Description

Description

Sinclair Broadcast Group is a U.S. media company with the largest collection of regional sports networks (RSNs) and local television stations in the country. The company owns 190 broadcast television affiliate stations in 88 markets, 21 RSNs, a 20% interest in the Yankee Entertainment and Sports Network (YES Network), a JV stake with the Chicago Cubs in Marquee Sports Network, and a digital direct-to-consumer platform. The stock is significantly undervalued due to a misunderstanding of the company’s unusual debt structure and its position as a critical pick-and-shovel sports betting beneficiary, offering 243% upside to our December 2021 target price of $99.17/share. Adjusting for the true debt exposure, as described below, the core business is trading at 2.6x EV / 2022E EBITDA.

Background

The company entered the sports media and betting markets in August 2019 through the transformational acquisition of Disney’s RSN assets, which the Justice Department’s Antitrust Division required Disney to divest during its acquisition of Twenty-First Century Fox; until now the RSNs have been branded Fox Sports. Sinclair acquired the RSNs in a highly leveraged, siloed transaction that, critically, provided no parent guarantee to bondholders and created carve-outs to allow Sinclair to extract ongoing cash flow from the silo without creating an event of default. Fixed income analysts have called the silo’s debt covenants among the loosest of any public company in history, a fact Sinclair insiders have taken advantage of through significant share repurchases but equity markets have not yet appreciated.

In November 2020 Sinclair entered into a second transformational transaction with Bally’s Corporation, an emerging interactive sports betting operator with direct licenses in eight states accounting for 80% of current U.S. sports betting revenues and with plans to enter further states directly or via sub-license (“skin”) arrangements. Sinclair will re-brand its RSNs under the Bally’s name in exchange for a 23% stake in Bally’s and ongoing committed marketing spend by Bally’s, incremental to Sinclair’s existing advertising revenue. Bally’s has indicated it will spend a large portion of its annual ~$175m in physical casino free cash flow towards marketing for sports betting and iGaming, a majority of which is expected to be spent on Sinclair’s RSNs. We conservatively benchmark this marketing spend to PointsBet’s estimated annualized marketing spend of $54m on NBC’s smaller RSN footprint.

Including the value of Sinclair’s stake in Bally’s and cash flow that can be extracted from the RSN silo to the parent, the core broadcasting business is trading at 2.6x 2022E EV/EBITDA, with upside optionality from a successful debt restructuring at the RSN silo and growth in sports betting. The stock is not only cheap by this analysis, the controlling family believed the stock was cheap enough to repurchase 21% of shares outstanding and 29% of the free float between March and August 2020. The company has consistently raised its regular dividend over the past ten years, paying special dividends twice, with a current regular dividend yield of 3%. The founding family controls the company through super-voting shares and owns more than a 35% economic interest in the company.

Business Model

Broadcast Silo (“Sinclair Television Group”)

Sinclair operates affiliate stations for the major networks, Fox, ABC, CBS, and NBC, plus other media and direct-to-consumer platforms. The segment generates roughly half of its revenues from distribution, i.e., carriage fees from multi-channel video programming distributors (“MVPDs”) like Comcast and OTT operators. The other half of revenues is derived from advertising: within advertising, local news accounts for ~35%, syndicated programming accounts for ~30%, network programming accounts for ~25%, non-RSN sports (including the Tennis Channel) accounts for ~10%. Carrier contracts representing 85% of Sinclair’s subscribers are three years or longer.

While much has been written about cord-cutting and the impact on broadcast programming, Sinclair’s broadcast distribution revenue has grown year-over-year for each of the first three quarters of 2020; local news has proven resilient, and the Sinclair news division has recruited several high profile former Fox News personalities to carve out a niche in issues important to Fox News viewers. Sinclair was one of the few media companies to host a Town Hall with President Donald Trump just weeks before the Presidential election, moderated by former Fox News host Eric Bolling. In January 2021 Sinclair will roll out a national headline news service called “The National Desk,” which will feature prominent news personalities and be broadcast weekday mornings across many of its network affiliate stations and its direct-to-consumer OTT platform STIRR.

Sports Silo (“Diamond Sports Group”)

This includes the acquired RSNs, which broadcast local NBA, MLB, and NHL games that are not nationally broadcast, based on contracts with the respective teams in each market; the average remaining life of these contracts is over ten years. This segment generates ~90% of revenues from MVPD distribution fees and the remainder through advertising.

The $10.6 billion acquisition of the RSNs was financed as follows: $700 million of cash on hand, $700 million in new debt issued by the broadcast segment (guaranteed by the parent), $1 billion in privately placed preferred equity (guaranteed by the parent), $4.9 billion in new bonds issued by Diamond and not guaranteed by the parent, and $3.3 billion in new term loans issued by Diamond and not guaranteed by the parent.

Debt Structure and Unusual Covenants

Other than the preferred equity, almost all of which has already been redeemed, there are no parent guarantees for the remaining $8.2 billion of debt at the Diamond silo. The company will not violate any leverage or debt incurrence covenants as long as the revolver is less than 35% drawn (it is currently undrawn). The indentures provide for two general restricted payments (“RP”) carve-out baskets that allow for a combined $1 billion transfer from Diamond to Sinclair, and it has an ongoing RP “builder basket” that allows for a recurring transfer of EBITDA - 1.4x interest from Diamond to Sinclair (which amounts to ~$500 million annually). Sinclair can also charge management fees to Diamond for joint negotiations, etc., although this would reduce Diamond EBITDA and hence the amount transferrable under the RP builder basket. Finally, there are additional carve-outs that allow for securitization facilities and cash for acquisitions in similar businesses, which can be used to boost EBITDA and the builder basket; we do not factor in this further liquidity transfer at the expense of Diamond creditors.

In purchasing the RSNs with this structure, Sinclair effectively paid $2.4 billion in cash and guaranteed debt in exchange for $1 billion of one-time cash flow transfers and an ongoing ~$500 million in cash flow. The soonest bond maturity is 2026, and by then Sinclair is likely to have negotiated contracts that will make it difficult for any third party to acquire the RSN assets in bankruptcy. For example, the Bally’s contract is with Sinclair parent group, meaning a third party acquirer of the RSNs in a potential bankruptcy would not receive sports betting upside, nor would it be able to share this potential upside when renegotiating contracts with teams.

While Sinclair has repurchased more than $330 million in shares this year and redeemed more than $800 million in preferred equity at par, Sinclair Television (Broadcast silo) bonds are trading close to par, but Diamond unsecured bonds are trading at 57c on the dollar. The bond markets are accurately reflecting the likely value transfer from Diamond to Sinclair.

In June 2020 $1.8 billion of Diamond’s 6.625% unsecured bondholders were given an offer to exchange their notes for 13.3% in cash and 46.7% in new secured 12.75% notes. Less than 4% of bonds held accepted the exchange offer, the remaining Diamond bonds subsequently traded down from 73c to 57c on the dollar (while Sinclair Television bonds and Sinclair Broadcast Group stock traded flat or higher since then). Diamond bondholders have begun to recognize their weak negotiating position, and a second attempt at an exchange offer is likely in the near future.

Below are the leverage profiles of both silos. We have adjusted the Diamond silo EBITDA by reducing the ongoing transferrable cash (builder basket RP) from Diamond to Sinclair; we have also reduced the Sinclair silo net debt by the net amount of the Bally’s stake and one-time general RP carve-outs (funded by 2021 Diamond cash flow), while adjusting the Sinclair silo EBITDA by adding the ongoing transferrable cash (builder basket RP) from Diamond to Sinclair. The effect of these adjustments, which the company has the right and the plans to make in actual cash, is that leverage at the Diamond silo is 12.7x EBITDA while leverage at the Sinclair silo is only 1.6x.

Valuation

While the core broadcast business trades at 2.6x EBITDA and direct peers TEGNA and Nexstar Media trade at 8.9x and 7.8x forward EBITDA, respectively, there is further upside to Sinclair Broadcast Group once it completes a successful debt restructuring of the Diamond Sports silo. We believe this is likely in the coming quarters, as the outstanding Diamond preferred will be redeemed in the near future, paving the way for Sinclair to threaten to extract cash from the Diamond silo to the benefit of Sinclair shareholders. 

We expect the Diamond bank debt to remain at par, the senior secured bonds to take a 10% haircut, and the senior unsecured bonds to take a haircut of 30%. These haircuts would provide a premium to current trading prices of 77c and 57c on the senior secured and senior unsecured bonds, respectively.

To reach our target price, we conservatively use the lower Nexstar multiple of 7.8x forward EV / EBITDA for the combined legacy sports and broadcast business (Sinclair has at least a two year tax shield); then we add the present value of Bally’s marketing spend and the net value of Sinclair’s equity stake in Bally’s. From this enterprise value we deduct the restructured Diamond net debt balance and the full Sinclair parent / broadcast net debt balance. This results in an equity value of $99.17/share.

Why Now

The narrative on the stock became increasingly negative over the summer, as cord-cutting accelerated and there was a general sentiment shift away from offline media. While we agree there has been a permanent shift in viewing habits, especially among younger viewers, some of the cord-cutting has already reversed, evident in the September quarter results of pay TV operators (some subscribers simply couldn’t pay their bills in the June quarter and have now resumed service). Live local news, as we can see from Sinclair’s results, and live sports are two of the most resilient segments within television, and they will remain appointment television for a large segment of the subscriber base (offline and online) for long enough to justify our target valuation multiple. The negative sentiment headwind and headline debt load explain why the stock is trading where it is, but it has not stopped the controlling family from effectively increasing its stake in Sinclair late into the summer.

We expect the narrative to change as the transformational Bally’s transaction attracts a new set of investors interested in sports betting. While we are wary of valuations in the B2C sports betting sector, the valuations have allowed even lower-tier operators to raise cash, which will be spent on customer acquisition for years to come. Sinclair benefits through its direct stake in Bally’s, but more importantly it benefits as a critical pick-and-shovel supplier of ad inventory to newly cash rich B2C operators.

Risks

Cancellation of Sports: The timing of a full resumption of professional sports is still unclear, and any negative news flow could impact sentiment for Sinclair stock. In practice Sinclair receives refunds from sports teams if scheduled games are cancelled, so the impact is neutral at worst; at best, Sinclair can negotiate better contract terms with financially stressed sports teams.

Accelerated Cord-Cutting: Despite this being a well-flagged risk, it could get worse. Local sports viewers who are only interested in the games and not in the supplemental RSN programming might opt to view games on streaming passes offered by the leagues. This would require viewers to access games via VPN, since local games are blacked out on league passes; we believe this would put the teams into direct conflict with the leagues if it becomes a meaningful trend, and some geo-fencing or other workaround allowing teams to maintain local broadcast (and sports betting) upside will result. Sinclair retains the rights to broadcast games over traditional pay TV and via streaming, and the company will likely remain the most profitable RSN partner for teams due its negotiating power and upside support from Bally’s. On the local broadcast side, Sinclair’s positioning in news (discussed above), its scale, and its cash flow will allow it to gain share organically and through accretive acquisitions as smaller peers struggle and competing local news bureaus are further gutted.

Management Credibility: While the company is acting in shareholder interests by negotiating loose bond covenants and repurchasing shares with cash flow that otherwise might have accrued to creditors, some analysts view management with suspicion. We believe this difficult negotiating period will be forgotten over time.

Catalyst

Diamond Sports Group Debt Restructuring: A quick review of the difference in bond trading prices in the two silos, as well as the effective stake increase by controlling family members, should indicate the consolidated balance sheet does not tell the full story. A debt restructuring at Diamond will allow sell-side analysts and prospective equity holders to look at a more reasonable consolidated debt load and play for the blue sky upside from sports betting.

Bally’s Roadshow and Analyst Coverage: Bally’s Corporation has undergone its own transformation in the past month, having rebranded from Twin River and entered into the transaction with Sinclair. Bally’s is planning to ramp up its investor relations activity in the coming two months and expects to receive research coverage from at least two bulge-bracket sell-side analysts. The direct integration of sports betting into a broadcast app is a unique proposition for Bally’s and Sinclair.

Further Share Repurchases: The company was repurchasing shares as high as ~$19/share prior to the Bally’s transaction. We believe the company was restricted from repurchasing shares during the Bally’s negotiation, but the company has renewed its share repurchase authorization, and we believe the controlling shareholders see deep value near current levels.

Acquisitions: It is likely smaller RSN portfolios (e.g., AT&T’s) and smaller broadcast portfolios will be available for sale over the next year, especially as regulations on ownership caps are expected to be relaxed; these potential acquisitions should be immediately accretive, considering Sinclair’s size and negotiating power with distributors and advertisers.