Description

What’s one indicator that sentiment is negative on a stock?  How about a 12.5% dividend yield? Or a cash flow yield of over 30%?  Salem Media self-identifies as “America’s leading multimedia company specializing in Christian and conservative content, with media properties comprising radio, digital media, and book and newsletter publishing.”  This is of course a fancy way of saying “radio company driven by necessity to expand into other media.” Also the book and newsletter publishing division hasn’t made a meaningful profit (positive or negative) in at least twelve years, so ignore that part.  The company owns and/or operates 116 radio stations in 39 markets, including 73 stations in 23 of the top 25 markets, making it one of three broadcasters with radio stations in all top 10 markets and the sixth largest commercial radio broadcaster in the U.S.  Here’s the company in a nutshell:

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Let’s get the following out of the way: Salem has a significant debt load and is a small company facing much larger aggressive radio competitors and continued share losses to digital advertising.  If performance drops significantly from here, the stock could be a zero. It is unlikely to be a very large position in anyone’s portfolio. However, with the stock trading at what is essentially option value, a management team that owns over half of the company, and a 30% cash flow yield directed squarely at debt reduction, this can be a multibagger.

It is not surprising that investors have left an illiquid, leveraged radio company with declining revenue for dead.  I think for the following reasons that this is unwarranted:

Point 1: Radio isn’t newsprint (not yet at least) and Salem’s revenue trends aren’t as bad as they appear on the surface

Radio is old media and is losing share to better-targeted digital options, but this hasn’t yet resulted in newsprint-like consistent 8%+ annual declines.  I don’t think anyone can make a credible prediction about how much more share is going to go to digital and how quickly. However, the reports I keep coming across (PWC, Pivotal Research, Winterberry Group, etc.) have radio somewhere between negative 3% and positive 3% annual growth, in most cases slightly growing, reflecting an environment in which media buyers aren’t signaling a rapid and precipitous drop in radio spend.

Before digging into the underlying revenue, it is worth noting that the drop in Salem’s stock price from $3 to $2 coincided with the company’s Q119 revenue guide of minus 3-5% (this was after delivering flat growth for most of 2018 and trading around $4-$4.50 for the first three quarters of the year), implying 50% to 100%+ upside just for stabilizing the business.  Salem’s Q219 guide for ex-political revenue is growth of 1-3% but the market appears to want to see it before giving credit for it.

On a normalized basis Q119 revenue declined only 2.2%, but this was obscured by lower political revenue in a non-election year, Easter falling in Q118 and Q219, and a publishing schedule that favored Q118 and Q219 but not Q119 (again: ignore publishing.  It’s been break-even for over a decade and has less than $1mm in assets to liquidate). So what we have is not a 5% declining business that is getting worse, but a 2% declining business that is allegedly returning to single digit growth.

Salem also had fewer stations in Q119 than Q118, so on an average-station basis, broadcast revenue declined only 1.6%, implying a fully adjusted consolidated revenue decline of only 1%.  Of course in a leveraged situation you can’t just sell off stations to goose revenue growth, but my point is that this is far from a 5% and getting worse revenue decline situation, raising the potential for a quick rerating when normalized performance is reflected in the financials.

Over 40% of Salem’s broadcast revenue is provided by block programming, which should remain a stickier and less economically sensitive revenue stream due to (a) long-standing (in some cases decades) customer relationships that become increasingly beneficial to customers as they develop a following on Salem’s stations and (b) the fundamental difference between the objectives of a Christian ministry radio show (attract a community of listeners and encourage them to give money) and a spot that attempts to sell a physical product.  The latter can be much more easily and trackably accomplished with a clickthrough ad while the ministry can’t expect to “meet people at the point of purchase” with a display ad and may be better served by reaching as broad of an audience as possible who may or may not be “ready to purchase”.

Finally, Salem may benefit from its “Salem Surround” initiative, which is essentially the creation of an internal ad agency targeting small local advertisers, who it believes are underserved with respect to media buying expertise.  Salem’s objective is to reclaim a portion of the local advertising revenue that radio is losing to digital by leveraging existing customer relationships and selling media planning and buying services to these customers. This may or may not ultimately work but it is a second opportunity for Salem to outperform the general radio advertising market.

Point 2: With over 50% ownership of the company, management is keeping a close eye on its basket and has proven its ability and willingness to cut costs when necessary

From the 2007 peak to 2009, Salem’s broadcast segment lost $34mm or 16.5% of its revenue.  Although broadcasting tends to be a mostly fixed cost business (radio station rent, staffing, etc.), the company was able to protect $31mm of EBITDA by cutting costs per average station by 16% to $1.15mm and reducing Corporate expense by 37% including company-wide (including senior management) salary cuts.  Since Digital and Publishing were slightly up during that period, total EBITDA declined by just over $1mm. Capex also was cut from $15.9mm to $3.7mm.

Broadcast expenses per station haven’t returned to pre-2009 levels, but they’ve increased about 10% so while likely not a lot, there may be some expenses to take out if necessary.  Salem has kept its corporate expense low since 2009, suggesting that there isn’t a lot of additional fat to cut there, but capex has returned to $8-9mm over the last couple of years so that could be temporarily reduced if necessary to further reduce leverage.  As a reminder, we’re not talking about streamlining operations here. These cuts would be last resorts to avoid a default. Given the management team’s ownership position (both percentage- and dollar-wise), it feels like we’re all on the same side of the table and Salem is willing to cut as deeply as necessary, including accelerating asset sales.  To the extent cash flow allows, Salem will continue investing in its Salem Surround initiative.

Point 3: Salem’s high cash conversion should provide an attractive cash flow yield for the equity as well as accretive deleveraging

Salem’s Q219 guidance for non-political revenue growth of 1% to 3% represents a significant improvement in the company’s revenue growth trajectory, including the strongest guidance and performance since Q117 (at which time the stock traded around $6.50-$7.50 / share).  One implication is that Salem’s investments in its digital strategy are gaining traction. The table below illustrates this implied shift in trajectory:

My model gives the company partial credit for the continuation of this performance improvement with revenue continuing to grow at 1%.  Salem won’t pay cash taxes for a long time due to its NOLs, interest expense, and depreciation. The company has been able to repurchase its bonds in the low 90s, providing some extra impact to its deleveraging.  I assume that this continues, resulting in lowered interest expense. At 5x 2020E cash flow, the stock is worth $3.18 or ~50% up from here. At 5x 2022E cash flow it’s up 90%. Given the uncertainty of radio and Salem’s operating and financial leverage, a cash flow multiple is more appropriate than a dividend yield, however this model “charges” the dividend to debt payback, so equity shares also receive a 12.5% dividend yield on top of the above returns.  Although the market is signaling strongly its expectation of a dividend cut, I note that this operating case ends 2023 at 4.75x leverage (cumulative 5-year debt paydown of ~$55mm), which is in the range of 4x to 5x that management has stated it desires when it is time to refinance the bonds in mid-2024 so the dividend may stay in place but I would not be at all surprised to see it cut to provide some extra breathing room.

Obviously with a levered situation like this, the EV-based equity valuation is very sensitive to the multiple.  At 6x EBITDA with the dividend in place, the equity is impaired until it hits $2.71 in 2022. At 8x EBITDA with no dividend, the equity is a 2.3x in 2020 and a 3.5x in 2022 (using $25mm NOL value, which is significant relative to market cap).  Although 8x feels high for a number of readily apparent reasons, Salem has certainly traded at 8x and higher for extended periods in the recent past on financial results and a radio outlook that were only marginally better than where we are today, if at all.  Salem’s trading history suggests that a couple quarters of operating improvements could result in a rerating that snaps the share price back to $4/share or higher. 

Risks

1. Further losses of share from radio to digital and other media

2. Aggressive price competition from other broadcasters in spot advertising market

3. Temporary stock price hit from dividend cut (though will accelerate deleveraging and may provide a good buying opportunity)

4. Multitude of related party transactions.  The founding members of the management team are personally involved (and have been for decades) with a number of radio stations and organizations that do business with Salem in various ways.  These transactions appear above-board and aren’t terribly large in the context of Salem’s income statement

5. Significant debt load.  Bonds don’t mature until mid-2024.  Also, fun fact about the springing fixed charge covenant in the ABL: Due to what appears to be a drafting error, the availability-based covenant technically never springs.

6. Dual share class gives voting control to founders/management

7. Advertisers step back from conservative / political content

Catalyst

1. Salem reports in the afternoon on Thursday August 8th.  Look for guidance that reflects continued traction in digital/Surround initiatives, return to nominal growth, continued expense control, and cash generation/deleveraging.

2. Further quarterly cash generation and deleveraging

3. Three quarters of (slightly) increasingly easy revenue growth comps followed by additional political ad revenue for the 2020 presidential election

4. Potential to sell off certain stations to a buyer who will reformat them, i.e. certain properties may be much more valuable to someone else