Description
BACKGROUND
I’ll keep this brief, as it’s timely and the SBGI/TRCO deal saga has been well covered in the press. In May 2017, SBGI announced a deal to acquire TRCO for $43.50/sh ($35/sh in cash and .23 shares of SBGI per share of TRCO). SBGI anticipated the deal would close in 4Q’17, but subsequently pushed the timeline back multiple times. Last month, we found out all the delays were due to SBGI taking an extraordinarily aggressive posture towards deal structure, specifically regarding required divestitures. Instead of approving the deal, the FCC chose the rare course of referring the deal to an Administrative Law Judge (ALJ). You can read the Hearing Designation Order here: FCC Website. Historically, referral to an ALJ has been tantamount to killing the deal.
This action by the FCC was shocking, as Pai is perhaps the most broadcast-friendly FCC chair ever. But as the HDO details, SBGI in its hubris, believed it could steamroll its regulator and set new precedent in TV station consolidation. It was defiant right up until the end, and that was its undoing. The deal could have closed months ago, if SBGI had just followed the same course taken by itself and so many of its peers in past deals.
Yesterday (8/8) was the walkaway date for the deal, where either SBGI or TRCO could kill the deal without any breakup fee. Instead of addressing investors’ questions regarding this deal on their earnings call yesterday, SBGI chose instead to make ‘no comment’ on any issues related to the TRCO deal (very convenient…).
Today however, the path forward was clarified, as TRCO killed the deal and announced a $1bn lawsuit against SBGI. Read the full complaint here (it’s actually quite entertaining): Complaint for Damages. TRCO argues it is owed $1bn of “lost premium to Tribune’s stockholders and additional damages.” In addition to the >$700mm in market cap lost by TRCO as a result of SBGI’s actions, TRCO incurred transaction expenses, employee departures, and operational distractions during the >1yr while the deal was pending. This is in no way a legal opinion, but I find TRCO’s arguments compelling, especially in light of the disclosure from the FCC’s HDO. Street’s average 2018-19 EBITDA for SBGI is just over $800mm. So, anything approaching $1bn in damages will materially increase SBGI’s leverage and EBITDA multiple.
THESIS
As of 6/30, SBGI had over $1bn of cash on its balance sheet that it intended to use for the purchase of TRCO. In response to TRCO’s deal termination and lawsuit, SBGI announced a $1 billion share repurchase authorization. See here: Press Release.
The stock reversed its losses (down >5% at one point) and ended the day +3%. It is now more than 10% off recent lows, despite the prospects for SBGI having further deteriorated.
I believe the share repurchase authorization to be an empty gesture, meant to temporarily appease investors. In practice, SBGI will not (and perhaps cannot) return anywhere near that amount of capital to shareholders. If they were serious about returning capital, they should have utilized an accelerated share repurchase program. Instead, I expect any repurchases will be underwhelming. SBGI has never repurchased more than $140mm in a year, even though the stock spent significant time at/below its current level in each of the past five years. Furthermore, SBGI has 4.8x of gross leverage, based on 2018/19 average EBITDA. To spend all of its cash would be to increase leverage from 3.6x net to 4.8x. None of the broadcasters have ever taken leverage up that high except for highly accretive deals, with clear visibility to reducing leverage in 12-18 months. SBGI’s posture has never been toward aggressive capital returns – it has always been toward growing bigger. Nationwide ATSC 3.0 coverage has always been David Smith’s endgame, and I do not believe recent events have changed that.
Financial flexibility is key for SBGI. They still need to do a deal to gain the nationwide scale they desire, and more imminently, they are facing very significant lawsuits and legal expenses that aren’t going away. TRCO’s suit is certainly the largest and most apparent legal risk, but they are also facing class action suits related to price fixing (stemming from the DOJ review of SBGI/TRCO documents) and possibly class action suits by their own shareholders.
Beyond the imminent risk of legal settlements/damages, SBGI has irreparably harmed its standing in the industry and in DC. Hatred for SBGI from the left cannot be understated, and SBGI has even drawn the ire of conservative interests. There are likely to face significant issues acquiring any stations in the future. That is, of course, if any sellers will ever seek to transact with them again. For any seller, there is significant risk to deal closing if SBGI is the buyer, and sellers know that now. Even more daunting longer term is the risk to SBGI’s existing licenses, when they come up for renewal. This risk will only grow more acute if the Dems take back the FCC in 2020. Read more here:Bloomberg Article.
About the only thing SBGI has going for it right now is that they beat Street when they reported 2Q yesterday. However, every other broadcaster beat as well. Improving core and extraordinarily high political spending is a ‘tide lifting all ships’. However, from a valuation perspective, SBGI isn’t even that cheap. On fully taxed FCF, it yield ~15-16%. This is about inline with the group average. NXST yields ~17% and GTN yield ~20% (albeit with higher net leverage of 4.3x and 6.1x, respectively. On EBITDA multiple, SBGI trades at about a 1x discount to peers, BEFORE lawsuit damages. If SBGI is forced to pay anything near the $1bn TRCO is seeking in damages, its EBITDA multiple will actually be a premium to NXST/GTN/TGNA.
CONCLUSION
Whether as a standalone short or a hedge for long broadcaster exposure (NXST is my personal preferred long), SBGI has significant downside. Furthermore, the prospect for meaningful capital returns that pumped up the stock today is likely an empty gesture by mgmt as they seek to appease investors and shield themselves from the deserved wrath of their shareholders. Finally, just when significant supply of attractive assets are coming to market (e.g., Cox), SBGI is out of the game. NXST has the potential to see 30%+ FCF accretion from a deal like Cox, but SBGI likely has no M&A upside for the foreseeable future.
I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.
DISCLAIMER: DO NOT RELY ON THE INFORMATION SET FORTH IN THIS WRITE-UP AS THE BASIS UPON WHICH YOU MAKE AN INVESTMENT DECISION - PLEASE DO YOUR OWN WORK. THE AUTHOR AND HIS FAMILY, FRIENDS, EMPLOYER, AND/OR FUNDS IN WHICH HE IS INVESTED MAY HOLD POSITIONS IN AND/OR TRADE, FROM TIME TO TIME, ANY OF THE SECURITIES MENTIONED IN THIS WRITE-UP. THIS WRITE-UP DOES NOT PURPORT TO BE COMPLETE ON THE TOPICS ADDRESSED, AND THE AUTHOR TAKES NO RESPONSIBILITY TO UPDATE THIS WRITE-UP IN THE FUTURE.
Catalyst
Pending lawsuits against SBGI
Underwhelming share buybacks in 3Q
Ongoing negative headlines