Description

Situation Overview:

SBGI has been impacted by significant volatility & a lot of changes surrounding Diamond Sports Group (“DSG”) over the past 24 months, and we thought it fitting to provide an updated writeup to highlight (i) the hidden value / depressed valuation of SBGI’s core broadcasting business vs. comps given the overhang of Diamond Sports, (ii) a number of different upside levers that can accrete to equity value, and (iii) a management team working on righting its wrongs and maximizing value to shareholders through repurchases, dividends, and boxing the DSG risk. Our view is that DSG is currently treated by the market as negative value, when in reality it should be a zero given the non-recourse nature of a majority of the asset level debt.

Stripping out the impact of DSG on financials (which should be more apparent under the Company’s new disclosure methodology) implies that SBGI equity can be created at ~25-30% FCF yield / ~6x 2022/2023E EBITDA vs. Comps @ 15% FCF yield / 7.2x 2022/2023E EBITDA (and TGNA which has a bid to go private closer to ~8x EBITDA).

The Company has a number of non-EBITDA generating upside options that can drive equity value beyond just the discount to peers at current levels. It should be able to capitalize on (i) upside from a spectrum asset that is a few years away from monetization, (ii) warrants in BALY worth $2-3/share, (iii) potential upside from a new, fast growing OTT advertising business called Compulse, and (iv) value from a new high-tech JV with Nexstar or other broadcaster players.

For investors who would prefer to be higher in the capital structure / in a debt instrument, the SBGI 2030 bonds @ $80 offer a 9% yield for a bond that is 50-60% LTV in our view, offering yields that are wide to the HY index for similar/better risk, that the Company has been actively buying back.

Taiidea’s writeup from December 2020 provides a helpful jumping off point (explaining the history of DSG and the non-recourse nature of DSG’s debt stack), but I think there are upside levers that are not necessarily captured in the description, along with maybe an aggressive description of SBGI’s ability to take restricted payments given the stress at DSG that we wanted to clarify.

Business Overview:

I won’t spend too much time on the broadcasting business – katana had a great writeup on Nexstar from last year which is a very helpful overview of the broadcast model and provided a pretty comprehensive secular long thesis on broadcast TV. Sinclair is the 2nd largest broadcaster in the US, owning/operating 193 stations across 100 markets, and it predominantly owns stations affiliated with Fox, ABC, CW, and MyNetworkTV today. The business generates revenues by establishing stations in local markets to create content for MVPDs to distribute – earning margin through net retransmission fees and advertising revenues.

This industry has been facing challenges due to cord cutting / the decline of PayTV subscribers but has been highly FCF generative through the top-line decline / is harvesting cash flows.

Situation Background / Acquisition of DSG:

Again I will be relatively brief here given it has already been covered in previous writeups – SBGI is the parent of DSG, which it acquired in August 2019 from Disney at a TEV of $9.6BN. DSG is a Regional Sports Network, with broadcast rights agreements for 43 pro sports teams (15 MLB, 16 NBA, and 12 NHL teams). Since the acquisition, DSG has faced a number of challenges as revenues have secularly declined and costs have significantly increased – the pandemic served to exacerbate some of these secular changes.

Revenues are declining due to continued subscriber churn / cord cutting, along with MVPDs cutting out the RSNs entirely in their contract renewals as described below. This trend is not unique to Sinclair – NBC’s RSNs are also facing stress / contract losses per public articles. At the same time, costs are increasing and largely fixed given built in escalators into team rights relationships. And sports rights are only getting more expensive as they come up for renewal. For context, EBITDA guidance for FY’22 is ~$200MM, down from $1.6BN at the time of the deal.

There is significant reason to believe the RSN business model is just structurally broken (or at least, was significantly overearning for a long time) – historically, RSNs earned revenues by charging affiliate fees to every subscriber on its MVPD platform, which included charges to subscribers that may not watch local sports (which may only represent ~15-20% of the subscriber base on our industry research. Over the 15 years prior to the purchase of the RSNs from Disney, significant inflationary adjustments were made to affiliate fees to reflect materially rising sports programming costs. As cord cutting has reduced overall subscribers on MVPD platforms, the sports subscribers who are charged for RSN affiliate fees would be permanently removed from the platform. Some MVPDs began to view RSN affiliate fees as low hanging fruit to cut / reduce their cost offering to their subscribers (or improve their own margins). Most notably, Dish did not renew its agreement with DSG in July 2019 & Charlie Ergen has publicly called RSN fees unsustainable and uneconomic (and subsequently cut the NBC Sports RSNs out of their contracts in 2021). Hulu/YouTubeTV also walked away from their RSN contracts in September/October 2020, and while distributors like Charter & Comcast have renewed them thus far (on relatively short 2-4 year contracts), the increasing questions around RSN fees could force more negotiations downwards on future price. Another issue is that a return of canceled contracts at lower affiliate fees may trigger MFNs on existing contracts. An interesting thought for the sports fans out there is whether or not RSN overearning and the corresponding significant rise in team rights costs have been funding overearning by the entire sports ecosystem, but that topic isn’t as relevant to this discussion.

DSG’s growth strategy from here is largely predicated on (i) the launch of a DTC app to recoup customer demand of sports fans that have cut the cord / are moving OTT, (ii) a strategic partnership with BALY (DSG Networks were rebranded from FOX Sports to Bally’s Sports, which could tee up launches of content with Bally’s down the line), and (iii) marrying the RSN negotiations with MVPDs with Sinclair’s broadcasting rights negotiations – management has done this with Cox/Comcast where the distributor relationships have become co-terminus (although DISH declined to go down this path). An issue with all of these strategic pillars is that they are long-dated turnaround efforts – the DTC app was just launched (the Company doesn’t even have DTC rights for all of its sports teams yet), and the Bally’s future content is just that… in the future. In the near-term, DSG is hemorrhaging cash given its heavy cash interest burden, EBITDA is declining, and it may require a strategic solution sooner rather than later. 

DSG has its own separately financed debt stack, which, importantly as Taiidea highlighted, is non-recourse to SBGI at the parent level. The operating implosion at DSG has put stress on the capital structure, and DSG’s structure trades like it is teeing up a bankruptcy. It has been kind of a dramatic change – the Company did a new money deal in February of this year with existing creditors, raising $635MM – and the financial performance since then has been so bad (missing Management’s bear case released just 6 months sago) that it is approaching bankruptcy anyways. 2L Secured debt now trades <$20 and unsecured bonds trade <$10.

How does a DSG CH.11 filing impact SBGI? 

In terms of impact to SBGI, a break from DSG would allow for much cleaner financial reporting to highlight the inherent value of the business / core cash flow generation, which we view as significant. Historically, the Company provided just enough disclosure to do that (where investors could subtract the Diamond supplementals in their financial statements from the SBGI reported consolidated financials), but doing this math was messy and inconsistent given the changing reporting over time – SBGI’s financials were consolidated with DSG until earlier this year and then deconsolidated beginning halfway through Q1. Doing so shows $400-500MM of levered FCF at SBGI parent in non-political years and $500-600MM of FCF in political years, representing an average FCF yield of almost ~30%. To that end, the Company’s guidance implies $11.9-$12.70 per share of Adj. FCF for the year, vs. a current stock price of <$24 / share, although our view is that this ignores certain cash charges that make it modestly lower than that. Management has used this cash flow to delever and has been aggressive about capital return to shareholders – the Company has repurchased $165MM of stock over the last 4 quarters is runrating $70MM of dividends, representing total capital return of almost 15% of the market cap JUST over the past 4 quarters (and it bought back >$100MM of 2027 unsecured notes at a discount to par in Q2).

A negative impact of a DSG filing could be any clawback / claims asserted against SBGI. One thing that we disagree with in Taiidea’s writeup of SBGI in December 2020 is crediting SBGI with dividends from DSG or RP capacity -> while SBGI could theoretically take advantage of the RP provisions, given DSG’s precarious financial situation, RP out of DSG to SBGI given that DSG is likely insolvent would likely result in fraudulent conveyance claims against SBGI, and a subsequent remittance of any distribution taken out of DSG. To that end, separating the cash flow statements of DSG and SBGI shows that they have not taken any distributions historically out of DSG, besides repaying debt that was jointly guaranteed by DSG and SBGI (which would likely be permitted under the documents). There is about $170MM of that preferred stock still outstanding, which presumably SBGI would be responsible for. One other intercompany tie up is a management fee that DSG was charged by SBGI historically, which is no longer really paid in cash, but represents an affiliate transaction historically, which maybe has some clawback risk to it. However, this may only be a cumulative ~$200MM over the past 3 years, which would not move the needle very significantly (and our belief is that it was not a high margin management fee).

SBGI Sources of Value:

As I mentioned above, SBGI has significant sources of value sitting outside of DSG away from just the strong cash flow generation – I will address them briefly here:

• Warrants in BALY that are worth ~$2 / share at current market value and closer to $3 / share on a Black-Scholes Modeled value

•  A Tax-asset that sits at SBGI HoldCo from the amortization of SBGI’s basis in DSG, which management believes is worth up to $1.1BN

• Spectrum value of up to $1.7BN (Using a valuation of $1 / MHz-Pop for the Company’s owned spectrum) – monetization of this is likely several years away, but management calls it out on conference calls and it clearly is not reflected in the TEV today

• Non-cashflowing JVs held on balance sheet at $3 / share (which the Company believes are severely undermarked)

• Compulse – a fast growing OTT advertising platform which is expected to reach $100MM in sales in 2022 per management’s guidance

SBGI Sum of Parts:

Putting all of this together, we see significant SOTP value at SBGI, well in excess of the current market value, especially if the upside levers succeed.

This math conservatively excludes any value from a growth multiple on Compulse, any DSG equity value, and includes the negative impact of the DSG Preferred Stock that SBGI guarantees. It also deducts fraudulent conveyance claims that could be owed given the historical preferred stock redemption (even though they likely were permitted under the documents), and strips out the DSG management fee at a high contribution margin, which may be overly punitive to SBGI’s results. It also does not credit any recovery on an A/R facility that SBGI has lent to DSG, which is collateralized by receivables.

For reference, here are the comps we are looking at – Sinclair is demonstrably the cheapest valuation of the compset:

Importantly, while management has a questionable track record given their clear overpay for DSG, they have been fairly good stewards of capital and aggressive at shareholder return / capturing debt discount. Management has stated on public calls that they view their NAV to be >$60 / share. I highlighted management’s return of capital to shareholders above, and per their disclosure, that has continued post quarter-end. Their view of NAV will likely inform continued repurchases, and accordingly, I expect the discount to accrete over time.

Risks:

1)    Clawback / FraudCo claims from a DSG filing in excess of the amount we are assuming / other affiliate transactions that we are unaware of

2)    Faster decline in subscribers in the core business than anticipated

3)    Poor capital allocation into value destructive M&A instead of shareholder return a la DSG purchase

Catalyst

Filing or separation of DSG (either explicit or more standalone disclosure)

Continued earnings outperformance and capital return to shareholders