Retrans Sharing Holding Back Station Sales

As the TV station trading market claws its way back from the economic downturn, it faces a new obstacle: network demands for big shares of stations’ retransmission consent revenue.

When network affiliates started collecting retrans fees from cable and satellite operators for allowing them to carry their signals several years ago, they viewed the new money as the beginning of a dual-revenue stream that would help revitalize the business and push up the value of their stations.

But the Big Four’s demands to siphon off much of that flow is further depressing station values and impeding deal-making.

“Potential buyers may be sitting on the sidelines until there’s clarity on what the networks in general — and Fox specifically — are going to be taking from stations,” says Avi Steiner of JP Morgan.

In fact, a couple of potential deals involving Fox-affiliated stations have stalled because of Fox’s non-negotiable demands from affiliates, sources told TVNewsCheck.

One involved a large station group seeking to buy a station that was a strategic fit, according to a source familiar with the situation.

“What screwed up the deal was the Fox affiliation,” the source says. “The buyer did not want the seller to sign the [affiliation] agreement — thought it was obnoxious — so the buyer walked away.”

In another instance, “the buyer said either reduce the price by 25% or we walk away,” the source says. Fox’s demands “make any group that has a lot Fox stations immediately worth less,” the source adds.

A securities analyst, speaking anonymously, says the anxiety over affiliation deals and how retrans money is to be split makes it difficult to calculate how much stations are worth.

“With the Fox and affiliates contretemps, there’s the potential that retrans doesn’t grow that much from here, and I would want to build that into models,” the analyst says. “It shouldn’t be just Fox. You have to think about what is happening with some of the others and factor that in.”

Indeed, it’s not just Fox, although it has been the most visible and aggressive in its reverse compensation demands — 25 cents per cable or satellite subscriber per month in the first year, escalating to 50 cents in the fourth year.

The other big networks are setting similar goals, sources say.

“CBS and ABC have put out plans that are a slower buildup, but eventually get to the same place,” said a station group boss who requested anonymity.

“NBC has a different approach,” that source says. “They’re saying you keep the first 25 cents, we keep the next 25 cents, then we share whatever we get after that. People seem to think it’s more palatable on the surface, but the question is how do we do it.”

In addition, NBC has offered to represent its affiliates in retrans negotiations with cable and satellite operators. Under Fox’s model, that burden rests entirely on affiliates’ shoulders.

The link between Fox’s programming fees and station values arose during meetings at this year’s NAB convention in April, says a source who attended one key meeting. Nexstar CEO Perry Sook “pretty much said … that if Fox doesn’t bend, there’s going to be a value denigration to Fox stations,” the source says. “He believes it lowers the value of a Fox station.”

Sook declined to comment for this story.

Traditionally, stations have been valued on the basis of a multiple of cash flow — the multiple reflecting, in essence, the buyers’ consensus on the growth potential of the stations and a host of other variables.

So, to the extent a station has to trim its cash flow to pay programming fees to networks or share retrans revenue with them, it devalues the station. What’s more, uncertainty about the cash flow would negatively affect the multiple and also depress values.

Those familiar with the broadcast M&A market today peg the multiple for good stations in healthy markets at eight or nine. “Fox affiliates are being valued at seven times or less,” one source says.

The networks began eyeing their affiliates’ retrans revenue two years ago after watching it grow rapidly for three or four years and become a major contributor to the affiliates’ cash flow.

Retrans revenues’ contribution to station groups’ overall revenue varies widely, a recent SNL Kagan report shows. At Gray Television, a publicly traded station group, it accounts for about 5% of overall revenue. At Sinclair, the percentage is 16. The average is roughly 10.

The networks “have more leverage than in the past and they’re not afraid to exercise it,” says an executive who heads a mid-size group. “Even if they get only half the milk with no risk, no deployment of capital and no demands on management, it goes right to the bottom line.”

Some predict a “firestorm” at the end of this year as stations and groups that haven’t solidified affiliation agreements face the new realities of networks’ escalating demands.

“The starting rates have more than doubled” for affiliation deals this year versus 2010 says the head of a mid-size group. “A deal that got done in February wouldn’t get done today.”

But without exception, the sources interviewed for this story consider networks’ claims on a chunk of affiliates’ retrans revenues reasonable.

“Should there be sharing? Absolutely, but sharing means sharing,” said an executive who heads a mid-size group with stations mostly in smaller markets. “Some fair discussion about sharing is appropriate.”

The networks need money to maintain the quality of their programming and to hang on to viewers, says Randy Bongarten, president of Bonten Media Group. “Whether it’s retrans or something else, the networks are going to be looking for additional resources for programming,” he says.

Stations and networks are what he calls a community of shared interest, both benefiting from strong network content and strong local operations. Their combined strengths give them an advantage over cable and satellite, he says.

United, they can use that advantage to compel consistent increases in retrans fees from cable and satellite and support station values. “It’s an ecosystem,” he says. “At the end of the day it’s in all our interests to have a healthy ecosystem.”

The financial community sees retrans as a positive for networks and stations alike, though it’s likely there will be swings between which benefits more.

“I think most analysts are treating this as the retrans line goes up at a single-digit escalator rate, but the take for stations going forward is half the line,” said Bishop Cheen of Wells Fargo. “[Retrans] is still 100% margin cash flow, but it is not the whole pie and it never was meant to be.

“So are stations better off today than they were two years ago? No. But four years ago? Yes.”

Despite the squabbling over the retrans revenue and its impact on station values, JP Morgan’s Steiner is optimistic that the station market will rev up.

“I believe the second half of this year and into 2012 will be active in M&A,” he says. “From a financing perspective, if you can sell into 2012 numbers, which generally would be higher, that doesn’t hurt the calculus. Flipping that around, perhaps some sellers … realize the same thing, and don’t want to sell in [the current] softer patch.”