy of the enterprise value of the Company.  While we expect Saga will continue to own these assets for the long-term given the conservative nature of the Company, these assets could be a valuable source of capital should Saga ever be acquired by an outside entity.  Importantly, in a volatile economic environment we expect this base of cash and owned assets provides an effective floor value for the Company.  

Income Statement, cash flow, and capital allocation: We forecast revenues in 2022 to increase 8% versus 2021 to $118 million, driven by the continued recovery from COVID-19 combined with increases in political, digital, and non-traditional revenue.  In 2022, Saga expects operating expenses to increase 5-7% to $89 million, due primarily to increases in compensation.  SG&A is forecast at $10.5 million, resulting in 2022 operating profit of $19 million.  We forecast cash taxes of $4 million with depreciation slightly exceeding capex spending for the year, resulting in FCF of $15 million, resulting in a FCF yield of 19%.  

Saga has historically allocated free cash flow to dividends, share repurchases, and acquisitions.  After halting their dividend during pandemic, in June 2021 Saga reinstated a $0.16/share quarterly dividend and recently increased the quarterly dividend to $0.20/share (3.5% yield).  In addition, Saga paid a special dividend of $0.50/share in Q4 2021.  While the recent dividend payments have provided an attractive return to shareholders, given the Company’s large cash balance Saga could be much more aggressive in returning capital to shareholders.  We believe other shareholders have encouraged the Company to return a large portion of the current cash balance via a tender offer or large special dividend along with a variable dividend that returns a percentage of annual free cash flow to shareholders.  The lack of a larger return of capital is likely attributed to management’s conservative nature and concern regarding a potential economic slowdown.  In the event of a slowdown, the Company’s current cash balance should be a key asset potentially allowing Saga to enter new markets at attractive prices.  In addition to having capital to deploy, Saga’s focus on local markets likely makes the Company a more attractive acquiror, especially to a local radio station operator that would prefer to not have his or her company folded into a national brand.  

Valuation: Saga was valued utilizing a discounted cash flow analysis arriving at a target enterprise value of $135 million.  We added $55 million of net cash to obtain a target market capitalization of $190 million, or $32/share, representing 40% upside.  In the event the Company would look to monetize its asset base through a sale and leaseback transaction or an outright sale, the underlying value of the Company could rise substantially.  Saga’s large cash balance and owned asset portfolio provide a valuable margin of safety in the event of an economic downturn.  

Risks: There are several risks that should be highlighted:

• Broadcast radio revenue has not recovered from the pandemic and declining revenues would negatively impact margins and cash flows.

• Saga generates most of its revenues through advertisements which are subject to economic cycles.

• The CEO owns and controls the Class B stock that gives him control over Saga.

• Any potential acquisition pursued by the Company could prove unsuccessful.  

This report expresses our research opinions. Any information contained in this report may include forward looking statements, expectations, pro forma analyses, estimates, and projections. These types of statements, expectations, pro forma analyses, estimates, and projections may turn out to be incorrect for reasons beyond our control. Be sure to first consult with a qualified financial adviser and/or tax professional before making any investment decision with respect to securities covered herein. Following publication of any presentation, report or letter, we intend to continue transacting in the securities covered therein, including any purchases or sales, for any time hereafter regardless of our initial recommendation. All expressions of opinion are subject to change without notice, and we do not undertake to update this report or any information contained herein. Past performance is not indicative of future results.

Catalyst

Dividend increase, share repurchase program, asset sales, free cash flow generation.