Description

Spanish Broadcasting Series B preferred stock is a speculation with near term catalysts and favorable odds for a positive outcome.  SBSAA's senior secured notes (the company's only debt) matured in April 2017 and were not repaid.  To repay the notes, SBSAA must refinance; however, SBSAA is contractually prohibited from incurring indebtedness to refinance the notes without the consent of the Series B preferred stockholders.  Consequently, SBSAA must restructure, either through Chapter 11 or through negotiations with the senior note holders and the Series B holders.  The most likely outcome of a Chapter 11 restructuring is that the Series B holders would own all or nearly all of the common equity.  SBSAA generates consistent EBITDA, and has minimal capital expenditure requirements, sizable net operating loss carryforwards, and favorable cash flow characteristics.  At the current price, purchase of Series B preferred creates the company at 7x EBITDA and a free cash yield of 19%.

SBSAA is a small cap stock, and the Series B preferred is a small issue and thinly traded.  Thus, this trade is appropriate for smaller funds.

BACKGROUND.

SBSAA is a Spanish-language media and entertainment company with radio and television operations.  The company produces and distributes Spanish-language content, including radio programs, television shows, music, and live entertainment through its multi-media platforms.

SBSAA owns and operates radio stations located in six of the eight most populous Hispanic markets in the United States:  Los Angeles, New York, Puerto Rico, Chicago, Miami, and San Francisco.  In addition to its owned and operated radio stations, SBSAA operates the AIRE Radio Networks with over 250 affiliate radio stations serving over 75 of the top U.S. Hispanic markets.  Radio revenue is generated primarily from the sale of local, national, and network advertising, and constitutes approximately 90% of the company's consolidated net revenue.

SBSAA owns and operates television stations in South Florida, Houston, and Puerto Rico.  The company's television stations and related affiliates operate under the "MegaTV" brand.  SBSAA produces over 70 hours of original programming per week, and broadcasts via its owned and operated television stations and through programming and/or distribution agreements with other television stations and various cable and satellite providers.  Television revenue is generated primarily from the sale of local advertising and paid programming and constitutes approximately 10% of the company's consolidated net revenues.

SBSAA also maintains multiple Spanish and bilingual websites, including www.lamusica.com, Mega.tv, and various station websites that provide content related to Latin music, entertainment, news, and culture, as well as the LaMusica mobile app.  In addition, SBSAA produces live concerts and events in the United States and Puerto Rico.

SBSAA's common equity was written up by rjm59 in October 2016.  I refer readers to rjm's writeup for additional background information.

CAPITAL STRUCTURE AND ENTERPRISE VALUE.

SBSAA has a relatively simple capital structure, consisting of senior secured notes due 2017, Series B preferred stock, Series C preferred stock, and Class A and Class B common stock.

Senior Secured Notes due 2017.  SBSAA has outstanding $275 million of senior secured notes due April 2017.  The notes matured on April 15, 2017; SBSAA did not repay the notes at maturity.  The notes bear interest at the rate of 12.5% per year (SBSAA is not required to pay default interest).  Interest on the notes is payable semi-annually each April 15 and October 15.  Although the company did not repay the notes at maturity, the company made the interest payment due April 15, 2017.

Series B Cumulative Exchangeable Redeemable Preferred Stock.  The Series B preferred stock has a liquidation preference of $1,000 per share.  Series B holders are entitled to receive cash dividends at the rate of 10.75% per year, based on the $1,000 per share liquidation preference.  All dividends are cumulative, whether or not earned or declared, and are payable quarterly in arrears.  As of March 31, 2017, 90,549 Series B shares were outstanding ($90.5 million liquidation preference), and aggregate cumulative unpaid dividends on the Series B preferred stock were approximately $67.7 million.

(Note:  Under GAAP, the Series B preferred shares liquidation preference and the accrued unpaid cumulative dividends are classified as debt on SBSAA's balance sheet, and accruing quarterly dividends are recorded as interest expense.  However, under Delaware law, SBSAA's state of incorporation, the Series B preferred stock is deemed equity.)

On October 15, 2013, each holder of Series B preferred stock had the right to request that SBSAA repurchase all or a portion of such holder's shares at a purchase price equal to 100% of the liquidation preference of such shares, plus all accumulated and unpaid dividends.  On October 15, 2013, Series B holders requested that SBSAA repurchase 92,223 Series B shares.  SBSAA did not have sufficient funds legally available to repurchase all of the Series B shares for which SBSAA received requests and instead repurchased a de minimus number of shares.  This resulted in a "voting rights triggering event" with respect to the Series B preferred stock.  The voting rights triggering event continues until (a) all dividends in arrears have been paid in full and (b) all other failures or defaults giving rise to the voting rights triggering event have been remedied or waived by the holders of at least a majority of the outstanding Series B shares.

During the continuation of a voting rights triggering event, the holders of the Series B preferred stock have the right to elect two members to the company's board of directors (the common shareholders continue to elect six directors to the board).  In 2014, Series B holders nominated and elected Alan Miller and Gary Stone to serve as the Series B preferred stock directors.  Until his retirement in 2005, Alan Miller was a partner in the business, finance, and restructuring practice of the Weil, Gotshal & Manges law firm.  He served as the trustee of the Collins & Aikman Litigation Trust during Collins & Aikman's Chapter 11 restructuring, and is serving or has served on the boards of (among other companies) Samson Resources Corporation and Friendly Ice Cream Corporation.  Gary Stone has 40 years of experience in the broadcasting industry, including 25 years with Univision Radio, of which he served as COO for 10 years.  Miller and Stone remain on the board.

In addition, during the continuation of a voting rights triggering event, the company is prohibited from incurring any indebtedness, including indebtedness to refinance the senior secured notes.  Thus, unless and until SBSAA cures the defaults underling the voting rights triggering event, it cannot refinance the senior secured notes.

As of September 2012, Lehman Brothers Holdings, Inc. owned approximately 38% of the Series B shares, and Lehman nominated Alan Miller and Gary Stone to serve as Series B directors.  Current ownership is unknown.

Series C Convertible Preferred Stock.  The Series C preferred stock is essentially a placeholder for common stock.  The Series C preferred stock was issued to CBS in connection with SBSAA's purchase of a San Francisco radio station from CBS.  Series C shares have a negligible liquidation preference and are due dividends on parity with common stock.  Series C shares are convertible into Class A common stock (two Class A common shares for each Series C preferred share).  Series C shares have voting rights commensurate with the Class A shares into which they are convertible.  There are currently 380,000 Series C shares outstanding, all of which are held by a trust of which Raúl Alarcón (SBSAA's chairman and CEO) is the trustee.

Common Stock.  SBSAA has two classes of common stock – Class A and Class B.  As of May 17, 2017, there were 4,166,991 Class A shares outstanding and 2,340,353 Class B shares outstanding.  Each Class A share is entitled to one vote and each Class B share is entitled to ten votes.  Raúl Alarcón holds over 18% of the Class A shares and over 99% of the Class B shares, and thus holds voting control of over 85%.

Enterprise Value.

RECENT FINANCIAL DEVELOPMENTS.

Spectrum Auction.  As reflected in rjm's writeup, SBSAA had high hopes for the Federal Communications Commission's 2016 auction of broadcast television spectrum.  In January 2016, the company filed applications to participate in the FCC's spectrum auction with respect to its television stations in Miami, Houston, and Puerto Rico.  SBSAA intended to use the (hoped-for) substantial proceeds to pay down debt and increase its financial flexibility.  Actual results were disappointing.  Consequently, SBSAA relinquished its spectrum for a single station in Puerto Rico and retained its television stations in Miami and Houston and its two remaining stations in Puerto Rico.  The company expects to receive from the FCC cash proceeds of $4.7 million from the Puerto Rico station spectrum sale in the fourth quarter of 2017.

Failure to Repay Notes; Forbearance Agreement.  As noted above, SBSAA's senior secured notes matured on April 15, 2017 and were not repaid.  The company did, however, make the interest payment due April 15, 2017.

On May 8, 2017, the company entered into a forbearance agreement with a group of holders of more than 75% of the senior secured notes; the forbearance agreement became effective on May 17, 2017.  Pursuant to the agreement, the holders agreed to forbear from exercising their remedies with respect to certain defaults under the notes indenture until May 31, 2017.  As part of the forbearance agreement, the company agreed to make monthly (as opposed to semiannual) interest payments on the notes for the periods of April 15, 2017 through May 15, 2017 and May 16, 2017 through June 15, 2017.  The company made the interest payment due May 15, 2017.  The interest payment that accrued for the period from May 16, 2017 through June 15, 2017 was due on June 15, 2017.

The forbearance agreement terminated on May 31, although pursuant to the agreement the company agreed to make a monthly interest payment on June 15.  Because the agreement terminated, the note holders are free to pursue remedies under the note indenture.  The company has provided no disclosure in that regard, nor has the company confirmed that it made the interest payment due June 15.  However, as discussed in the next paragraph, the company did announce that it was using property sales proceeds of approximately $10 million to partially pay the senior notes.

Property Sales.  On June 9, 2017, SBSAA sold its facilities in West Los Angeles, California for $14.7 million.  Net proceeds of approximately $10.3 million were used to repay a portion of the outstanding senior secured notes.  The company has also listed for sale an 11,421 square foot property located at 26 West 56th Street in Manhattan.  The listing price is $17 million, dropped from $19.75 million.  Given the property's location and unique character, a realized price of at least $11 million ($1,000 per square foot) seems realistic.

FINANCIAL PERFORMANCE.

Terrestrial radio faces challenges, and by no means can it be classified as growth industry.  However, it is not dying – the ice cube is not melting.  Over the past five years, SBSAA's radio revenue and EBITDA have been virtually flat (see below).  Further, compared to the American market as a whole, SBSAA's target market has favorable demographics – it skews younger, has higher population growth, and over time will constitute an increasing share of the country's middle class.  Although media business forecasting is especially fraught, I believe an assumption of steady EBITDA (neither growing nor shrinking) is not unreasonable.

Radio Revenues and EBITDA ($ millions):

As noted in the introduction, SBSAA has minimal capital expenditure requirements and sizable NOL carryforwards ($280 million* at YE 2017).  Accordingly, free cash flow conversion is high.  Assuming a proper price, a business that throws off steady free cash flow makes an appealing investment.

* With proper planning, the conversion of Series B preferred stock into common equity in connection with a Chapter 11 reorganization should be eligible for the special rules of Internal Revenue Code Section 382(l)(5) or 382(l)(6), meaning that a significant portion of the NOLs should remain available after a Chapter 11 reorganization.  An out-of-court restructuring may potentially result in material limitations on the use of the NOLs.

RESTRUCTURING.

It is difficult to conceive that there would be any recovery by common stock shareholders in a Chapter 11 reorganization.  Put differently, common stock recovery in a Chapter 11 reorganization should be zero.  Consequently, assuming the senior notes are refinanced with new debt in a similar amount, the most likely outcome of a Chapter 11 restructuring is that the Series B shareholders own 100% of the common equity of the restructured entity.

However, it seems unlikely that Raúl Alarcón would give up control of the company, and accept nothing for his holdings, without a fight.  Alarcón owns over 40% of the common equity (Classes A and B), and controls over 85% of the voting power.  He is the chairman and CEO, and historically been well compensated ($3.5 million in 2014 and over $2 million in both 2015 and 2016).  A protracted contested Chapter 11 proceeding would be a boon to attorneys and consultants, reducing the ultimate recovery to legitimate claimants.  It is conceivable that the company's current cash balances, plus the proceeds of the sale of its Manhattan property and Puerto Rican spectrum, could be completely depleted by the conclusion of the proceedings.  A protracted bankruptcy may also damage SBSAA's business operations and its commercial relationships, in some cases perhaps irreparably.

On the other hand, SBSAA would enter the proceedings with substantial cash balances, and the company generates significant cash flow before debt service.  Accordingly, DIP financing should not be required, and the company should have the wherewithal to survive protracted proceedings.  Furthermore, a change of control in an out-of-court restructuring may result in Section 382 limitations on the company's NOLs, thereby reducing the value of the post-restructuring entity.  Thus, in negotiating an out of court restructuring, it is worthwhile to the senior note holders and, especially, the Series B holders, to give some value to Alarcón and the remaining common shareholders, and there is room to do so.  However, I don't believe the price should be high.

If I were negotiating an out of court restructuring for the Series B holders (I am not), I would be willing to give the common shareholders up to 10% of the (new single class of) common equity (i.e., no more dual class shares), and I would probably be willing to give Alarcón a board seat.  However, if the price of avoiding an in-court restructuring was Raúl Alarcón's retention of voting control and continuation as chairman and CEO, then unless I was receiving a significant cash payment for my Series B shares, I would take my chances in Chapter 11.

Obviously, the range of possible outcomes in a negotiated out-of-court restructuring is large, with numerous permutations in cash payments, new securities, etc.  However, I believe that (1) the most likely outcome of a Chapter 11 restructuring is that the Series B shareholders own 100% of the common equity of the restructured entity, and (2) assuming competent negotiation by the Series B holders, the value to them of any out-of-court restructuring should, at a minimum, be equal to the most likely result of an in-court restructuring.  Accordingly, my base valuation is based on the Series B holders receiving 100% of the common equity in a Chapter 11 reorganization, taking into account the cash depletion that would result from the proceedings.

VALUATION.

Below is a base case valuation post-restructuring.  Assumptions include:

• The Series B preferred receives 100% of the common equity in the restructuring.

• The senior notes are refinanced with debt in the same amount bearing the same rate of interest (12.75%).

• Flat financial performance post-restructuring compared to actual 2016 results.  This does not account for impaired results that may potentially result from Chapter 11 proceedings; however, it also gives no credit for potential reductions in SG&A and corporate expenses, which I expect have room for cutting.

• No credit is given for the company's current cash balance or for cash flow generated during the Chapter 11 proceedings (put another way, assume that the attorneys and consultants end up with the cash).

• No credit is given for the partial payment of the senior notes from the sale of SBSAA's Los Angeles property.

• No credit is given for the sale or value of the Manhattan property or for the proceeds from the sale of the Puerto Rican spectrum (assume the attorneys get that too).

Enterprise Value - Series B Preferred Converted to Common Equity:

Under the foregoing assumptions, the current valuation of the Series B preferred creates the company at 7x EBITDA; comps range from 6.3x to 16x, with an average of 10.4x.  The estimated free cash flow yield is 19%.  If the company is able to retain a portion of its existing cash, and the sales proceeds from the sale of the Manhattan property and Puerto Rican spectrum, these metrics would improve (most likely through a reduction in the amount of refinanced debt).  In addition, I would be surprised if the company could not obtain a lower interest rate on its refinanced debt, either by borrowing entirely from a bank or banks, or through a combination of bank debt and other debt.  A 400 basis point interest rate reduction (to a still generous 8.75%) would result in annual interest savings of over $10,000, doubling free cash flow.

RISKS.

Protracted contested Chapter 11 proceedings dissipating cash and irreparably damaging the business, materially reducing the value of the post-restructuring entity.

In a bid to retain control, Raúl Alarcón takes actions prior to restructuring that irreparably impair value.

The Series B holders negotiate a poor out-of-court restructuring (e.g., a substantially lower percentage of the post-restructuring common, and Alarcón retaining control of the company).

Terrestrial radio is dying and future financial results reflect that.

Catalyst

Negotiated out-of-court restructuring.

Chapter 11 proceedings.