Media General (NYSE:MEG) reported Q4 2011 earnings on Thursday, January 26 2012. The company actually performed well relative to expectations but as typical with MEG’s imbecilic management team, was able to steal defeat from the jaws of victory by citing concerns regarding its ability to remain within compliance of its covenants in 2012. As a result, MEG is going hat in hand to its lending group to ask for an extension and amendment of its current debt deal. Since S&P downgraded MEG’s debt in October 2011, the stock has increased from near $1.00 to $5.50 before MEG management squashed investors in the Q4 2011 call. The stock was due for a pullback given the aggressive run up into earnings but the main question longs and shorts must consider is is there any more upside left in MEG? I think the answer is that MEG could still run up significantly from current levels. Before discussing why MEG has potential upside, let’s first review what MEG observers already know. MEG management is perhaps the worst team ever assembled. This is a team that along with their “financial advisors” missed the biggest refinancing window in years back in Q1 2011. A review of the conference call transcripts during that period shows a lazy management team that felt comfortable that refinancing would be possible at any time and never focused on getting this accomplished. To be clear, CEO Marshall Morton cost MEG investors roughly $10-25MM through this incompetence which led to the share price declining from well over $7 to the near $1 over 2011. So any investor in MEG must immediately realize that MEG’s team are simply looters, transferring millions from investors, creditors, and employees while providing nothing but strategic and financial failure. The main issue is that the founding Bryan family controls the voting block and for whatever reason, J. Stewart Bryan III has seen no reason to change management as he has watched the value of his family’s stake in MEG decline from roughly $23MM to<$3MM. Bryan III is proving the Chinese proverb “Wealth does not pass three generations.”
Going long MEG is partially an assumption that underlying business fundamentals overwhelm the incompetence of management while shorts assume that management will eventually find a way to destroy this company. I still believe that underlying fundamentals remain strong and that the credit issues presented by MEG can be addressed in a way that works for investors. When one reviews Q4 2011, it should be noted that MEG matched sellside expectations of revenue of $168MM while also exceeding the EPS estimate when adjusting for one-time items. With $27.7MM in adjusted operating income and $14.6MM in interest expense, MEG generated EBT of $13.1MM. The company recognized a non-cash $7MM tax expense leading to EPS of $0.27 compared to a $0.10 estimate. If MEG had successfully addressed credit issues in the early part of 2011, MEG stock could have skyrocketed off these results.
Instead, management warned that it would seek to amend its existing credit agreement with its bank group because it felt it could struggle to remain in compliance with its covenants in 2012. This would be a concern if a management with credibility stated this but MEG management has a laughable track record of predicting how MEG business will fare. In early 2011, MEG management reinstated a number of expenses and spoke boldly of an improving economy that would benefit the company only to provide the pathetic “it’s the economy” excuse a few months later when results did not materialize. In fact, management’s concerns about remaining in compliance make me feel somewhat optimistic as it seems that even conservative forward projections indicate it would be difficult to breach covenants.
FY 2011 EBITDA figures should be the lowest EBITDA MEG recognizes for the next four quarters. This is because Q1 2011 was poor while Q1 2012 should be much much stronger. In fact, each quarter in 2012 should be considerably stronger than 2011 whereby EBITDA figures should match 2010 numbers which should allow MEG to remain within its compliance levels. Table I presents MEG’s historical quarterly data from 2009 through 2012, using my own estimates for 2012 figures. I have been relatively close to MEG’s own realized estimates in 2011, generally hitting the operating profit number. For example, if one goes to my post in October and scrolls to Exhibit I, they would see that my Q4 estimate for MEG’s EBIT and EBITDA was$24MM and $36MM, respectively. This is pretty much what MEG achieved for Q4 2011 per their earnings release when adding back the $6MM in goodwill impairment.
TABLE I: MEG HISTORICAL AND PROJECTED QUARTERLY FIGURES
One area that MEG management cited as a potential problem in terms of coming under its covenant levels is its Publishing segment. While I anticipate continued struggles in the Publishing segment, the challenges appear to be moderating in that the pace of the decline seems to be abating. While the first three quarters of 2011 notched 9+% declines in Publishing, the Q4 decline was 6.6%. In contrast, in Q4 2010, the Publishing segment’s decline accelerated so this slight change in Q4 2011 is a welcome sign. It hardly means any gains from Publishing will accrue but it does suggest the drag on MEG’s business may be less acute. Management also stated uncertainty in the economy and challenges in Florida could cause problems but I am skeptical given that in 2011, management was optimistic about the economy and stated that they believed the downturn in Florida was past them. Florida has a number of state-specific positives related to MEG in 2012 covered further below.
It’s been covered numerous times but 2012 will be the first Presidential election in a post-Citizens United world. In 2010, political ad dollars exceeded 2008 ad dollars, despite 2010 being a non-Presidential election year. According to AdWeek, total political spending hit $4.6B in 2010, exceeding the 2008 Presidential election by 8%. In 2012 the Republican party has been holding hotly contested primaries with different winners in each state since primaries and caucuses commenced. Aside from the Publishing segment, MEG should have a very strong 2012 due to the political cycle. MEG has already racked up revenues that exceeded its expectations in Q1 2012 from South Carolina and Florida, with Florida still yet to have been completed. MEG properties will benefit from Super Tuesday in March when primaries in Georgia, Ohio, and Virginia occur along with a primary following in Alabama later in Q1 2012. The Super Bowl will also take place in Q1 and reports indicate that Super Bowl Ads Sales set a record for NBC. This is why Q1 2012 EBITDA levels should improve markedly from Q1 2011 and allow MEG to remain within compliance despite some covenant step downs. In Q2 2012, primaries in Arkansas, North Carolina, and Rhode Island will benefit MEG along with an expected increase in Presidential level ad spending.
Q3 2012 could also be a monster quarter for MEG. The London 2012 Summer Olympic Games will commence in late July, benefiting MEG’s NBC stations. Further, political ad dollars should begin to coalesce around the Republican Party’s Presidential candidate leading up to the Republican National Convention (“RNC”). The RNC will be held in Tampa, FL – the heart of MEG’s Florida division – in August 2012. This is a huge benefit to MEG and should yield significant positive business for its television and publishing segments in Florida. The Florida division was a major cash drag in 2011 but the Republican primary in FL, the RNC in Tampa, and the battleground status of the state should help make Florida a strong contributor to MEG in 2012.
In Q4 2012, the Democratic National Convention (“DNC”) will meet in Charlotte, NC, once again benefiting MEG’s various media properties. MEG owns two CBS stations and two NBC stations in NC which should benefit from DNC related ad spending. More importantly, Q2-Q4 should all start to increasingly incorporate heavier and heavier political spending, particularly in key battleground states. Using the 2008 election by state breakdown from Real Clear Politics demonstrates how well MEG’s properties are situated.
CHART I: 2008 TOSS UP STATES (SOURCE: REAL CLEAR POLITICS)
MEG has operations in Florida, North Carolina, Georgia, Virginia, and Ohio, all of which should capture major political ad dollars. There is a very strong expectation that these states will remain big targets for political ad dollars given the slight margin of victory in these states in 2008 along with the significant level of electoral votes attached to each state. Despite all of these positives, I have kept my estimates for 2012 pretty much inline with 2010. Table II uses the 2012 estimates along with MEG’s debt covenants to demonstrate how MEG can remain in compliance throughout 2012.
TABLE II: MEG DEBT/EBITDA RATIO 2012 PROJECTION
In comparison to the last political cycle year in 2010, MEG will have the Summer Olympics vs the Winter Olympics which should result in roughly double the Winter Olympic revenue and a NBC broadcast Super Bowl while 2010 had no NBC Super Bowl. In addition, political revenues for the Presidential election and specific battleground states should be at least if not meaningfully higher than 2010 political revenues. In comparison to 2010, there will be a potential drag of about $50MM from lost Publishing revenue but this could be partially offset by retransmission revenue. More importantly, revenue through MEG’s Broadcast division yields much higher margins than Publishing so lost revenue on the Publishing side does not need to be fully recouped to make up for lost operating profit dollars. Conservative estimates of continued losses in Publishing and Digital and strong performance in Broadcast still yield EBITDA levels that allow MEG to remain within compliance throughout 2012.
These conservative estimates should assuage some concern of MEG blowing through covenants. Since the earnings release, MEG stock has been in free fall and some reporting appears somewhat sensationalist regarding MEG’s covenants. The discussion above should help illustrate that MEG can generate solid EBITDA in 2012 as well as generate up to $40MM in free cash flow after interest expense, pension, and capex costs which will be used to reduce debt.
However, since management is uncomfortable with the covenant step downs, it is seeking relief from its bank group, which is lead by Bank of America (“BAC”). MEG has $363MM of bank debt which matures on March 2013 and is working with BAC to amend its agreement. The question is whether MEG can successfully amend its existing deal and I think MEG has a good chance to achieve this. Management blew a huge chance to refinance at extremely attractive rates last summer. In doing so, management cost investors tens of millions of dollars. MEG’s $363MM is a Term Loan A but its current credit profile has it buried in the high yield market. As a result, short sellers are foaming at the mouth and longs have dumped the stock in concern that MEG may have trouble in getting covenant relief. I’m a bit more optimistic, however.
Credit profiles matter but so do incentives. In the current market, bankers have a lot of incentive to avoid writing down debt. MEG’s Term Loan A puts its paper in the hands of typical banks which don’t want to write down any impaired debt as opposed to hedge funds which could seek to force the company into a precarious situation. BAC is the lead bank in MEG’s deal and would likely prefer to extend rather than write down large pieces of corporate debt. BAC probably also recognizes that credit markets are currently jammed so an extension could give its borrower some more time whereby it could refinance out into a healthier market, should a window like last spring’s emerge in the coming years. In structuring the right amendment and extension, BAC could generate up front cash fees, avoid any write down of debt, have a higher yielding performing asset on its balance sheet, and ultimately when credit markets thaw, be made whole when MEG refinances. In contrast, BAC could agree to not work with MEG and potentially have to deal with a significantly impaired asset on its books. It appears that BAC and MEG have aligned incentives.
This is also the same dynamic/benefit the rest of MEG’s banking group faces. It should be noted that extensions do not require unanimous consent, another aspect that favors MEG.
Table III presents MEG’s current debt components along with a sensitivity analysis on a potential new deal with BAC and it’s impact on interest expense. What’s very clear is that the current deal for MEG is extremely attractive, priced at L+475 or effectively 5.25%. Recent financing transactions by companies such as Lin TV (“TVL”) suggest that MEG could obtain an extension that is a win-win for both MEG and BAC. MEG will likely push for a 3 year extension but my guess is that BAC would give them just about 2 years. The main challenge for MEG is its leverage covenants and it would probably seek a waiver for these. For BAC to agree to these covenants, it would likely price MEG at the very high end of the Term Loan A market which could range from L+600-700 with a LIBOR floor or 1+%. In addition, BAC would charge an upfront fee of 1%+ to do this deal. This could work out well for BAC’s bankers and in exchange, MEG could get a reset on its leverage covenants whereby BAC would potentially waive or set a very high leverage covenant for the near-term and then implement quarterly step downs.
TABLE III: MEG SENSITIVITY ANALYSIS TO NEW BAC DEAL
As with its prior schedule, MEG’s bank group recognized the cyclical nature of MEG’s business and as such allowed leverage covenants to expand based on off years. In Q3 2011, MEG was allowed to have a maximum leverage ratio of 8.0x compared to a maximum leverage ratio of 7.6x in Q3 2010. I would anticipate that BAC would implement a similar schedule, perhaps waiving covenants for Q2 and setting a leverage ratio of 6.5x and fixed charge ratio of 0.95x and Q3 2012, slowly bringing leverage levels down for 2012 before allowing them to rise in the off political 2013. Table IV presents MEG’s 2012 quarterly estimates using a scenario whereby BAC extends MEG’s Term Loan under terms of L+700 with a 150 basis point LIBOR floor (the last row in Table III for Bank of America and Debt Sensitivities). While this would raise MEG’s interest expense by over 20%, it provides the company with the breathing room it feels it needs on a covenant basis.
TABLE IV: MEG PROJECTIONS BASED ON NEW BAC DEAL
Q1 2012 would recognize interest expense under the existing term loan agreement while future quarters would increase due to the new deal. In either case, the additional covenant relief would likely remove the discount shares have currently experienced. BAC would probably also incorporate a schedule similar to the existing one that allows for covenant expansion in an off political year like 2013. This type of schedule would allow debt/ebitda ratios to reach levels near 8.0x and fixed charge ratios at roughly 0.95x, similar to the existing deal’s 2011 debt/ebitda ratios, and would allow MEG to be in the clear even with a return to 2011-like performance in 2013.
TABLE V: MEG SUMMARY 2012-2013 PROJECTIONS UNDER NEW BAC DEAL
BAC and its lending group do not want to recognize a severe write down on MEG’s bank debt. They will probably recognize that credit markets have seized up but that refinancing windows can appear in the future as they did in the spring of 2011. By buying MEG some time with a deal its near-term issues, BAC avoids any severe writedowns and can also incur some additional fees, potentially as much as $5MM as shown in Table V for acquiescing to an extension. If a refinancing window appears, MEG can then refinance out of the amended deal, taking out BAC and its lending group, whereby all parties win. While the terms in the above charts can fluctuate, the overall reasoning presented above will definitely be a part of BAC’s consideration when determining how to structure an extension and amendment.
The benefit to MEG investors is evident in the reaction of a number of companies once a successful financing occurs. Recently, Lee Enterprises (“LEE”) was able to successfully complete a refinancing which yielding near term gains over 100% for investors in those companies. In both cases, the overall assets were worse than MEG and so were the near term business prospects and thus the financing terms were far worse for those companies than what MEG should confront. In addition, while Marshall Morton and his team of cronies clearly are focused on lining their pockets, a larger shareholder such as Gabelli could attempt to get more involved and suggest putting the entire company up for sale, or perhaps Bryan III might wake up and realize he could rather quickly double the value of his family’s share in MEG.
As previously discussed, MEG’s Broadcast division alone could be valued at $855-950MM including total debt. This is based on using a four year average cash flow figure which would include one Presidential year, two off political years, and one Congressional year, averaging about an estimated $95MM. Recent comparables imply MEG could easily command a valuation multiple of 9.0-10.0x. The New York Times Company (“NYT”) recently sold off its regional papers business suggesting there could be some value with MEG’s Publishing division in more capable hands. With about $28MM in platform cash flow, MEG’s Publishing unit could conservatively be valued at 2-4x this cash flow or $50MM-$100MM. Ignoring the Digital segment (DealTaker), breaking off the Broadcast and Publishing segment could total about $900MM-$950MM. If one netted out the existing net debt of $635MM and pension obligations of about $160MM, MEG shareholders would walk away with $7.00+ or 80% above current share prices. The challenge is that management has demonstrated that its incentive is solely to continue to command undeserved, excessive compensation at the expense of shareholders. Given the M&A activity in MEG’s industry, I am somewhat skeptical that management has been willing to listen to potential suitors, despite management commentary that they are open to deals.
While a sale process could generate immediate value, the near term catalysts and incentives for both borrower and lender suggest an acceptable amendment/extension could materialize whereby MEG can achieve a valuation near $7-10. MEG has historically commanded a valuation of 6.8x EV/EBITDA. Even in October 2011, when MEG prices were near $1…this translated into about 6.8x EV/EBITDA with $23MM in equity value and about $650 of net debt. At the time, MEG’s pro forma LTM Q3 EBITDA was about $99MM. As with most cyclical companies, this valuation multiple “detaches” during cycle turns which is what occurred in Q4 2011. Participants start buying the stock knowing that the current quarter (which was Q4) would be the bottom. As a result, MEG is now valued at 7.9x EV/2011 pro forma EBITDA. However, if history repeats MEG will get back to the 6.8x multiple as EBITDA improves. Assuming MEG gets to $125MM in EBITDA in 2011, I expect MEG to carry an enterprise value of $850MM which would result in an equity valuation of about $9.50 or so.
However, under a new deal with BAC, the market could reduce the overall EV/EBITDA multiple MEG deserves as a higher level of interest expense would be paid out. If MEG commands an EV/EBITDA multiple of 6.25-6.50x as a result, MEG’s share price would still range from $6.50-$8.00. What would also be of use would be to compare the EV/Revenue multiples of highly levered old media companies such as LEE and the McClatchy Company (“MNI”). Both are worse assets than MEG and have significant leverage but trade around 1.4x EV/Sales. Using that multiple, MEG would command prices over $12.
The main challenge right now is waiting while management potentially bumbles and stumbles in its negotiations with BAC. The above discussion laid out a number of incentives BAC and its lending group have to work on a deal that works for MEG and performance by other levered old media entities post positive financing news suggests if MEG can secure a decent deal, the stock could continue to perform well as MEG captures significant upside from 2012′s political season. MEG is working to secure a deal before filing its 10K and with 42% of the stock sold short, the wait for potentially explosive good or bad news won’t be long.
DISCLOSURE: AUTHOR MANAGES A HEDGE FUND AND MANAGED ACCOUNTS LONG MEG
About the author:
Amit Chokshi is the founder and owner of Kinnaras and affiliated companies and is responsible for security analysis, selection, portfolio management, and Firm operations. Prior to founding Kinnaras, he worked as an associate at the Royal Bank of Scotland ("RBS") in the firm's Corporate Advisory Services group, which provided corporate finance and mergers and acquisition ("M&A") services to the firm's clients with a particular emphasis on private equity firms. Amit also worked at Morgan Stanley and received a B.S. in Finance from Bryant University and an MBA from Emory University. In addition to passing the NASD Series 7, 63, and 65 exams, Amit is also a CFA Charterholder and on the Board of the Stamford CFA Society. Amit has appeared on Bloomberg Radio and has also been quoted in various publications regarding Firm-specific holdings.