| Media Maven Volume 8, June 2011  Download PDF |
The Local TV M&A Cycle – It's That Time Again
A lot has been written about declining TV viewership and the implied declining effectiveness of TV advertising. However, Nielsen data shows that total TV viewing continues to climb. While broadcast TV viewing has declined, spending on broadcast TV is projected to increase, indicating that broadcast television remains advertisers' preferred means of reaching large audiences. In fact, as media consumption fragments, advertisers are placing a premium on television's ability to reach mass audiences.
This is evident in the results of the recent broadcast TV upfront marketplace, during which the broadcast networks generated approximately 6%-7% higher ad revenues for the coming 2011-2012 television season. This growth is derived from the networks garnering high single to low double digit CPM increases which offset the previous season's mid-single digit viewership declines. Advertisers are proving they are willing to pay higher CPMs to reach broadcast audiences as these audiences remain the last bastion of true mass audience reach.
The outlook for television advertising in the coming years looks promising. Interpublic Group's MAGNA Global recently forecast that the U.S. TV ad market will grow steadily and capture a dominant share of total U.S. ad spending. While online advertising is projected to grow faster than TV, by 2016, MAGNA estimates that TV's share of ad spend will increase to 38% from 34% today, suggesting online advertising's growth will likely come at the expense of other mediums but will be less impactful on TV ad spend. Agencies view online advertising as complementary to TV advertising, with TV creating awareness (the "top of the funnel") and online advertising helping to drive conversions (the "bottom of funnel").
TV and online advertising were two mediums that performed best during the recession and recovery. Internet, cable TV and broadcast TV (including network TV and syndication) were the strongest advertising mediums in 2009 and 2010. Ad spend on broadcast TV outperformed all advertising mediums except internet and cable TV ad spend during 2009, and all but internet advertising during 2010.
Focusing solely on the local TV stations, results were more pronounced given local TV's exposure to auto and political advertising: an analysis of 20 publicly traded companies with local TV station operations showed broadcast station net revenues declined by 17.6% on average in 2009 and increased by 22.9% on average in 2010. The 2010 recovery was important to local TV station owners in many ways, but probably most significantly in how it enabled local TV broadcasters to significantly de-lever their balance sheets. The average leverage ratio of seven publicly traded TV broadcasters fell from 8.6x EBITDA at year-end 2009 to 5.6x at year-end 2010. Given the backdrop of a slowly improving economy, advertiser enthusiasm for the 2011-2012 TV season, improved balance sheets, and the return of political advertising, we believe local TV broadcasters are poised to see a recovery in M&A.
Local TV M&A in 2011 – Looking Ahead by Looking Back
In one of our recent notes (Media Maven, Vol. 7, "Radio M&A Roars Back to Life"), we observed that over $3.6 billion in radio station transactions had been announced year to date. The local TV station M&A marketplace, on the other hand, remained tepid, with operators still waiting for the first "bellwether" transaction in several years.
One might expect 2011 to be a strong year for local TV M&A based purely on cyclical attributes of the TV ad spending, as sellers like to sell based on forward projections (i.e., 2012 estimates) that include substantial political advertising, and buyers like to close deals early in an even numbered year so that revenues from political advertising can be utilized quickly to reduce leverage.
For cyclical reasons, we expect M&A in the local TV industry to pick up in 2011, but for secular reasons, we believe M&A levels are unlikely to match 2007 levels. In 2007, local TV stations were just beginning to develop a second revenue stream (retransmission consent fees from local cable MSOs). While local TV owners have proven adept at developing several new revenues streams, secular issues such as reverse compensation and voluntary spectrum auctions have created some uncertainty in the marketplace. This will likely have the effect of private equity remaining hesitant and prevent the local TV M&A marketplace from returning to previous levels. Nevertheless, with McGraw-Hill announcing its intention to sell its 4 station TV group, our thesis of an improved local TV M&A marketplace may be realized.
2007: The Last Great Year of TV Station M&A
2007 was a standout year for local TV station M&A. According to BIA/Kelsey, roughly $4.5 billion in local TV stations traded hands in 2007, nearly twice that of 2005, and nearly 5x that of 2003 and 2004 levels.
Our analysis of TV station deals in 2007 shows that there were eight transactions whose purchase price exceeded $100 million. These eight deals represented over $4 billion in TV station transactions covering 126 TV stations and included private equity sponsors such as Providence Equity Partners, Oak Hill Capital, Cerberus and HBK Capital. For the five transactions for which we have data, cash flow multiples were in the 12x-15x range, buoyed by a very favorable lending market.
In addition, 2007 nearly saw the sales of Nexstar Broadcasting and LIN Media, both of which were put on the auction block in June 2007. However, these potential deals were pulled later in that year when financing markets soured.
Political Advertising – A Cyclical Driver of M&A
We believe enthusiasm for local TV in 2007 was motivated by both cyclical (a return of political advertising in a presidential election year), and secular (the advent of a 2nd revenue stream in the form of retransmission consent fees) drivers. Acquiring TV station groups late in an odd numbered year or early in an even numbered year is the right time to buy (and sellers to sell), as it enables the acquiring entity to quickly pay down debt from political advertising shortly after closing. It is even more helpful that political advertisers pay in advance of the on-air date that their ad campaigns run, which enables acquirers to pay down debt even quicker than regular advertisers who typically pay 60-90 days after airing.
As shown in the chart above, political advertising on TV has grown by a compound annual growth rate of 13% since 1998, to $2.25 billion in 2010. Political spending was 32% higher in 2010, a non-presidential election year, than 2008, a presidential election year, according to TNS/Kantar Media. The increased spending was driven by a number of factors, including the Supreme Court's decision to allow corporate and union spending. Moody's believes that political advertising will increase by 9%-18% in 2012 over 2010 levels.
Retransmission Consent - A Secular Driver, With a Catch*
In 2007, a projected rise in retransmission consent fees to local TV stations from local cable MSOs also fueled M&A activity for TV stations. In October 2005, after being off Cox Communication's cable systems for 10 months, Nexstar Broadcasting became the first local TV station group to reach a deal to get paid by a cable MSO when it signed a long-term retransmission consent deal covering 12 of its stations in Cox markets.
As shown in the chart below, over the last five years, Nexstar's retransmission consent revenues increased by 244%, from $8.7 million (3% of net revenues in 2006) to $29.9 million (10% of net revenues in 2010). Retransmission consent revenues have become an integral cash flow generator for local TV stations, accounting for approximately 25% of Nextar's EBITDA in 2010.
According to SNL Kagan, annual broadcast retransmission revenues have increased from $119 million in 2007 to $766 million in 2010, a 545% increase. During 1Q 2011 quarterly conference calls, many broadcasters projected double digit revenue growth from retransmission consent agreements.
As a research analyst at Bear Stearns, our team wrote a note on retransmission consent fees and analyzed the potential value of retrans fees to some of the largest TV station owners. Today, this analysis (which is replicated in the "low", "middle" and "high" columns below) shows that many broadcasters have begun to realize the "middle" ground of the potential for retrans revenues.
In the fourth column we have provided the actual retrans revenues for those broadcasters that reported 2010 retrans revenues combined with 2010 estimates provided by SNL Kagan. The final column suggests that broadcasters are generating between $0.10 and $0.43 per sub per month with an average of $0.27 per sub per month.
If our estimates are in the ballpark, then affiliates of the largest broadcast networks will continue to have significant upside potential in generating retrans fees from cable, satellite and telco providers. The average subscriber fees of the top 10 rated cable networks is $1.02 (including ESPN) or $0.64 (excluding ESPN).
Given the much smaller audiences of cable networks, over the long term, we expect broadcast network affiliates to continue to reap significant subscriber fee growth from MSOs; growth that is likely to come at the expense of subscriber fees currently paid to second and third tier cable networks. In short, there remains considerable upside to retrans revenues based upon the audience delivery that network affiliates provide to cable MSOs.
The Catch* – "Reverse Compensation"
Instead of celebrating this newfound revenue stream, it looks like local TV operators have more work to do. Station affiliates are now tasked with accelerating the growth of these fees, or risk margin erosion in this important cash flow driver. This is because the broadcast networks, which often provide 40% of total day content on local affiliates (and approximately 53% of during the hours of 7am and 11pm), have begun to assert their bargaining power over affiliates. Networks such as CBS and ABC are negotiating for a percent of retransmission fees from local network affiliates. NBC has floated a plan to negotiate with the MSOs on behalf of local affiliates and to share in the fees generated from these discussions. FOX has determined it wants a fixed subscriber fee per month from its affiliates, which will force Fox affiliates to extract those fees from MSOs or risk having retrans revenues evolve from a 100% margin revenue stream to a materially lower, and possibly negative, margin revenue stream. Fox has told affiliates that the terms of the new agreements are "non-negotiable". Local affiliates that don't like FOX's proposal risk losing their affiliation, as Nexstar (in Evansville, IN; Fort Wayne, IN and Springfield, MO) and Block Communications (in Boise, ID) learned recently. The LA Times reported that for stations in the top 125 markets, FOX is insisting on stations paying the network $0.25 per month per subscriber rising to $0.50 over the life of the contract. FOX's approach is fairly aggressive given that this equates to a substantial majority of the retrans fees that local affiliates have been able to extract from MSOs, and requires them to get substantially more from MSOs in subsequent years or lose money to remain a FOX affiliate. Perhaps this is why Nexstar did not come to an agreement with FOX in three markets. It is interesting that FOX is driving the hardest bargain despite providing just 2 hours of programming per day (8% of total day programming and 12% of programming between 7am and 11pm), while the Big 3 networks provide roughly 9 hours of programming per day.
Secular Issue #2 – The Spectrum Debate & Incentive Auctions
The National Broadband Plan (the "Plan"), first released by the FCC in March 2010, set forth a number of initiatives to optimize the availability of broadband to US consumers and enterprises including making more spectrum available for the carriers and potential new entrants to satisfy growing wireless demand. Specifically, the Plan recommended that an additional 500 mhz of spectrum be made available for broadband use by 2020, with 300 mhz available for mobile use within 5 years, 120 mhz of which would result from a reallocation of spectrum currently utilized by existing TV stations within the top 30 markets.
The FCC has proposed that this re-allocation occur through an incentive auction process whereby interested TV broadcasters would voluntarily offer their spectrum for auction with a floor price and interested parties would compete to acquire the spectrum offered. The FCC articulates that such a process is consistent with commercial competitive market practices and would provide a new opportunity for those interested in selling their spectrum in the open market the mechanism to do so while allowing those who believe that higher value is to be gained through the continued pursuit of the traditional and/or a new broadcasting model (mobile TV, for example) sufficient spectrum to accomplish their objectives. All prices at which a local TV operator would be willing to sell would be kept confidential unless it becomes a winning bid.
As might be imagined, re-allocating spectrum from existing users is controversial and both the justification (spectrum shortage by 2015 due to growth in wireless data traffic) and the mechanism (incentive auctions) are the subject of competing studies and rhetoric. In order for the FCC to move forward, legislation must be passed by Congress and several bills have been introduced in the Senate while little action has occurred in the House. If and when legislation is passed the FCC will commence a rulemaking proceeding which will take a year or longer, suggesting that incentive auctions will not likely take place, if at all, until late 2013 or 2014. In the meantime, there are already entities being formed to acquire underperforming TV stations in the top markets with the idea of selling all or some of their spectrum when/if the auctions take place.
Should local TV stations in the top 30 markets sell spectrum, we believe it would make for a healthier local market for those remaining broadcasters. These remaining broadcasters might also become a conduit or partner for wireless carriers, as the broadcast signals could alleviate traffic on carrier 4G or LTE networks.
The Wait Continues for a Bellwether Transaction
Shortly after our firm's participation in the Citadel Broadcasting bankruptcy process, we noted the difficulty in valuing radio broadcasters given the lack of research coverage in the equity markets combined with a lack of precedent transactions. The local broadcast TV industry is in a similar situation as it pertains to precedent transactions, as there has not been a bellwether transaction in the industry since 2007. For example, it is difficult to argue that the 2008 privatization of Hearst Television, at a $1.2 billion valuation, was a bellwether transaction both because it represented a parent company with a control stake buying a subsidiary as well as a deal multiple with exceptionally large trailing and forward multiples (the deal equated to 5.7x 2008 BCF and 10.7x 2009E BCF).
For over a year, we have been waiting for a potential announcement regarding the sale of Freedom Communication's TV stations. However, it is possible that Freedom's stations will be sold as part of the newspaper group, which will make it difficult for those not party to the transaction to understand how the TV group was valued. Both the LA Times and the Wall Street Journal reported that the deal was back to square one, though each noted that the TV assets were being valued at 8x while the newspaper assets were being valued at 4x.
Last week, McGraw-Hill announced that they intended to sell their TV station group (shades of 2007?). However, one could argue that neither Freedom nor McGraw-Hill's 4 station ABC affiliate group represent true "bellwether" transactions. At a minimum, they will provide valuation data points that have been sorely missing in recent years. We would not be surprised if transaction multiples in the coming months coalesce around the prices that these two station groups fetch.
Well Positioned to Compete Locally with a Three Screen Strategy
Historical TV M&A has revolved around which markets and which network affiliates an acquired station group would bring to an existing TV station platform. These are important criteria, certainly. However, we believe local TV broadcasters need to determine whether they choose to be defined or perhaps confined by their legacy systems and practices. Are local TV stations in the business of providing local services to the local markets or are they mostly a conduit for network programming? The fastest growing component of online advertising is video advertising and the largest untapped opportunity in online advertising is local. Shouldn't broadcasters be developing online video ads for local business given their expertise in video? Mobile marketing is projected to grow even faster than online advertising (albeit off a very small base), and two separate entities (the Mobile Content Venture and the Mobile 500 Alliance) are launching new mobile services in 2011. Given the increase in mobile commerce that is likely to accompany mobile advertising, are local broadcasters preparing to participate in the "lower funnel" to close the loop and demonstrate ROI to advertisers and prove the effectiveness of the medium.
We believe local TV broadcasters are very well positioned to compete locally on all three screens (TV, computer and phone), though we don't believe this message is getting through to public investors or private equity firms. The broadcast industry needs to make it more apparent to investors that it understands that incorporating online and mobile into a strong over-the-air product is key to the industry's future.
Final Thoughts
As media continues to fragment, TV remains one of the last effective ways for advertisers to reach mass audiences. We expect the potential sales of the Freedom and McGraw-Hill stations will likely result in continued industry consolidation where acquirers benefit from economies of scale and duopolistic efficiencies. We also expect that those local TV companies that succeed the most will be those that best marry their traditional media businesses with online and mobile opportunities that offer consumers the best viewing options and advertisers the most compelling mix of online and over-the-air solutions.
Sincerely,
Chris Ensley
(212) 901-4160
chrise@coadydiemar.com
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