Pure Plays Improve, But Wall St. Skeptical

While most of the pure-play TV station group stocks have posted gains in 2012, they have lagged the growth of the big media companies that own TV networks and big-market stations along with lots of other media assets.

Comcast, which owns NBC, is up nearly 47% year-to-date, while CBS Corp., ABC owner Disney and Fox owner News Corp. are all up by more than a third.

On a percentage basis, pure-play gainers are up impressively, too — Gray Television, 26%; Nexstar, 26%; Belo,  24%.

But the gains are somewhat misleading. They come on small prices that are way off the stocks’ pre-recession highs. For instance, Belo’s 24% year-to-date gain amounts to just $1.52, to $7.82. The stock was trading near $18 five years ago. (See chart at bottom of story.)

“There is a certain part of Wall Street that is very skeptical that television has good fundamentals today,” says Bishop Cheen, who retired in August from a long run as an analyst at Wells Fargo Securities and its predecessor companies.

“Add to that the cyclicality of political — which is a binge and purge, feast and famine every two years — and Wall Street says, look, you know, there’s not a whole lot of growth in spot, local or national, and we’re not getting the granularity anymore because station owners are just piling retrans fees into what they call ‘local television revenue,’ so it’s difficult to see what local spot is. We get percentages on the conference calls. It’s difficult to get the dollars to keep the running score.

“And then you have the networks, which have always been predatory – it’s a predatory relationship – and they say the networks are going to screw the stations anyway they can. So there’s all these issues, the clouds hanging over television.”

“The pure plays have been maybe not orphaned, but are clearly the ignored child in the family,” says Drew Marcus, who founded Sugarloaf Rock Capital, a private investment firm, in 2009 after 16 years as a media analyst at Deutsche Bank Securities and its predecessor, Alex. Brown & Sons.

He notes that the pure-play TV station groups have a total market cap of just under $2 billion, which limits analyst coverage of the sector. That market cap also means limited liquidity for large investors.

“If you want to play TV you have larger, liquid names like CBS or News Corp.,” he says.

Still, he sees plenty of positives for the pure-play TV sector. “What Wall Street likes about them is that they’ve developed a second revenue stream in retransmission rights,” he says. “They like their continued success on getting political revenue during even years. More recently we’ve seen the deal market come back to TV. Wall Street always likes seeing the affirmation of underlying asset values.”

“They’re trying the best they can, making acquisitions, beating the [analysts’ consensus] numbers, paying down debt, doing all of the right stuff,” says analyst Ed Atorino, who has most of the TV companies in his coverage portfolio at The Benchmark Co.

But what they can’t do is guarantee there will be no recession, and Wall Street hasn’t forgotten how far and how fast ad revenues dropped in 2008 and 2009, he says.

“In the end it all comes down to revenue growth,” Marcus says. “Given the operating leverage in the business, the growth or shrinkage of revenue has dramatic impact on underlying values.”

No TV group has yet sold stock, either as an IPO or an add-on, since the Great Recession, but plenty of broadcasters have been able to place debt, either with banks or via bond sales.

“The high-yield [bond] market has been very generous to media companies to help them recapitalize,” says Cheen. “We are still very much into the recap of America and certainly the recap of media America – and that’s the way it should be. Companies need liquidity.”

Cheen says balance sheets have improved dramatically in the last year and a half, and he notes that the TV sector has thus far de-levered more than its cousins in radio. If a company wants respect for its stock on Wall Street it has to be able to generate free cash flow, he says, and companies can’t generate free cash flow if they are over-leveraged.

Marcus also applauds the efforts of broadcasters to de-leverage and build equity value.

Even with that balance sheet improvement, however, TV stocks on Wall Street are trading below the cash flow multiples seen in recent station transactions.

“In TV, where obviously we’ve seen a bunch of transactions lately, all around nine times, the group trades as seven times,” Marcus notes. “That gap ultimately should narrow. If it doesn’t, you’ll see more companies getting sold or doing LBOs.”

Atorino agrees that the pure plays are undervalued by historical standards. “In the past 10 to 20 years these stocks have not sold at five to six times cash flow,” he says. “Typically it’s been eight to twelve – and in some years even better. But now we’re looking at six or seven, maybe eight at the top, but there are no double-digit multiples now.”

Although private market multiples are higher from the seller’s perspective, Sinclair, Scripps, Nexstar and others have been buying because they see immediate synergies that will make such acquisitions accretive to their cash flow quickly.

“The broadcasters believe in the business. They’re adding stations because they can buy them as cheap as the market is selling and they think that in time ‘the market will rectify itself’ and the multiples will return to ‘more normal’ levels,” Atorino says.

“I’ve been recommending these stocks, believe it or not, when they were a lot cheaper, so to a certain extent I was right,” says the Benchmark analyst. “But I thought they’d be higher. They seemed to run out of gas.”

Atorino still thinks the TV stocks will move up from their current levels. “I hope there’s no recession and I think that television is having a little bit of a renaissance in terms of its advertising strength.”

The Street, though, loves new growth pitches.

“A lot of people get excited about social media,” Atorino says. “You talk to companies [that advertise], they don’t sell anything on social media,” scoffs Atorino. “First of all, the people on social media don’t have any money and they don’t buy stuff. The newspapers are losing ground because people have stopped reading them. The magazines are struggling. It’s basically the Internet, broadcasting and cable that are the dominant media.”