Description
Summary:
First, because of the spin-off, there is structural selling pressure. Second, the merger with a complex business has created a complicated story, thus, hiding true earnings. Third, Triple Crown might be getting a newspaper discount. These factors have created an undervalued company.
Adjusting for excess (non-reoccuring) amortization this company is trading at 7.6x 2005 earnings. Net income is growing at an average rate of 42% from 2005 to 2008. 2006 FCF yield to equity holders is 21.5% (assuming prf. Conversion) and 30.9% (assuming no conversion).
2005 2006 2007 2008
Net Income 4.48 8.28 12.17 12.87
% Growth 85% 47% 6%
Geometric Mean 42%
Current Mkt Cap 33.9mln
2005 NI 1.48mln
excess amortization 3mln
Adj. 2005 NI 4.48mln
P/E 7.6x
w/out prf dilution w/ prf. dilution
Current Px 6.63 6.63
FDSO(w/out prf) 5.12 mln 7.35 mln
Current Mkt Cap 33.9 mln 48.7 mln
2006 FCF to equity 10.5mln 10.5 mln
FCF yield to equity 30.9% 21.5%
The Business:
Triple Crown:
Gray Television spun off TCMI on 1/3/06. TCMI consists of 5 small rural newspapers and a wireless division. While most of the newspaper industry’s circulation is shrinking, TCMI’s local newspapers are less affected by these macro trends. Nationwide US newspaper circulation declined 7% from 2002 to 2005. Meanwhile, TCMI’s circulation declined 5.7% over the same period. This decrease in circulation is deceiving. In fact, the trend has stabilized (still the company does not expect to grow circulation count as a whole, going forward). The largest circulation paper, Gwinett (60,000 circulation out of 125,000) has a contract where cable subscribers get the paper for free. Thus, there is not much incentive to grow the paper. Second, the Newton and Rockdale papers actually increased pay subscribers (but by reducing the free papers circulation technically went down). The Goshen paper was pretty stable. Meanwhile, the main laggard was the Albany paper, which had downward circulation pressure (but management said it was stabilizing). While circulation revenue is implicitly tied to ad revenue in the long run, this fact has limited impact on Triple Crown’s newspaper. First, Triple Crown owns local newspapers, where circulation decline is mostly tied to population shifts (as opposed to non-newspaper competition). Second, circulation revenue only accounts for about 12% of newspaper revenue, historically. Further, this revenue is naturally lower margin revenue than ad sales, which historically account for 85.5% of newspaper revenue (and growing).
% of Rev % Rev Growth
YTD 09/2005 2002-2005
Retail Ads 54% 11%
Classified Ads 31.5% 13%
Circulation 12% (8.5%)
Other 2.5% 20%
Third, the growth in ad revenue surpasses the decline in circulation revenue on both a % and dollar basis. Thus, the management expects newspaper revenue to continue to grow at 4% annually (and taking into account the higher margin revenue and cost efficiencies they can take advantage of, the company expects to grow Ebitda Margins at roughly 1% a year). Historically, the Triple crown margins have been 26%. The forecasted post events margin jumps to 28% due to allocated corporate overhead of 1.4mln. The full 1.4mln of overhead (built into the proforma numbers but not the projections) is unnecessary due to overlap with the overhead built into the Bull Run projections. Thus, the 28% margin post-events is consistent with the 26% margin pre-events.
The newspaper will miss revenue and Ebitda guidance for 2005 due to gas prices, newsprint prices, and an Atlanta paper production problem. Ultimately, management believes that they have fixed and adjusted for these issues in 2006. Thus, they should be back on track with their forecasts. Regardless, I have made some downward top-line and margin adjustments in my model.
Aside, due to cross ownership between Gray Television and TCMI, the FCC is forcing TCMI to dispose of the Goshen News (6mln Revenue and 2mln EBIT). Basically, you cannot own both a television station and newspaper with the same distribution area, and Gray is purchasing a television station that overlaps with the Goshen News’ distribution area. TCMI has about 12 months to dispose of the Goshen News. Management has found an equitable swap, which should go through. The swap is for several smaller papers near some of TCMI’s other assets. Thus, the new papers will have some cost efficiencies and help solidify market share in that area. Meanwhile, the revenue and EBIT stream is an equal swap. If the deal falls through, similar papers in that area go for about 12x EBITDA (25-30mln), which would be great for debt paydown. Regardless, there is a carve out for Goshen in the debt covenants. So, there is no risk of breaking a covenant due to Goshen.
Graylink Wireless:
The wireless business was mainly a paging service business. As paging revenue declined, the revenue was replaced with celluar service resale agreements (such as Cingular and Nextel agreements). In line with what other paging businesses have said, management believes that the paging business clientele has stabilized. Currently, the mix is about 65% paging (3.9mln YTD 09/05)/35% (2.1mln YTD 09/05) with margins slightly deteriorating. This revenue is forecasted to remain flat at 6.5mln. However, in 2005 YTD 09/2005 they will beat the 6.5mln projection. This is due to two events: frontloading of a Nextel contract and just a conservative est. (in 2004 they did 8.1mln of rev). The wireless revenue and Ebitda that exceeds the forecast will help make up for lagging newspaper numbers. Overall this segment's 2005 Ebitda margins should be around 27% and with the newspaper rev shifting into ads, management expects this margin to increase to 31% (my model has 29.3%) in 2008
Bull Run:
On 1/6/06, TCMI merged with Bull Run. Bull Run is mainly a collegiate sports marketing company. It also has an assoc. management business which accounted for 10mln out of 65mln of revenue in 2005. The association management business is very stable, niche business. They use cost plus pricing (low D/A and 25-40% Ebitda margins) and there are huge barriers for the clients to switch companies (because Bull run literally runs everything for the association from recruiting to conferences). Also, a new client was added in the middle of 2005, which is not included in the projections (about 1mln in revenue and 400k FCF annually). Further, the projections forecast a new client every other year. They already have another client in the pipeline for 2006.
The sports marketing business is the growth driver for TCMI. The Sports Marketing business has 8 contracts including The University of Kentucky, The University of Texas and Florida State. The two main competitors are private. This business is highly leveragable, in fact, management believes that the majority of the growth in their projections will be from current contracts (new contracts typically will need to ramp over 1-2 years, and as they ramp up the growth will go straight to the bottomline). Typically, these contracts employ a minimum payment to the school plus a % of profits beyond a target (The UT contract is a straight % across the board). In 2005, the minimum payments account for 16.5mln on about 65mln of revenue, which gives the company a large amount of flexibility on the downside. Further, this structure incentivizes management to grow revenue. The business employs negative working capital of about 15-30mln because the payments to the schools are made at the end of period. The business is very low capex (Management forecasts 1.5mln annually for TCMI as a whole, but feels they can keep this number below 1mln).
Historically, this business’ revenue has been extremely volatile due to a lack of focus. Bull Run was neglecting its core competency of sports marketing to focus on an events business. This move along with a couple bad sports marketing contracts (a fixed payment to the school, and too competitive of a marketing environment) was disastorous. Tom Stultz who ran the newspapers for Gray came in and turned things around. In 2004, Bull Run exited the unprofitable events business, the bad contracts expired, and the focus returned to sports marketing. Since that time, relationships with the existing sports marketing clients have been phenomenal. Both contracts that were due to expire at the end of 2006 (UTx and UK, the two biggest contracts) have been extended for 10 years (typically, contracts are only 3-5 years). This is a testament to the great relationship that Bull Run has with its clients. Management said that the only contract they have that will go out for bids is the University of Tennessee in 2007, which is required by state law. Further, there are several non-client schools going out for bid in late 2006 (Penn State, Clemson, and Virginia). Thus, going forward the growth prospects are very promising, and the company has room to clean up the expense side. Management expects to grow revenue for this business at about 7% annually with 2005 Ebitda margins increasing from 7% in 2005 to 12% in 2008.
Management:
The CEO of TCMI is Tom Stultz. He ran the newspapers under Gray’s control and then moved to Bull Run about 2004. At Bull Run he has focused on getting the business refocused to its core competency, sports marketing. So, he has a good understanding of both businesses.
Mack Robinson , the ex-chairman of Bull Run, is the only large shareholder. He owns the Preferred Series A and B and 10+% of the common. He has no management position in the new company. However, because he had strong ties with both businesses, it is promising that he is on both sides of the preferred dilution.
The Model:
Currently, there is 122mln in debt and about 1mln in cash. In addition, there is about 3mln in excess a/p left from Bull Run. TCMI plans to gradually pay this excess 3mln a/p off. The majority of the debt is broken down into two liens one for 30mln and one for 90mln, the higher interest 30mln lien cannot be prepaid until the lower interest 90mln lien is repaid in full. Also, there is 27.3mln in redeemable convertible preferred stock. The Series A (21.3mln) has a 4% dividend and the Series B (6.05mln) has a 6% dividend. Both of these issues have the same characteristics. The conversion premium is 40% on the 6 month anniversary 30-day average trading price. Unfortunately, these do not have a floor on the conversion price. For the foreseeable future, the company will be paying these dividends in kind (due to a debt covenant). For my dilution, I have used the anniversary price of $10 (conversion price of $14). This creates approximately 2.22mln shares of dilution.
2005 2006 2007 2008
Series A @ 4% 21.3 22.15 23.04 23.96
Series B @ 6% 6.05 6.41 6.8 7.21
Anniversary Px 10
Conversion Px 14
Total Dilution 2.226 mln shares
Current Shares out 5.125 mln shares
FDSO 7.35 mln shares
The company has filed an S-8; however, the details of the stock compensation have not been agreed upon. Thus, I have not included any dilution for this matter. There are 1mln shares authorized for the plan. Ultimately, my FDSO is 7.35mln.
Also, TCMI will be paying minimal taxes. The company has a 70mln NOL. This NOL is limited to 8.5mln a year through 2010 (past 2010 it is limited to 1.7mln). Any unused portion of the 8.5mln carries forward to the next year. Thus, TCMI will not be paying taxes until 2008 (negligible taxes in 2007).
2005 2006 2007 2008
News Rev 46.8 50.0 52.86 54.98
Wireless Rev 7.5 6.53 6.53 6.53
Total TCM Rev 54.3 56.53 59.4 61.51
EBITDA 14.5 15.5 17 18
EBITDA % 26.7% 27.4% 28.6% 29.3%
Bull Rev 66.26 74.02 81.66 89.18
EBITDA 4.73 6.97 8.71 10.34
EBITDA % 7% 9% 11% 12%
TOTAL REV 120.56 130.55 141.06 150.69
TOTAL EBITDA 19.23 22.47 25.71 28.34
TOTAL EBITDA % 16% 17% 18% 19%
D/A 3.5 3.4 3.3 3.2
EBIT 15.73 19.07 22.41 25.14
EBIT % 13% 15% 16% 17%
Interest 11.25 10.79 10.24 9.36
Pre-Tax 4.48 8.28 12.17 15.78
Actual Taxable Inc 0 0 0 7.28
Tax 0 0 0 2.91
Tax Rate 40%
NI 4.48 8.28 12.17 12.87
Tax Adj. EBIT 15.73 19.07 22.41 22.23
D/A 3.5 3.4 3.3 3.2
Capex 1.5 1.5 1.5 1.5
FCF unlevered 17.73 20.97 24.21 23.93
FCF levered 6.5 10.25 14.0 14.5
BB Debt 125 114.82 100.86
Interest @9% 10.79 10.24 9.36
Paydown + Interest 20.97 24.21 23.93
EB Debt 125 114.82 100.86 86.29
Cash EB 1 1 1 1
Net Debt 124 113.82 99.86 85.29
Current Best Base Down
Share Px 6.63 30.79 23.09 4.06
FDSO 5.12 7.35 7.35 7.35
Mkt Cap 33.9 226.45 169.77 29.84
Net Debt 124 85.29 85.29 124
Prf. 27.3 0 0 0
EV 185.2 311.74 255.06 153.84
EBITDA 19.23 31.17 28.34 19.23
Multiple 9.63 10 9 8
FCF unlev. 17.73 26.32 23.93 17.73
Multiple 10.44 11.84 10.66 8.68
NI 4.48 14.16 12.87 4.48
P/E 7.6 16 13.19 6.6
Upside 16.46
Downside 2.57
Rew/Risk 6.4
Considering, the low d/a low capex businesses, TCMI deserves a high Ebitda multiple. This way the P/E multiple will be in line with the market. If the multiples become too much lower, TCMI can be bought and the newspapers sold off for 11-12x Ebitda to pay down debt (this provides downside protection). Ultimately, the stable FCF from the newspaper business and the growth of Bull Run provides a good combination.
Risks:
There are two main risks: the company violates its debt covenants and the preferred conversion creates a death spiral. I have included a debt covenant table. Also, TCMI can miss my models EBITDA numbers by 15% (3.3mln) in 2006, 19% (5mln) in 2007, or 20% (5.8mln) in 2008 before a covenant is broken (my Ebitda numbers are lower than company projections).
2005 2006 2007 2008
1st Lev. Ratio 4.78 3.63 2.62 1.85
Req 5.25 4.50 3.50 2.50
Margin .47 .87 .88 .65
Lev. Ratio 6.34 4.96 3.79 2.91
Req 6.75 6.00 5.00 4.00
Margin .41 1.04 1.21 1.09
Ebitda % safety 6% 15% 19% 20%
Mrgn of Saf. 1.1 3.3 5.0 5.8
(mln Ebitda)
The second risk is that the preferred creates a death spiral because there is no conversion floor. Assuming the 6 month anniversary price will be limited by option value of 25mln (mkt cap), this will limit the conversion price to $7 ($5 + 40% premium). This creates twice as much dilution (4.45mln shares). This ultimately takes away about 28% of the upside.
Catalyst
As the market realizes several things, this company should become appropriately valued. First, as this business deleverages from a current EV/Mkt Cap ratio of 5.57 there is a large amount of upside for the equity holders.
Current EV 189
Current Mkt Cap 33.9
EV/Mkt 5.57
Second, the FCF yield to equity holders is about 20% (see above). Third, as the structural selling pressure dissipates (from the spin-off) the stock should be more fairly valued. You are paying approximately 3x 2008 earnings for a growing, profitable company with about 20% FCF yield to equity holders (2006 FCF to equity of 10.5mln and current market cap w/ prf dilution of 55 mln) and trading for a 1/3 of revenue. Lastly, when the company reports full year 2005 results the stock should attract more attention.