Data Can Help Preserve M&A Tax Advantages

I will admit that tax considerations are generally seen as the least exciting part of any media industry transaction. However, as every business person knows, taxes can represent a significant out-of-pocket expense when new properties are acquired.

This is why some groups have used like-kind exchanges to achieve their market goals while minimizing their tax exposure. While the practice has been common for many decades, a challenge from the IRS to a transaction involving the swap of radio stations underscores the need to provide qualitative data in order to demonstrate the exchange involves properties of equal value.

With this in mind, we sought out the insights from two attorneys familiar with the case, Stephanie Loughlin, a tax partner at Venable LLP, and Mike Hines, who spent more than 40 years at Dow Lohnes before becoming a consulting attorney. Mike, a frequent legal expert for MFM’s educational programs, also served as a tax expert in the case. Their summary appears in the March-April 2014 issue of MFM’s The Financial Manager (TFM) magazine, so I wanted to pass along a few of the observations that I found particularly helpful. For more information, I encourage you to read the complete article in the online version of the magazine.

This particular matter, which was resolved just last year, dated back to a challenge lodged by the IRS against Deseret Management Corp.’s (DMC) Bonneville subsidiary concerning its swap in 2000 of KZLA-FM for four St. Louis radio stations owned by Emmis Communications.

The parties had agreed that the transaction value of the exchange was $185 million. Bonneville reported on its tax return for that year the exchange of $177 million in FCC license value, all of which was exchangeable tax-free under the like-kind exchange rules.

“Bonneville used the ‘residual method’ to value the license of KZLA and reported that no goodwill had been transferred in the exchange. Goodwill, of course, does not exchange tax-free,” the lawyers explained.

However, the Internal Revenue Service disagreed with DMC, asserting that Bonneville had vastly overstated the KZLA license’s value. Using the discounted cash flow (DCF) valuation method for the KZLA license, the IRS initially determined the license was worth $104 million. That left $73 million to be assigned to taxable goodwill as the residual asset. Subsequent IRS valuations increased the FCC license value “again and again” but still assigned substantial value to goodwill.

After a lengthy trial process, the court sided with Bonneville and the opinion of its tax experts that there had been no measurable amount of goodwill transferred in the exchange. However, in a departure from earlier cases the court rejected any argument that a broadcast station could have no taxable goodwill as a matter of applicable case law.

“Judge Allegra appeared to try and limit the reach of the earlier claims court opinions, especially the 1969 Meredith Broadcasting opinion, which had been read to stand for the proposition that broadcast stations generally do not possess goodwill,” our experts noted.

As they went on to explain: “Judge Allegra set out to write a major opinion on license (or franchise) value and goodwill that applies to the broadcast industry in particular, but extends generally to intangibles valuation. This case should be considered carefully in planning and defending the tax treatment of any media transaction, especially a broadcast or cable exchange, which can be largely tax-deferred except for the amount of going concern and any goodwill.”

With that in mind, it will be very important to incorporate into future like-kind exchange valuations the type of qualitative analysis that Bonneville presented to the court. It included:

• Data that illustrated the Los Angeles market at the time of the sale was “explosive.”

• Evidence of the impact of FCC regulations on license values, including the easing of multiple station ownership limits and KZLA’s grandfathered status as one of 17 “superpower” stations in Los Angeles.

• Information validating KZLA’s premier tower location, which is high on Mt. Wilson.

• Financial data that showed the station’s operations were underperforming.

“Based on this extensive factual development, Bonneville was able to demonstrate — as a matter of fact, not law — that the value of KZLA resided overwhelmingly in its FCC license,” the experts point out.

Comparable data also proved to be very valuable to the case. This included evidence concerning KFSG-FM, which was sold at about the same time for $250 million, and which had a weaker signal than KZLA. According to the court, this comparable confirmed the high value that the Los Angeles market placed on the FCC licenses of radio stations with strong signals.

According to the tax law experts, one of the lessons of this court decision is the critical importance of developing the specific facts that support a taxpayer’s valuation of an intangible asset, whether an FCC license or other intangible. “Although Bonneville did not value the KZLA license using the DCF method, it had a unique set of circumstances, including a constantly increasing FCC license value being asserted by the IRS and a very persuasive comparable in KFSG-FM.”

Because the IRS had relied heavily on DCF for its valuation, the experts believe it is going to be very important in the future for broadcast and cable companies to not only provide a DCF to support a license valuation, but to also support the DCF itself. As the Bonneville case demonstrated, this support should include an analysis of the station, the market and the regulatory environment provided by an expert who understands these qualitative factors as well as the quantitative ones.

The outcome of the Bonneville case and other legal factors affecting merger and acquisition activities in the industry will be explored in sessions slated for Media Finance Focus 2014, the 54^th annual conference for MFM and its BCCA subsidiary. In addition to discussing the latest regulatory matters, our attendees will hear from more than 175 industry experts concerning the accounting, economic, credit and collections, HR and technological developments affecting the media industry.

The opening keynote address for this year’s conference, which is being held in Miami May 19-21, will be from Kevin Mills, Univision’s VP of strategy, news. Not only is he very familiar with our host city, Kevin’s keynote will provide the perfect lead-in to our conference discussions by tapping into his knowledge about Millennials, the “browning” of America and other cultural trends that will shape the future of the media industry. Drawing upon his most recent experiences at the Fusion Network, a joint venture with Disney, Kevin will also discuss the factors consumption in today’s media environment — is it linear or digital first?

Additional keynoters include Carl Salas, VP-senior credit officer of Moody’s Telecommunication/Media Group; Borrell Associates CEO Gordon Borrell; John A. Weinberg, SVP-research director for the Federal Reserve Bank of Richmond; Laura Martin, media industry analyst for investment firm Needham & Co.; and Christine Romans, CNN anchor and chief business correspondent.

More information about the conference may be found on our website, www.mediafinance.org, and we hope you can join us. Media Finance Focus serves as the industry’s primary source of professional education for financial and business executives and this year’s Conference Committee has put together an outstanding agenda that’s available for you to preview via the Web. In the case of MFM’s annual conference, we aren’t discussing a “like-kind exchange”; what you will receive in valuable knowledge is sure to exceed the cost.

Mary M. Collins is president and CEO of the Media Financial Management Association and its BCCA subsidiary. She can be reached at [email protected]. Her column appears in TVNewsCheck every other week. You can read her earlier columns here.