The increasing interest of private equity funds in broadcasting is pushing up station multiples and prices and making it tougher for publicly-traded TV station groups to expand their portfolios.
Hey, broadcasters: Your gap is showing.
It’s no secret that there’s a spread between public and private market valuations of broadcast television properties. With public values hovering around a 10 times multiple of cash flow, private values are as much as five points higher.
Pushing the private values to as much as 15 times cash flow is the arrival of money from private equity funds that see a bright future for broadcasting, even though its growth has been sluggish for the past half dozen years.
How bright? How does doubling your money, or better, in five years sound?
“Really what drives private equity is return, not the multiple,” says Randy Bongarten of Bonten Media Group. “The annualized return on investment for private equity firms typically is 20%, plus or minus 2-3 points.”
Bongarten should know. Backed by private equity firm Diamond Castle, Bonten recently purchased Bluestone Television, consisting of eight full-power and two low-power stations for $230 million.
Others in the private equity arena say annualized returns can be as much as 30%. The private equity folks typically look at a four to five year window for an investment. That translates into an 80% to 150% return over the life of a deal.
Bonten/Diamond Castle has plenty of company in paying well above blue book. Cerberus, Oak Hill and Pilot Group-backed Barrington Broadcasting have all paid premiums to public market values to take a shot at doubling their investments.
Here’s how a typical, best-case private equity-TV station group deal might look:
Blue Sky Equity Fund identifies Mid-America Broadcasting as a viable acquisition at 10 times cash flow of $10 million, or $100 million.
Blue Sky structures the deal so that it pays about two times cash flow, or $20 million in equity. The rest, $80 million, is debt.
As soon as the deal closes, Blue Sky may use some free cash flow to pay down the $80 million. That, in turn, helps create a virtuous
cycle: the less debt, the more free cash flow, the more debt can be paid down. Blue Sky doesn’t want to pay off all the debt before it sells in five years because servicing that debt translates into tax deductions.
Moreover, leaving the bulk of its investment in debt helps keep Blue Sky’s return on investment up. Blue Sky may also sell off assets that don’t contribute to cash flow.
Over those five years, Blue Sky manages to grow cash flow at around 15% annually. How? Lowering debt so interest payments decline, increasing revenues through retransmission fees, boosting political and local advertising, adding Internet-generated advertising revenues and capitalizing on the conversion to digital.
Around year five, cash flow has doubled to about $20 million and Blue Sky sells Mid-America for $200 million at the same 10X multiple. After paying off the $80 million in debt, Blue Sky’s take is $120 million, an impressive six times its original equity investment of $20 million.
So, the question is: If the potential payoff is so attractive, why isn’t the stock market pricing the station assets of the publicly traded broadcasting companies closer to the private market price for stations? Even with the big run up over the past several months, TV stocks are still trading at only 10 or 11 times cash flow at best.
One answer is that the public companies are subject to the whims of public markets. If a sector, say broadcast TV, is out of favor on Wall Street, it hardly matters whether company management sees a rosy future.
“Wall Street has been very fickle,” says Bishop Cheen, a fixed income analyst at Wachovia Securities. “I call this exhaust sucking: People with no perspective, 25-year-old rocket-science guys, just convince themselves that no one watches TV anymore because they download to an iPod or they TiVo.
“They’re sucking each other’s exhaust,” he says. “They didn’t bother to think through the economic model. If iPod and TiVo are really going to replace broadcast TV, how are we going to pay for programming? And if we’re not going to pay for programming, who’s going to make programming to go on iPod?”
Right now, the equity firms are simply more bullish on broadcasting than Wall Street. For instance, the private investors see value in broadcasters’ digital spectrum, even though no station group has shown how it intends to make a return of its considerable investment in digital facilities. The public investors are not so sure.
“I don’t think Wall Street is baking in one penny based on the February 2009 digital world,” says Cheen. “I think they look at it as an uncertainty and potentially negative.”
The private-public gap is more than academic. Right now, it is making it tough for publicly traded station groups to expand their portfolios, unless it is a well-calculated strategic move.
The public broadcast companies use debt for deals, and other purposes, too, but are often restricted by covenants, market conditions or Wall Street perceptions to keeping the leverage multiples much lower, say five or six times cash flow.
For public companies, those leverage constraints and a sector’s perception in the public—even if it’s only tenuously connected to reality—are crucial in determining whether a deal’s a go or no-go.
In the end, it comes down to math.
“We always look at it relative to our multiple of EBITDA,” says Vincent Sadusky, CEO of LIN TV, one of the hottest broadcast stocks. “Currently, we’re trading somewhere between nine and 10 times forward EBITDA. In order for a deal to be accretive, we essentially have to have that cash flow come to us from that television station that is nine or nine and a half times.”
LIN might be able to bid on a station selling for 11 times, figuring that that it can shave the effective multiple by a point or a point and a half through cost cutting and otherwise improving EBITDA, Sadusky says. But LIN can’t close the bigger gaps.
So if 15 times is the price, he says, “we’re not interested.”
It wasn’t so long ago that public and private market values were roughly even. Easing of ownership rules in the late 1990s spurred a deal frenzy that peaked at more than $45 billion in 1999, just before the dotcom implosion. But even then the financial model for broadcast TV was changing.
“Traditionally, broadcasting was a growth stock,” says Larry Patrick of Patrick Communications. “As revenues have flattened, TV is still a terrific cash generator. Companies are still doing 30-40% cash margins. But they still haven’t completed the transition to becoming a real dividend machine.”
That accounts for some of Wall Street’s disinterest, until recently, in broadcast TV stocks. Coupled with getting burned in the dotcom meltdown and the relentless scramble for the hot, new sector, public investors focused on satellite radio, for instance, instead of broadcast TV.
Broadcast has also suffered, in public perception, from its dependence on cyclical political ad revenues.
What’s it going to take to reduce the valutation gap? A narrowing of the gap between public and private investors’ perceptions of broadcast’s future.
The uptick in some broadcasters’ stock prices “is very encouraging vis a vis the public perception,” says Mark Fratrik of BIA Financial.
“Stronger 2006 ad revenues than predicted, and what that portends going into 2008, as well as other industry issues, retrans, Internet revenues—I think it’s a combination of lot of things that certainly has improved public perception,” he says.
“It may be that the public is finally catching up to what smart equity people knew 9-12 months ago,” he says.
But don’t expect the gap to close any time soon. Clear Channel has put all of its TV stations on the block and the betting is that most will go to the private equity investors that are willing—and able—to pay the top dollar.