Description

Sinclair Broadcasting Group (“SBGI”), pro-forma for its acquisition of Tribune Media (“TRCO”’), will emerge as the largest independent broadcasting company in the US, reaching 72% of households. This transformational deal provides beneficial scale as well as significant cost and revenue synergies. We believe the recent sell-off in SBGI’s stock reflects the market’s misunderstanding of the financial benefits of the merger, business drivers for the broadcast industry, and potential FCC deregulation that could spur further industry consolidation. Given these factors, our view is that SBGI should re-rate to an 8.5x EBITDA multiple. Applying this multiple to our 2017/2018 EBITDA estimate, inclusive of all synergies, of at least $1.83B suggests over 70% upside from today’s stock price. Alternatively, a high single digit multiple on SBGI’s stated 2017/2018 pro-forma FCF per share guidance of $7 would yield a similar valuation. This upside does not include any value related to the broadcasting benefits of ATSC 3.0 or SBGI’s intellectual property ownership in the standard and the related monetization potential of excess spectrum.

History of Value Creation

Founded in 1971 by Julian Sinclair Smith, SBGI began operating with a single TV station in Baltimore and, pro-forma for the TRCO acquisition, has grown to over 220 stations in 108 markets. Chairman David Smith orchestrated this prodigious growth and, along with his family, will own an approximate 23% economic interest and 62% voting interest in the “new” SBGI. Despite having a dual class share structure, SBGI has demonstrated shareholder-friendly capital allocation: Over the last decade, SBGI has kept M&A confined to broadcasting assets and related adjacencies while returning capital to shareholders. In 2016 alone, SBGI repurchased ~8% of its float, a strong signal from management and the Smith family that they intend to create value for all shareholders.

Improving Revenue Profile

Today’s local broadcast revenue sources are more diverse and stable than ever. Approximately 40-45% of SBGI’s revenue base comes from highly recurring and less cyclical “retrans” and “carriage” fees related to their broadcast and Tennis Channel operations. Retransmission Consent or “retrans” fees are a recurring revenue stream where MVPDs compensate local broadcasters for retransmitting their signal to their subscribers. Local broadcasters in turn pay their affiliated network a portion of this “gross retrans” revenue, leaving them with a “net retrans” profit. “Gross retrans” fees should double over the coming years given that broadcasters deliver 34% audience share yet only get 14% of pay TV fees. Another 5-10% of SBGI’s revenues come from faster growing digital ad and marketing services. The balance of SBGI’s revenue comes from core TV advertising, which skews heavily towards more stable local ads versus national ads. While SNL Kagan estimates that both ad and “retrans” revenues will grow through 2020, we assume flat ad revenue (combining political, core, and digital) and low teens “net retrans” growth, which would lead to mid-single digit organic EBITDA growth.

Trends in Local Broadcasting

As the traditional media ecosystem rapidly changes, the financial drivers for local broadcasters appear misunderstood and should remain relatively defensible. Specifically, we believe that investors erroneously:

• Conflate trends in national advertising with that of local advertising

• Conflate cable channel subscriber loss with broadcaster channel subscriber loss

• Confuse competition in distribution and network-type content with the local broadcast business

• Attribute share gains in local digital advertising with meaningful share loss of local TV ads

• Undervalue local programming and the symbiotic relationship between networks and affiliates

By contrast, we believe that:

• Local ratings and local advertising trends are relatively stable

• Cord shaving or transitioning to basic pay TV packages will not impact broadcast TV subs as they are on the most “basic” tier packages; cord cutting may be offset by “OTT”/”Skinny bundles”

• Emergence of Amazon, Netflix, and Facebook as “content creators” establishes more competition for primetime network and cable scripted content, not local news and sports

• Direct mailing (25.3% local ad share), Print Newspaper (9.4%) to cede greater share to digital in the local ad market

• Local news is highly relevant to most of America; recent “retrans” and “OTT” deals prove both MVPDs and Networks value local broadcasters/affiliates

Merger Synergies

In our view, the SBGI/TRCO merger will create significant value given the powerful underlying financial and industrial rationale. Given the specific merits of the deal and the >40% accretion to FCF per share, we believe the recent sell-off belies the value created. The deal presents several idiosyncratic opportunities:

• Unusually large “retrans” synergies

• Unusually large programming savings opportunities

• Sizable corporate and station-level expense savings opportunities

Some of the weakness in SBGI’s stock may be attributed to a misunderstanding of the $100MM+ in “medium-term” synergies highlighted by management. We believe these synergies are readily attainable and should exceed $100MM. This can be illustrated by looking at just two of the four buckets called out by SBGI, namely “station level expense reductions” and “overlap market redundancies”:

1. “Station level expense reductions” - TRCO’s station level operating margins appear to be ~10% lower than SBGI when controlling for “net retrans” and WGNA. If we assume that only half of this gap relates to station-level non-programming expenses, we get $66MM in cost-savings.

2. “Overlap market redundancies” - FCC deregulation would enable SBGI to keep as many as 11 duopolies yielding an estimated $42MM in cost-savings.

Given the TRCO/SBGI transaction does not require an SBGI shareholder vote and certain incremental synergies are contingent on further deregulation, we believe SBGI’s management team is incentivized to provide conservative estimates and downplay further opportunities.

ATSC 3.0 – Free “Call Option

Finally, SBGI provides a unique “call option” on the new broadcasting transmission standard ATSC 3.0, an IP-based, mobile friendly standard that will help broadcasters reach consumers on whatever device they are using. Beyond enhancing the traditional broadcasting business, ATSC 3.0 will also enable the deployment of data on a “one to many” basis by utilizing excess spectrum not used for broadcasting. We believe SBGI could see the financial and commercial benefits of this new standard within 3 years. In addition, SBGI is the only publicly traded broadcaster with meaningful intellectual property in the ATSC 3.0 standard, which given Samsung’s and LG’s involvement, should eventually be deployed in both TV and mobile devices. Even if SBGI earns a modest royalty on a per device basis, the sheer number of mobile devices sold per year could yield a healthy eight-figure annual royalty stream at some point in the next 5 years.

Valuation

We believe the “new” SBGI is an even stronger company with organic mid-single digit EBITDA growth, plus ATSC 3.0 and the potential monetization of excess spectrum. The “new” SBGI is less cyclical and should command a premium multiple to its historical average of 8x EBITDA. Historically, periods of consolidation and deregulation are major catalysts for re-rating: We expect an easing of local market rules this fall, which would galvanize another wave of M&A. In addition, 2018 should be a particularly cash generative year for SBGI given its political footprint and intentions to sell its non-core real estate portfolio whose estimated value is in excess of $500MM. As such, organic delevering (20%+ FCF yield!) will shift value from debt holders to equity holders. Our view is that the stock is worth $59 per share with upside potential from ATSC 3.0 and the related potential monetization of excess spectrum.

Catalyst

FCC Deregulation In Fall 2017

Ensuing Wave of Consolidation

2018 Cash Generation + Sale of Real Estate Resuting in Delevering