Description
TV Azteca represents a compelling opportunity to invest in an underappreciated and misunderstood high quality, cash generative business at an extremely attractive valuation. To fully appreciate the enviable business position of TV Azteca, consider how valuable it would be in the U.S. if you could own a major television broadcaster, say NBC or CBS, and together with only one other player, you controlled the entire broadcast market. Further, consider how valuable that business would be if there was no chance of a new entrant in the market and cable and satellite television did not pose a major competitive threat. That’s the position TV Azteca has in Mexico as the #2 broadcaster with 30% market share in a very rational duopoly with Televisa.
TV Azteca’s value mainly consists of three pieces: (i) the Mexican broadcasting business which generates around $735 million in revenues and over $340 million in 2005E EBITDA (46% margin) – EBITDA should grow to over $400 million in 2006, supported by the World Cup and the Mexican presidential elections, (ii) a high growth U.S. network that is still in its infancy generating over $40 million in annual revenues and is currently about break-even at the EBITDA level, but is expected to contribute significantly to profits over the coming years and (iii) a 46.5% stake in the #3 wireless company in Mexico, called Unefon. The Company is in the process of spinning off Unefon to shareholders on a tax-free basis (should be a late 2005/early 2006 event), so I deducted the approximate value of that stake for valuation purposes:
Stock Price 6.00 pesos
Shares 2,973
Market Cap (Pesos) 17,838mm pesos
US$/ Peso x-Rate 10.65
Market Cap (US$) $1,675mm
Value of Unefon (300mm)
Market Cap Less Unefon Stake $1,375mm
Net Debt $565 mm
Media Enterprise Value $1,940mm
Media Enterprise Value /
2005E EBITDA 5.7x
2006E EBITDA 4.8
2005E EBIT 6.4x
2006E EBIT 5.3
Market Cap Less Unefon Stake/
2005E FCF 10.2x
2006E FCF 6.2
There are three interesting things to point out about the above valuation:
(i) These numbers attribute no value for the Azteca America (U.S. broadcasting) business given its current break-even status, but it should under all reasonable outcomes be worth at least a couple of hundred million dollars, given its high free cash flow potential, ability to leverage all of TV Azteca’s Mexican content and high growth position in the attractive U.S. Hispanic broadcasting market (as a side note, the Company has invested $130 million in this business);
(ii) The above valuation also excludes (1) approximately $50 million of value for the Company’s unconsolidated stake in a UHF Channel 40 (the Board already rejected a $65 million offer for the channel) and (2) around $20-30 million of value for Todito, a leading Spanish-speaking portal that the Company owns, but has not consolidated in historical results (the business should generate about $10-15 million in revenues and a few million dollars of EBITDA); and
(iii) The free cash flow generation of the overall Company is enormous given (1) low corporate taxes in Mexico (TV Azteca as well as many other Mexican companies realize an effective tax rate of only around 10-15%), (2) the low capex nature of the business (less than 10% of EBITDA) and (3) low working capital requirements due to the upfront payment feature around most of their advertising.
If you subtract the value of Azteca America at an estimated value of $200 million and Channel 40 at $50 million, the stock is trading at only 4.2x 2006E EBITDA and 5.0x FCF! Compare this to other global broadcasting companies that trade at 20x FCF and local competitor Televisa that trades at around 14x. Also, to add to the attractiveness of the investment, the Company is currently paying out approximately 50% of its free cash flow in the form of tax-deferred return of capital distributions to shareholders (the rest of the cash is used for debt pay down and stock buybacks). These distributions over the past two years have amounted to almost 25% of the current market cap and that figure rises to almost 30% if you exclude the Unefon stake that will be delivered to shareholders. These cash distributions should continue for years to come as the Company’s controlling shareholder, Chairman Ricardo Salinas, owns 60% of the stock through a holding Company that has about $170 million of debt (with his TV Azteca stock being the holding company’s only asset) and he uses those dividends to pay the high interest costs and principal payments on the debt. This would indicate around $350 million of future distributions (representing 25% of the market cap less Unefon stake) for the holding company to fully pay down its debt and interest costs. I would anticipate the distributions to continue well after Salinas has de-levered his holding company as the cash flow will be strong, TV Azteca has low leverage and Salinas will likely use the distributions to grow his own wealth and satisfy his personal liquidity/cash flow desires.
Why is the stock so cheap? Well, it mainly has to do with its ownership, which has overshadowed the Company’s ever-improving fundamentals. Ricardo Salinas is one of Mexico’s wealthiest individuals and most successful entrepreneurs, but he is certainly no stranger to controversy and criticism. The Company’s stock has been under pressure over the past year or so as the SEC has filed a civil complaint against Salinas for not disclosing his involvement in buying some discounted Unefon vendor financing from Nortel in early 2003, and then recovering par value from Unefon just months later following the sale of some of Unefon’s spectrum assets (I will discuss this in more detail later on, as it is quite important). In addition to some fines and disgorgement of profits, the SEC is seeking to bar Salinas from sitting on the Board of a U.S.-listed company. As a move toward prompting some form of resolution with the SEC, Salinas announced the delisting of TV Azteca's ADRs (and his other companies, Elektra and Iusacell) from the NYSE in May 2005, citing the high costs of Sarbanes Oxley. The Company will continue to be registered with the SEC, so it files 20-Fs and 6-Ks. Salinas contends that he did nothing wrong, and it is important to note that the SEC is mainly focused on fines against Salinas personally, not the Company. TV Azteca continues to trade, as it always had, on the Mexican Bolsa, a market which has seen growing global investor interest and the entrance of local pension funds, which only recently were permitted to buy stocks. The ADR delisting process has created a turnover in the shareholder base and heavy sell pressure on the stock over the past several months, and the SEC complaint has generally kept many investors away from the Company altogether over the past year and a half. Wall Street analysts are almost uniformly negative on the stock despite their bullish appraisal of the business, because they generally want nothing to do with a Company that is currently under SEC scrutiny.
While I believe the stock will always trade at a meaningful discount to the global peers and some discount to Televisa due to the controlling shareholder issues, I believe the current discount borders on the absurd and provides enormous upside with very limited downside, given the stable market position, high dividends, strong cash flows and very good underlying growth. Assuming a conservative 20% discount to Televisa multiples and approximately a 40% discount to the global broadcasting peers (which would put the valuation at only 11x FCF), the Mexican broadcasting business alone should be worth 8.50-9.50 pesos per share in one year’s time. I believe the U.S. business is worth at least 0.50-1.00 pesos per share, Unefon is worth about 0.75 -1.25 pesos per share and Channel 40 is worth about 0.20 pesos per share. I am ascribing no value to Todito, as it is small and will likely not be sold any time soon. Over the next 12 months, the Company will likely distribute around 0.40 pesos per share in dividends. This represents a 12-month target value of 10.35-12.35 pesos per share, representing about 70%-100% upside from the current value. Note: if the Mexican business traded in line with Televisa, the upside would be 12.35-14.35 pesos per share.
Sum-of-the-Parts (12mo. Forward Value) Low – High
Core Mexican Media Business 8.50 – 9.50 pesos per share
U.S. Network 0.50 – 1.00
Unefon 0.75 – 1.25
Channel 40 0.20 – 0.20
Next 12 months Dividends 0.40 – 0.40
Total Potential Value 10.35 – 12.35 pesos per share
BACKGROUND
—Overview—
TV Azteca is the second largest producer of Spanish-language programming in the world and the second largest television network in Mexico, with 30% market share compared to Televisa’s 70% market share. The Company owns and operates the channels Azteca 7 and Azteca 13 that are broadcast throughout all of Mexico. Televisa owns four stations and the government owns one. Due to technical limitations, there is no capacity in Mexico City for VHF spectrum for additional channels. Pay television represents less than 20% of the market and provides limited penetration opportunities due to the lack of affordability of that product to most of the Mexican population.
The Company operates in a very rational duopoly. Market shares are stable and TV Azteca is virtually assured its share of the market as advertisers need to keep two viable options available for their ad placements. Televisa has operated very rationally, adhering to strict cost controls to keep operating and talent costs low. Very simply, there is no incentive for either broadcaster to increase costs or reduce ad prices. In fact, the competitive environment is so benign that the two broadcasters collectively bid on special events such as the World Cup rights and Olympic rights in order to keep costs under control.
The domestic market is growing at 1.0x to 1.5x GDP on the top-line annually. Decent growth should be supported by the fact that Mexico is under-advertised vs. the rest of the world – advertising expenditure as a % of GDP is only 0.5% in Mexico vs. 0.9% in Brazil, 0.9% in Chile, 1.3% in the U.S. and 1.6% in Chile. Increasing competition in Mexico and a growing economy due to U.S. growth and strong government oil revenues are the main growth drivers. TV Azteca has ample spare airtime capacity to fully capitalize on the long-term growth, and the beauty of this business is that this growth will come with minimal additional costs or capital expenditures, so the free cash flow leverage is very high.
It is important to point out that TV Azteca also generates a meaningful portion of its revenues from “special events” that are lumpy in nature – mainly World Cup, Olympics and political elections. The interesting thing about buying into TV Azteca now is that they are heading into the year of presidential elections and the World Cup (a Mexican broadcaster’s “perfect storm”), which collectively should bring over $50 million of high margin revenue in 2006.
—Azteca America—
In order to leverage its Spanish-language content to capitalize on the growing U.S. Hispanic advertising market, TV Azteca created the Azteca America Network in 2001. This is a very attractive market given estimates of around 40 million Hispanics currently living in the U.S., with estimates of that number reaching over 60 million by 2020. Hispanics have accounted for 40% of the U.S. population growth. As a result, the advertising market targeting this segment has been growing at over 10% per year, but this segment still remains well under-penetrated as U.S. Hispanics represent 8% of U.S. purchasing power, but just 2% of domestic ad share. The total television advertising market for this segment currently is estimated at $1.8bn and should grow to around $2.5bn by 2009. TV Azteca is aiming to capture 10% of this market along with its affiliates (which roughly share half the revenue), bringing the Company’s revenue opportunity to $125 million – this is an aggressive goal, but given their 30% share in Mexico, it seems attainable. The profit margins associated with this revenue stream will be extremely high since almost all of the programming costs are already incurred in the Mexican operations. Assuming $40 million of Azteca America costs (based on Company estimates), the EBITDA and FCF potential from this business is $85 million (and additional revenue growth should flow through to FCF at extremely high margins). While this will take several years to fully materialize, it is clear to see how this can be a meaningful contributor to overall Company profitability, and it also highlights why this business should be worth well more than its $130 million investment.
Currently, the U.S. operations consist of a Los Angeles station and a national network. Combined, revenues have grown from around $14 million in 2003 to $36 million in 2004 and an estimated $45 million in 2005. Importantly, the network has begun to reach a critical mass with recent carriage agreements reached with Comcast, Cox, Time Warner, Echostar and DirectTV in key markets. Nielsen coverage is 70% giving the Company official national network status, which the Company believes will result in dramatically increased ad sales.
—Unefon—
Unefon is Mexico’s third largest wireless phone company behind America Movil and Telefonica Moviles with approximately 1.4 million users and $125 million in EBITDA. The Company focuses on low-cost prepaid telecommunications services to lower income individuals with coverage in 16 cities. The Mexican wireless market has been growing quickly as penetration levels have increased from 25% in 2002 to over 40% in 2005.
TV Azteca owns 46.5% of Unefon, with a Mexican businessman Moises Saba owning 46.5% and the public owning 7%. TV Azteca has separated its Unefon investment from its business by creating Unefon Holdings, which it is currently seeking to list on the Mexican Bolsa. This has been a long process, but it is expected to be completed either later in 2005 or early 2006. There have also been on and off talks with Nextel International about selling them this business. Ricardo Salinas also controls the number four carrier in Mexico, Iusacell, so there is a possibility that Unefon and Iusacell merge at some point in the future.
The value of Unefon has been publicly quoted (but with a very small public float) at a value that implies $300 million for TV Azteca’s stake, or 5.9x 2005E EBITDA. This valuation seems reasonable given the growth of the market and the company’s strategic value in a consolidated market. (Also, to illustrate the value of the Company’s spectrum assets, the company leased just around 30% of its 1,900 MHz frequency to America Movil for $268 million in 2003).
FINANCIAL PROJECTIONS AND VALUATION
Below are some rough projections for TV Azteca’s EBITDA and FCF, as well as implied valuation multiples. I broke out growth based on core domestic business, special events, and Azteca America. I ignored the value of Channel 40 and Todito for valuation purposes. As you can see below, with the cash build, you would effectively own this growing business at under 2.5x EBITDA by 2008 (after deducting the Unefon stake). Furthermore, the Company should be completely debt free by the end of 2008, making the cash flow yield to the equity all the more valuable as it will be a completely unlevered yield.
2005E 2006E 2007E 2008E
Estimated EBITDA (in $US mm)
Core Mexican Business Excl. Spec. Events $340 $360 $390 $415
World Cup 0 20 0 0
Presidential Elections 0 17 0 0
Olympics 0 0 0 15
Azteca America 0 3 20 30
Total EBITDA $340 $400 $410 $460
Interest (75) (60) (45) (20)
CapEx (35) (25) (30) (35)
Taxes (20) (30) (35) (45)
Working Cap & Other (incl. legal) (25) (15) (15) (25)
Other Non-Cash (Barter, Inflation, etc.) (50) (50) (50) (55)
FCF $135 $220 $235 $280
Dividends $80 $80 $80 $90
Debt Paydown 55 140 155 190
Ending Net Debt (Cash) 485 345 190 0
Current EV / Projected EBITDA 5.7x 4.9x 4.8x 4.2x
Current EV + Accumulated Cash / EBITDA 5.4x 4.0x 3.4x 2.4x
FCF Yield on Current Market Cap Less Unefon 9.8% 16.0% 17.1% 20.4%
SEC COMPLAINT
Early in 2005, the SEC filed a complaint against Ricardo Salinas and the Company for failing to disclose a debt deal between Salinas and Nortel in 2003. The target of the investigation has been Salinas personally, but the Company has been named in the suit given that it is the issuer of financial disclosures. The Company has sought to remove itself from the issue entirely through a court motion claiming it was uninvolved and unaware of the transaction. This is currently ongoing.
The issue dates back to early 2003 when Ricardo Salinas and Moises Saba (46.5% owner of Unefon) purchased $325 million of face value vendor financing from Nortel owed by Unefon at a price of $107 million. At that time, Unefon was struggling and Nortel just wanted to recoup some of its money and was content with the $107 million. Salinas and Saba restructured the debt to extend its term to give Unefon more financial flexibility. Three months later, as the economy and telecommunications industry started to regain steam, America Movil (the top wireless player in Mexico) was running out of spectrum capacity in Mexico City and leased spectrum from Unefon for $268 million. Unefon in turn used the proceeds to repay the debt at par, yielding a handsome profit for Salinas and Saba. It is unknown whether Salinas and Saba knew about the America Movil deal at the time of the debt purchase, but it is pretty clear that they understood the value of the spectrum.
The problem arises from the fact the involvement of Salinas in the purchase of the debt was not disclosed to the TV Azteca board or the public. The information came to light when Azteca’s lawyers, Akin Gump (who were involved in the structuring of the debt purchase), told Salinas he needed to disclose his involvement in the transaction. The issue was shortly thereafter made public through the NY Times. Salinas claims that Akin Gump originally told him of no need to disclose the matter since the transaction was not with a related party – it was in fact privately negotiated with Nortel. After the debt was repaid at par, Akin Gump reversed their opinion and the matter became public before Salinas and the TV Azteca board disclosed the matter themselves. As a result, the SEC is seeking fines, disgorgement of profit and a bar from Salinas serving on the board of a U.S. public company. Salinas has denied any wrongdoing and he recently announced the delisting of his three public companies from the NYSE – in effect, rendering the SEC’s ask for the director bar a moot point. The most likely outcome should be some sort of settlement over the next 12 months. In any event, this is mainly a Salinas issue and any fines against the Company should be small. The Mexican authorities already issued their fines and it amounted to $2.25 million for Salinas and just $50,000 for the Company.
RISKS/CONCERNS
—SEC Complaint / Governance —
The biggest overhang in the stock right now is a result of the SEC’s civil complaint against Ricardo Salinas and general concerns about governance and minority shareholder treatment. Of course, each investor must make his or her own determination of the impact/signficance of the SEC complaint, but in my opinion, Nortel was the real victim of Salinas’s profiteering since they sold debt that was really money-good at a discount (Nortel has not sought any damages as both parties agreed to end all disputes as part of the debt restructuring). One could make the case that Unefon or TV Azteca should have bought that debt and kept the discount for shareholders. While this argument has merit, the reality is that Unefon did not have the funds (which was the reason for the debt restructuring to begin with) and TV Azteca was already under minority shareholder pressure to cut off funding ties to Unefon since it was viewed as a “sink-hole”, having little or no value at the time. If TV Azteca used its own funds to buy that debt and say, a month later, the economy and business continued to deteriorate, then those funds would be at risk and that would have been scandalous given shareholder sensitivity to the Company’s use of the cash from the jewel Mexican broadcasting business. While there is no justification for what was poor behavior in not disclosing the purchase, I think the issue is of overall limited impact.
This is a tough case for the SEC to try given the issues with dealing with the Mexican legal system and the lack of precedent for applying recent U.S. disclosure laws to foreign filers. The SEC is generally a settling body and I would expect this case to ultimately be no different. There is a possibility that Salinas refuses to settle the case, but I would suspect if and when a trial approaches, settling the case for a reasonable sum of money would be to the benefit of all parties since it’s unlikely that Salinas would want to sit on a civil trial in the U.S.
Salinas has a reputation as a shrewd businessman and has a good business track record with each of his major business ventures being very profitable, but he has been highly criticized for questionable minority shareholder treatment – the major examples are the funding of Unefon out of TV Azteca in 1998 and the Nortel/Unefon debt deal in 2003. The Company has recently taken steps to improve its corporate governance and restore minority shareholder confidence. Following the attention and scrutiny that the debt deal brought to the Company, TV Azteca retained independent U.S. counsel to revamp its governance practices and as a result, the Company is increasing its independent directors and forming new independent committees to ensure better governance practices and strict review of any related party transactions or potential conflicts. The heightened public scrutiny should also make the Company cautious about actions that will be perceived to negatively affect minority shareholders. Additionally, the Company has responded to prior minority concerns by adopting a very shareholder friendly cash uses plan which details a commitment to cash distributions to shareholders (which the Company is on track to exceed) and debt repayment targets. It is also important to keep in mind that the majority of Salinas’s net worth is tied to TV Azteca stock and his interests are aligned with the minority shareholders in many respects.
—Rising Programming and Legal Costs—
Some bears have pointed to rising programming costs as a source of potential concern. For example, in the first six months of 2005, programming costs have risen 9% while sales have only risen 6%. There are two major reasons for this. First, is the build out of the Azteca America network – the dollar increase in costs for the network have thus far grown with revenues, thereby diluting overall margins. Second, the Company has increased its spend domestically to make sure it is well positioned with programming to take advantage of market growth. After the Company’s investment in programming this year, Azteca America build out costs will be largely complete and the Company’s domestic spend should be at adequate levels, allowing the Company to revert to its historical path of revenue growth exceeding costs. As mentioned earlier, the benign competitive environment supports a long-term favorable cost environment.
The Company has also been racking up large legal bills (below EBITDA, but included in FCF) primarily relating to the SEC complaint. I would suspect this to fall over the next year or so as the Company and Salinas approach some resolution.
—Mexican Economy—
The Company is of course exposed to any of the economic or political risks of Mexico. The Mexican economy has been on the upswing over the past two years due to U.S. growth and strong oil revenues, but has exhibited volatility in the past. Mexican risk can be hedged if desired through a short peso position, a Mexican bond credit default swap or a short position in a Mexican or Latin American equity index.
Catalyst
* Investors return focus to the great business and value
* Growing cash flow and dividends
* Increasing focus on the impending strong 2006 results, supported by the World Cup and presidential elections
* Growth and emergence of profitability in Azteca America
* Spin-off of Unefon
* Resolution of issues with the SEC
* Sale of the Company