Description

Buy TV Azteca (TZA $4.80) or Azteca Holdings June 2005 bonds
February 24, 2003

Summary
TV Azteca (TZA) is the number two TV network in Mexico’s television duopoly. It commands 30% of Mexico’s $2 billion TV advertising market. The other 70% goes to Grupo Televisa (TV).

TV Azteca’s core business is very well managed. It has generated about $125 million of free cash flow a year on average for the past four years. It benefits from a very stable competitive situation in terms of prices and market share. And, it has an attractive long term secular outlook. Mexico’s total ad spend as a % of GDP is still very low relative to most Latin American countries and to the US. Unlike the US, Mexico’s two networks are vertically integrated. They produce their own content. They own the broadcasters. And, they don’t face significant competition from paid TV, which they own anyway.

The stock’s valuation has been plagued since it came public by disappointments and the controversial behavior of the controlling shareholder. The stock came public at a rich valuation (mid teens EV/EBITDA) in 1997 when margins and market share were at their peak. The company proceeded to disappoint shortly thereafter as competitor Grupo Televisa regained some market share and programming costs rose to sustainable levels. In 1999 the controlling shareholder, unable to fund a commitment to invest in a wireless venture, invested on behalf of TZA, against the will of minority shareholders. In late 1999/2000 the stock benefited from a strong advertising market, the stock markets infatuation with meida companies, and the apparent early success of the wireless investment. In 2000, management broke it’s programming agreement with Telemundo, and decided to launch its own US Hispanic network, once again against the will of minority shareholders. To be fair, in the end not much value was actually destroyed, especially when compared to other global media companies that were caught in the internet craze. TZA will eventually have to recognize the loss of it’s equity investment in wireless (about $180 million including loan guarantees), but will recuperate 100% of its investment in Azteca America’s (about $140 million). But, credibility has been completely shot and opaque accounting and questionable inter-company transactions give most investors pause.

Summary Financial Information Stock price 4.80 2/24/2003
52 week high 8.85
52 week low 4.22
Shares outstanding 189
Market capitalization 907
Debt as of 12/02 594
Cash as of 12/02 134
Value of settlement with Pappas Telecasting (US bus) 138
Value of Unefon (20)
Enterprise value 1,249

2000 2001 2002
Revenues 564 633 645
EBITDA 198 260 266
Operating cash flow 184 168 86
Capex (19) (18) (23)
Other investments (105) (88) 0

Investment Case
The company is attractively valued given the quality of the business franchise. It trades at roughly 7x recurring free cash flow and 5.5x EBITDA. What has held the stock back has not been the core business, but rather the investment in other ventures and issues concerning corporate governance. There are now some catalysts in place that could result in a re-rating of the stock.


Company Description Pasted From Compustat
TV Azteca, S.A. de C.V. (TZA) is the second largest television broadcasting company in Mexico based on audience and market share. TZA owns and operates two national television networks in Mexico, Azteca 7 and Azteca 13.
These networks are comprised of 315 television stations located throughout Mexico that broadcast programming at least 23.5 hours a day, seven days a week. Two hundred seventy-two of the network's stations are repeater stations
that solely rebroadcast programming and advertisements received from the Mexico City anchor stations. The remaining 43 network stations broadcast local programming and advertisements in addition to the programming and advertisements supplied by the anchor stations. The Azteca 7 network primarily targets middle and upper income adults between the ages of 18 and 44. In 2001, the company produced 42% of the Azteca 7 network's weekday prime-time
programming hours and 21% of its total programming hours. The network's programming consists primarily of situation comedies, children's programs, news programs, game shows, sports broadcasts and major feature films. As of Dec. 31, 2001, the Azteca 7 network reached 95% of all Mexican television households. The Azteca 13 network primarily targets middle-income family viewers of all ages. In 2001,the company produced 100% of the Azteca 13 network's weekday prime-time programming hours and 73% of its total programming hours. The network's programming consists primarily of telenovelas, news programs, talk shows, musical variety programs and sports broadcasts, principally soccer. Telenovelas are the most popular programming genre in Mexico and are a key factor in attracting the network's target audience. In 2001, the company produced seven telenovelas, four of which were among the top five highest rated, regularly scheduled, prime-time programs on the Azteca 13 network. As of Dec. 31, 2001, the Azteca 13 network reached 97% of all Mexican television households. TZA continually evaluates strategic opportunities to expand its business and operations. In an effort to capitalize on the rapidly growing Hispanic market in the U.S., the company is developing its Azteca America network. In addition, TZA has an investment in the telecommunications industry, through Unefon, and an investment in the Internet marketplace, principally through Todito. The company also owns a recording company, Azteca Music, and a professional soccer team in Mexico.

Catalyst

Catalysts
The holding company, through which Ricardo Salinas Pliego controls TV Azteca, is leveraged and faces a liquidity crisis. Privately held Azteca Holdings’ only major asset is its 56% stake in TV Azteca. It has $279 million of dollar denominated debt. $150 million of that is in bonds maturing July 2003. The remaining $129 million matures in June 2005.

The ‘03’s are currently trading in the mid 90's and the ‘05’s are trading at a bid ask of 90-92 or 17% yield to maturity on the ask side. In order to refinance the 2003 Azteca Holdings debt, Ricardo Salinas needs to act decisively to convince debt holders that Azteca Holdings can service its debt. A simple rollover, as has been done in the past is not possible given where the bonds are trading. So, the controlling shareholder will have to upstream dividends from TV Azteca in order to pay down some of the ’03 bonds at par, and present a credible dividend plan to entice bond holders to rollover the remainder of the debt into a new issue with a longer dated maturity. The bond restructuring plan is in the works and will be completed in March or April. The dividend policy has already been disclosed (see TV Azteca press release dated February 7, 2002). The board of TV Azteca has approved a dividend plan that intends to distribute $500 million of dividends or, coincidentally 56% of TZA’s current market cap, in dividends over the next six years. TZA, in the Q and A section of its last conference call stated that will it pay a $110 to $120 million dividend in the next three months to help Azteca Holdings service with its debt refinancing process. This would result in roughly a 13% dividend yield to current stock holders of TZA.

There are two ways to play this. One is to own TZA stock. The stock has been firm in a declining market, but there is still a lot of skepticism out there. After the company pays the dividend and Azteca Holdings announces the debt refinancing plan, the multiples should expand slightly as investors begin to look focus on the cash generation and dividend paying capacity of the core business and worry less about the deployment of future cash flows. I believe that you get a $.60 cent dividend and the stock either holds its current levels or moves to a trading range of between $5 and $6 or 7.5 to 9 x free cash flow in the short term. The other way to play it is to own the Azteca Holdings ’05’s. They yield to worst is 17% and best of all, the bonds are over-collateralized by 1.6 times with TV Azteca stock. Regarding future governance issues, it remains to be seen. TV Azteca now has an independent board. The independence of the board remains to be seen. There was a questionable inter-company transaction in 2001 involving a sale of content to the parent that was later resold at a profit. Nothing questionable has taken place recently. The risk reward at current levels seems attractive.