The Art of Streetplay

Thursday, July 14, 2005

HTV-- the next MWY? (Aug 30th 2004)

The essential characteristics of MWY’s story—

The company was in a losing position. It had been losing money for 5 years, and wasn’t well followed.
Sumner Redstone had been buying for 9 months, raising his stake in the company from 30% to 75%. He decided to buy all of his shares in the open market instead of tendering, which was odd. His actions only recently really became very noticed—looking into a database of news articles, it seems the first was written in April. So five months of buying went without much mention. Finally, looking to the transcripts of the conference calls, the CEO of MWY was very reluctant to shed any details. In the Q4 earnings call (which was held in February) made no mention of Redstone. Even in the Q1 conference call, when people asked questions about it, the CEO provided no answers at all. The price had gone from 2 in November to a high of 13 in July as a result. This move has inflated the company’s valuation metrics above the industry average (MWY’s EV/EBITDA is 22 while that of its peers is in the mid teens). It has also brought in the short sellers, because the fundamental underlying value of the company is undoubtedly lower than the current value. Short sellers now account for approximately 30% of the outstanding shares.
To take the company private or do a related transaction, Sumner needs 80% or more of the company’s stock. He seemingly reached this point, but in a surprise twist, the company disclosed that it had another 12mm more shares than it had previously disclosed. So he continued to buy.

Not much top-line growth at all. Revenue has been about the same for 5 years in a row after a ramp up period (1999 to 2003, in $mm): 661.386, 747.281, 641.876, 721.311, 686.775. Seems sinusoidal, doesn’t it?

However margins have improved dramatically over the past 2 years. After a multi-year period of low profit margins [(1999 to 2001, $mm): 4.89%, 6.01%, and 4.84%], margins jumped to 14.98% in 2002 and 13.72% in 2003. In general, margins are very nice right now. The EBITDA margin is at around 50% because HTV has very low operating costs.

Debt has gone down by about 25% over the past two years or so. Finally, the cash position has been rising steadily. Two years ago, the company only had 4.359mm in cash. Starting a year ago, it started to add to its cash position very heavily—5 quarters ago, cash stood at 7mm. It then tripled to 21.85mm, then tripled again to 71.53mm. Since then the cash position growth has leveled off, jumping to 116.7mm two quarters ago and 138.1mm last quarter.

Company Analysis

Hearst-Argyle Television is one of the country’s largest independent, or non-network-owned, television station groups. It manages 27 television stations reaching approximately 17.8% of television households in the US.

This is how the company makes money. The company gets the rights to broadcast certain TV shows and news reports on the channels that it owns. A large number of those channels which HTV owns are local. So it puts on its shows and tries to get people like us to watch them, which is of course contingent on a number of factors, but the main ones which the company can control is the quality of the TV shows it puts on and the quality of the news broadcasts. It receives advertising revenue from major companies (25% of its revenue is currently from auto manufacturers, however it also receives a large percentage from retail, some from pharmaceutical companies, as well as political advertising both local and national, among others). Obviously HTV wants as many people watching its shows as possible, because the amount of money and the general demand for HTV’s advertising spots will depend on two things mainly—the demographic watching the shows, and the total number of eyeballs. This accounts for over 90% of the company’s revenues.

It gets those programs in a number of ways. (1) It sets up agreements with networks like NBC and ABC to broadcast those network’s shows in exchange for the right to sell some of those ad spots. This is called a network “affiliation agreement.” It’s a symbiotic relationship. These transactions are called “barter and trade transactions.”

(2) It must compete for non-network programming, which involves haggling with national program distributors or syndicators that sell the types of shows which HTV buys, called “first-run (like the Oprah Winfrey Show)” and “off-network” packages, and “off-network reruns (like Seinfeld).”

HTV’s competitive advantage is its strong news offerings. Lots of people watch them apparently, as they are highly ranked and command a premium for the ad spots. HTV is weak during prime time. So its ad spots are much cheaper there because of the lack of demand.

Cable-originated programming is becoming a bit more prevalent. Made-for-cable programming has been gaining market share over the past year or so. This is an alternative to HTV’s broadcasting.

Also, of course because HTV touts itself as one of the largest non-network-owned TV station groups, networks are competition. HTV currently has network “affiliation agreements” with most of these companies and has had the agreements for a while now, but there is no saying that the networks won’t turn on HTV if the payoffs were right. The terms of the affiliation agreements was stated above—HTV gets network shows, network gets the right to sell some of HTV’s ad space. It seems like the networks have been playing off this point already. They used to compensate HTV for the broadcasting of network programming—but this is coming to a halt. Also, there is no saying that the networks won’t cut off agreements once the contracts run out.

Direct broadcast satellite (‘DBS’) programming is the final threat, which I think has the potential to be the worst. EchoStar (DISH Network), and DIRECTV, which transmit programming directly to homes equipped with special receiving antennas, bypass HTV entirely. Those customers don’t watch HTV’s broadcasts, they watch the dish network’s.

Cyclicality, Seasonality
Highly cyclical business. A quarter of the company’s revenue is coming from auto manufacturer ads. Things may be swinging in HTV’s favor right now, but that is not to say they won’t in the future. I get the impression that a recession would hurt this company very badly.
HTV is also seasonal. It has seasonally stronger first and third quarters. It also experiences higher sales in the even years because of political elections and the Olympics.

The Current Situation
The company is doing well, aided by double seasonal effects and a semi-cyclic upturn. It is an even year, it was the first quarter, and auto manufacturers have started to increase their ad spending to market new model cars. The company says organic growth will be driven by macro-economic factors, which leaves a bad taste in my mouth.

The last quarter basically had a revenue increase of 18mm on the prior year. 9mm of that was from political revenue (seasonality). The other 9mm can be further broken down into 5mm which was lost last year due to the Iraq war. So this means only 4mm came from the company’s core business—and remember, most of that must have come from the auto segment. There’s some doubt that the company will be able to keep its costs in check, sonsidering how much it may have to spend to provide adequate coverage of the political events coming up. In general, I am not impressed with the underlying fundamentals of the company and think there isn’t an adequate downside risk for me to make a trade.

I have gone into the “going private scenario” fairly in depth in the document below on HTV’s situation.
Hearst-Argyle’s Situation—

Hearst-Argyle Television (HTV ), spun off in 1997 by media giant Hearst, has been on the ropes since January, when it traded at 29. Now at 23, guess who is buying stock? Hearst itself. Since April, Hearst has bought -- through its Hearst Broadcasting unit -- 1 million shares of Hearst-Argyle in the open market, bringing its total stake of Class A shares to 35%. Hearst-Argyle owns 25 TV stations and manages three others, reaching 18% of U.S. households. The company also manages two radio stations. "It's one of the largest non-network-owned groups," notes Amy Glynn of Standard & Poor's (MHP ). Hearst Broadcasting already owns 100% of Hearst-Argyle's Class B shares, whose holders pick most of the board. These buys have led some hedge funds to buy, too, in the belief Hearst will take Hearst-Argyle private. They note that Cox Broadcasting recently said it would go private at a 16% premium to its stock price. Meanwhile, Hearst-Argyle has also repurchased 180,000 shares this year. Sean Butson of Legg Mason (LM ), who rates the stock a buy with a 12-month target of 35, sees earnings of $1.30 in 2004, up from 2003's $1. Both companies declined comment.

So this company is also on the ropes, as was MWY. The buyer, media giant Hearst, has an obvious direct relation to HTV, which probably increases its chances of being taken private because the integration would probably be more smooth. It would definitely be an odd move for Hearst, because it would be essentially reversing its decision in 1997. It does call the shots on votes though, because of its large ownership of the class B shares. HTV’s share repurchases also shine favorably on the probability of HTV’s being taken private. MWY didn’t have share repurchases, to the best of my knowledge. MWY might have been trading at relatively “cheap” valuation before, but not really. It was cash flow negative with negative earnings and negative EBITDA. HTV seems to be in a better position financially, which I think would be a plus. It has an EV/EBITDA of 8.45 and a P/E of 21.13. It has huge margins. Profit margin is 15%, and EBITDA margin is around 50%. It trades at from 5.5 to 8 times free cash flow, which (at the lower end) is good considering that this company has a market cap of 2.3B.

The underlying situation is better than it was, and the company is currently doing well, but seasonality and cyclicality make this a risky investment from a value standpoint. I’d like a better idea of the environmental situation.

I think this situation looks more similar to what is currently happening at TROY. TROY, a family run company, has owners controlling 67% of the outstanding shares. The stock had been languishing (what a strong common trend!). It is alleged that management is purposefully keeping the price down so that it can take the company private at a low valuation. TROY is a good value, attracting the likes of value investor Whitney Tilson. However it seems like HTV has a stronger financial position than both TROY and MWY. HTV has very wide margins; EBITDA, and profit. It trades between 5.5 and 8 times free cash flow. TROY has a trailing P/E above 40 and an EV/EBITDA of 19. TROY and

HTV diverge on the cash trend also. TROY used up a great deal of its cash four quarters ago, dropping their cash position from 8mm to 1.7mm. HTV’s cash position went from 4.5mm to 138mm. It was a debt laden, low cash, lower margin company with lower revenue. Over the past seven years, it has knocked off some debt (I believe), increased its cash position, expanded margins and brought the top line to a level it has maintained for five years. It indicated in its conference call that this is most likely because it intends to acquire another company, or do a major deal, in the near future. Regulatory issues are holding up HTV’s ability to do anything at the moment, so if those problems get squared away, then HTV will go and act. I don’t like the sound of that. That will knock away their cash position once again, and they will probably be at a higher leverage ratio like before. Also, I’m not sure how this factors into the probability of HTV’s being taken private.

TROY tells a different story though. It wants to take itself private (management is taking the company private, not an external company). Secondly, it is being pursued by Westar Capital, which wants to acquire the company and pay a premium on the price. Cash is well-known to make a company an attractive target of an acquisition, so a logical reason for the diminishing cash position could be as an acquisition deterrent. MWY is interesting. A year ago it had around 60mm. It then burned around 20mm, and had its cash hand at around 40mm until last quarter when it added 100mm to its cash position. It was truly against the ropes. It wasn’t talking about acquisitions, it was simply floundering.

Finally, Hearst filed with the SEC its intention to buy up to 20mm shares of HTV in the open market. As of the end of 2003, it had purchased 19.3mm of the 20mm. After the recent spate of buying, it has 20.58mm. In other words, it has gone above the limit. I am not sure what this could mean, but I would tend to think it means something. This and the industry consolidation trend interest me. The rest of the situation doesn’t. It seems to me like making a trade on this would expose me to too much risk so I’m staying on the sidelines.


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