David Smith, Sinclair: Turnaround Champs

In mid-2009, Sinclair Broadcast Group was staring into a financial abyss. The company’s back was bowed under $1.33 billion in debt and a debt-to-cash flow leverage ratio of nearly six times, pushing it dangerously close to defaulting on loan covenants.

When a strategic ally’s own default threatened to topple Sinclair as well, Sinclair management took the unusual step of warning it might be forced into bankruptcy.

Today, a scant two-and-a-half years later, Sinclair is financially healthy and positioned to capitalize on the improving economy. It has whittled down debt and corresponding leverage ratios significantly, all while steadily upgrading station technology and striking deals that expand its scope and scale.

The strongest evidence of Sinclair’s return to health came late last year when it purchased two other station groups, Four Points Media and Freedom Broadcasting, for a total of $585 million.

The Freedom deal is expected to close this quarter or early next, but Sinclair has been managing the stations since the deal received antitrust approval last year.

Those two acquisitions boosted Sinclair’s full-power station count to 60 in 45 markets, according to BIA/Kelsey. The deals also pushed Sinclair past ABC’s O&Os in terms of television households reached.

Based on Nielsen’s 2011 count of 114.7 million total television households, Sinclair stations reach 25.3% of the market while ABC O&Os reach 21.8%.

Sinclair also operates eight other stations, BIA/Kelsey says. Only Ion, with 69, has more stations.

All the more impressive, Sinclair — among the few remaining family-owned-and-controlled television station groups — has achieved that without a single station in a top-10 DMA.

“Early on in the company’s history, it appears that David Smith [Sinclair president-CEO] made the pragmatic and strategic decision to avoid competing directly against the size and scale of vertically integrated media companies with endless resources,” says Damian Riordan of the M&A advisory firm Peloton Media Advisors.

“He competes and has consolidated just outside that trench.”

Sinclair stock, meanwhile, has benefited from broadcast’s rising economic tide, rebounding strongly from the recession’s depth, thanks in large part to recovery by the auto advertising segment.

Shares had traded as low as 89 cents in 2009’s first quarter. While they had clawed their way back to about $2 shortly before the bankruptcy warning, that red flag drove them back down to around $1.34. Shares currently are trading around $12. That’s still well off a five-year high of $17.26 in April 2007, but all broadcast stocks have suffered a secular decline since then.

All in all, a dramatic turnaround. So just how much of it is timing, luck or savvy management?

“They did an outstanding job refinancing the debt,” says Barry Lucas, senior vice president-research at Gabelli & Co. “And they put whatever free cash there was to paying down debt. … Just a year ago, they were discussing how quickly they brought the leverage down to record lows for them. It was clear to me at that time they were going to buy something.”

Sinclair last year pushed its leverage ratio down to about 4.2 times, and buy it did. The company pulled the trigger first on Four Points Media’s seven stations in September, paying $200 million.

Barely a month later, Sinclair announced it was buying Freedom Communications’ eight stations for $385 million.

The buying may not be over. Sinclair still has a ready supply of dry powder should more deals materialize.

“I think it’s prudent for us to focus on middle markets, as we refer to them,” David Smith, Sinclair CEO said during last week’s earnings call. “If we see opportunities to make acquisitions, we would certainly go after them.”

Smith has said he can envision growing the group to 100 stations or more.

David Smith’s company

Four Smith brothers — David, Robert E., J. Duncan and Frederick G. — own and control Sinclair. Together, they hold 96% of the supervoting (10:1) Class B shares and 49% of the Class A shares for a total of 82% of Class A and B shares combined.

But it is David whose name has been synonymous with Sinclair since 1986, when he helped his father, Julian, found the company. Two years later, he became president-CEO. And two years after that, David Smith and his brothers bought out his parents’ interest in the group.

“It’s his company, make no mistake about it,” Riordan says. “I think David, at the root of everything, is a committed and very loyal guy to his people and his company. And he can be fiercely protective.”

“Ninety-nine percent of what he’s accomplished over the last two decades has prompted everyone else to follow,” Riordan continues. “It seems he’s been willing to stand out front and take the bullets. The guy is unique to the industry. David’s always been a catalyst for change.”

People familiar with Smith characterize him as a visionary, iconoclastic, Machiavellian and often outspoken to the point of being brash. He is willing to ruffle the feathers of friends as well as foes if his conscience, and economics, dictate.

“He’s not a member of the club,” Lucas says. “He doesn’t play by their rules or follow the typical corporate line. We kind of depend on the fact that he’s involved in wealth creation so from time to time I cut him a little slack.”

Smith is not a joiner. Sinclair’s not a member of TVB and only recently signed the station group up to join the NAB. But that hasn’t stopped Smith from taking the lead on a number of industry issues — from LMAs, JSAs and SSAs to centralization of station operations and pushing for a different transmission standard for digital TV.

“Back when the original broadcast digital standard was being put out, he promoted a different standard and the industry scoffed at it,” says another station group owner. “Now, it appears he was right. He was promoting a standard that’s being used across the world.”

Smith, along with Nexstar Broadcasting boss Perry Sook, led the push for retransmission consent fees that are a growing piece of the broadcast television revenue pie. It was the kind of initiative that bought him considerable goodwill among station group owners, but strong resistance from MPVDs.

In what was perhaps the most high-profile example of Smith’s hardball tactics, Sinclair in 2007 pulled 22 of its stations from cable operator Mediacom’s system after the two sides were unable to reach a retransmission agreement. The two sides eventually reached a deal, but not before Sens. Daniel Inouye and Ted Stevens called on then-FCC Chairman Kevin Martin to resolve the issue.

Some in the broadcast sector complained that Sinclair’s tactics prompted unwelcome scrutiny of broadcasting as a whole. But today, broadcasters are benefitting from steadily rising retrans revenues.

“You may not necessarily agree or like what he has to say, but you’ve got to respect this guy,” says a source in the investment banking sector. “He’s a battle-tested negotiator.”

A couple years ago, Smith riled up some broadcast peers when he struck an affiliation deal with Fox. Critics felt he should have worked with the Fox affiliate group, then headed by Brian Brady of Northwest Broadcasting, to forge a deal that benefitted all the affiliates, not just Sinclair’s stations.

“Some may not agree with this, but I think David’s just doing what he needs to do to survive in the world,” says Steve Mosko, who got his start in broadcasting with Julian Smith and subsequently worked for David. Mosko’s now president of Sony Pictures Television.

“He’s using every piece of leverage he has to maximize that business. … I don’t know anybody who’s as passionate about the business as David.”

As of press time, Smith had not responded to multiple requests to be interviewed for this story.

Critics and detractors point out that it was Smith’s willingness to pile on debt that drove Sinclair to the edge in the recession. Of course, money was cheap and plentiful and everybody else was doing it.

But if it was Smith who steered Sinclair close to the edge, he must also get credit for bringing it back.

Flashback to 2009’s “Days of Default,” when the recession was laying waste to overleveraged broadcasters.

Several other station groups, including Pappas, Young and Freedom had already taken the dive into Chapter 11 and analysts were warning that high debt compounded by free-falling cash flow put several other high-profile groups in danger of default.

Sinclair was one of those. As it turned out, it wasn’t so much Sinclair’s $1.33 billion in debt or a leverage ratio just under six times, it was Cunningham Broadcasting Corp., in effect a shell company that owns stations Sinclair runs.

Establishing LMAs with Cunningham, a company owned by members of the Smith family not involved with Sinclair, was a quintessential David Smith move: It enhanced Sinclair’s economies of scale, boosted revenue and cash flow, all while dodging FCC rules limiting duopolies.

At the peak of the credit crunch in 2009, Cunningham contributed about $77 million to Sinclair revenues and, perhaps more importantly, roughly $26 million to Sinclair’s $179 million in overall cash flow for the year.

But Cunningham, like many other station groups, had taken on debt and a cross-default provision between Cunningham and Sinclair meant that if Cunningham couldn’t repay some of that debt, or at least restructure terms, its default would trigger a covenant default at Sinclair.

And while it had the cash on hand to pay the loan, Sinclair was legally prohibited from doing so.

“We certainly weren’t happy about it at the time,” says one analyst who requested anonymity. “But I wouldn’t say it was a huge, huge surprise. The sense that I had at the time, given that there was over $1 billion in debt at the parent company, was they would find a way to figure it out. Certainly, there were no guarantees that they would be able to refinance the debt.”

As it turned out, Cunningham managed to renegotiate its covenants to avoid default, thus saving Sinclair from what clearly would have been the biggest broadcast bankruptcy of the time.

It was Smith’s brinkmanship that averted disaster.

“In hindsight, I thought the way it was structured actually provided him with some leverage,” says a source in the investment banking community. “If Cunningham defaulted, it would force Sinclair into default. Smith said if you want to mess with me, I’ll detonate the whole thing. Don’t think he wasn’t three moves ahead when the language was written originally. Nobody was going to drive Cunningham into the ground on his watch.”

But even then, Smith’s tendency to polarize was on display. Comments on TVNewsCheck’s website when the bankruptcy warning story ran evidenced far more schadenfreude than sympathy. Most, it seemed, were not so secretly pleased at the idea of Smith getting some comeuppance.

“Karma’s a …” one comment read. Another: “No tears for Mr. Smith.”

Sinclair now has duopolies — many of them the result of LMAs and JMAs Smith pioneered — in more than 20 of its markets. While critics of broadcast ownership concentration criticize such arrangements as circumventing FCC duopoly rules, they’ve now been widely adopted by other broadcasters.

“From the standpoint of what goes on in the trenches, the boiler rooms of the business, he’s as on top of it as anybody I know, maybe anybody in industry,” says Riordan. “Over the last two decades, he’s done a masterful job of building this company while working within the confines of the FCC’s archaic rules.”

It’s not only Smith’s business practices that have raised eyebrows among peers, the media and the FCC. His unabashedly conservative politics have prompted criticism not just of Sinclair, but the broadcast sector in general.

Two weeks before the 2004 presidential election, Sinclair required all of its stations to air a documentary critical of Democratic candidate Sen. John Kerry’s anti-Vietnam War stance. Public outcry ensued as some stockholders threatened lawsuits and Sinclair shares took a hit.

And in 2010, it was reported that five Fox affiliates and one ABC affiliate owned by Sinclair aired an infomercial funded by the National Republican Trust Political Action Committee that was highly critical of President Obama and included the claim that he had received some 2008 campaign funding from the Hamas terrorist organization.

What’s next?

The year ahead is shaping up as an active one for the broadcast sector in general and for Sinclair specifically. On the deal front, no one should be surprised if Sinclair buys more stations.

The investment community likes acquisitions timed to take advantage of the full political year, like Sinclair’s Four Points and Freedom buys. But it’s worth noting that the biggest chunk of political spending comes in the second half, particularly the fourth quarter. If Smith sees the right opportunity for a station or stations in the markets he favors, there’s little doubt he’ll pull the trigger.

Retransmission and an affiliation deal with Fox clearly will be front-burner items. Sinclair has 20 Fox stations, which gives the company some leverage. But with the take-it-or-leave-it terms Fox mandated for affiliates last year, there’s a strong likelihood that talks between the network and the station group will be challenging.

In March of last year, Sinclair extended its affiliation agreements with Fox through the end of this year.

Interestingly, the Four Points and Freedom deals added primarily CBS and ABC affiliates to Sinclair’s stable — no Foxes.

With a lone NBC affiliate, Sinclair won’t hit the politics-Super Bowl-Olympics trifecta like some other groups, but Wells Fargo analyst Marci Ryvicker noted early this year that of the companies Wells Fargo covers, Sinclair and LIN are “best positioned for the 2012 elections,” in large part because of their presence in key battleground states.

Early signs are that political might be even better than expected.

“The PAC money we’ve gotten so far [in the first quarter] is more than interesting; it’s an eye opener,” Steve Marks, vice president-COO of Sinclair’s television group, said during the company’s earnings call last week. “It’s clearly different from what we’ve experienced before. We’re not dealing with a lot of volume yet, but January was clearly different and a big eye opener.”

Meanwhile, Smith’s been out front on a different political and economic issue — broadcast spectrum.

After the FCC floated its plan for an incentive auction of unused or underused broadcast spectrum in larger markets, Smith didn’t leave it to the NAB to lobby against the plan, though the association did.

Smith, on his own, jumped on the auction proposal, calling the spectrum issue a “manufactured crisis.”

“We’ve been … getting out there and looking at the whole spectrum issue, not just the auction itself and I think … based on what I’ve seen on the Hill, there may not be an auction,” Smith told analysts last week. “There’s a fundamental disagreement between the Democrats and Republicans on what the bill would say.

“But the $64 question is will anyone want to come and sell their business. We’ve seen a tremendous number of broadcasters come out and say we have nothing for sale. We certainly have nothing for sale.”

Sinclair last year commissioned a report from Business Analytix called “The Economic Value of Broadcast Innovation — Impact on the U.S. Treasury.” In essence, it is an alternative to the FCC’s plan.

The report outlines how allowing broadcasters to use their spectrum to deliver video via wireless broadband would be a more efficient use of spectrum than the proposed scheme of auctioning it off to wireless broadband providers.

The white paper also notes that such a scheme would produce, conservatively, about 10 times more revenue for the government than the estimated $6 billion one-time yield from an auction.

For several months, Smith has shuttled between company headquarters in Hunt Valley, Md., and Washington or New York to present the case to lawmakers, legislators and the investment community.

“If there’s more value for a broadcast company to use spectrum in the way described in the white paper and it creates more value than the existing plan, well then case closed,” says Lucas.

Like all broadcasters, Sinclair is dependent on the overall economy, advertising and the on-off two-year political cycle.

But Sinclair’s growth is viewed as one sign of the industry’s recovery, and, in a sense, a bellwether.

“I happen to not compete with them anywhere and I’m glad I don’t,” says Steve Pruett, CEO of Communications Corp. of America, adding that he uses Sinclair as a model for his own group. Pruett first met Smith when he sold him some stations in the 1980s.

“They’re incredibly efficient, incredibly well structured,” Pruett continues. “Having dealt with them on certain issues, I think they have management capacity to maybe double in size. … These acquisitions are not even a speed bump to them.

“They’re pretty goddamned good sausage makers.”