After a large rally in the S&P in the second calendar quarter, we struggled to find ideas that we liked a lot. One of our last trades in June was a short S&P500 ETF, a reflection that we thought the market might head for a pullback. However, July saw a continuation of strength in the market, so we redoubled our efforts to look for ideas that had not already benefited from the market surge.
One such idea, in fact the only one we purchased, was Emmis Communications (EMMS). We have been familiar with EMMS since 2005. At that time, EMMS was a radio and TV broadcaster, owning both TV and radio stations in many markets nationwide. The company was highly levered, and embarked on a subsequent program to sell its TV stations, repay debt and buyback shares over the next several years. In 2007 or 2008, the founder, chairman and CEO, Jeff Smulyan, made a bid to take the company private at a price over $10 per share. However the board and several large shareholders resisted this overture, indicating that they believed the "stick value" of the company was worth more than the price Smulyan was offering.
Stick value is a concept related to the value of each individual market in which the company braodcasts (think of a big antenna, or stick that broadcasts radio in a given market). EMMS, while a small company located in Indiana, owns several valuable sticks: NYC (Hot 97), LA (Power 105) and two stations in Chicago. The company also owns other radio stations in smaller markets as well as in Eastern Europe. The key angle to the EMMS story is that the NY and LA sticks are very valuable, in large part because they serve the two largest markets in the country and also because radio licenses are limited in number. If a radio player wants to enter a market, it has to buy a stick from an existing player; supply is limited.
Whereas valuation multiples for radio companies have been as high as 10-12x ebitda, the valuation for individual market sticks in places like NY and LA is thought to be much higher (15-20x or more). I say thought to be because these sticks trade infrequently and the multiples will vary based on the audience of the particular station.
Numbers-wise, at the time of our purchase, here is what we were looking at:
Market cap: $11m
Net debt (incl minority): $540m
Cash: $20m
Enterprise Value: $530m
EBITDA: $60m
EV/EBITDA: 9x
As one can see, nearly all of the value in EMMS is represented by the debt holders. I'd note that we did not have access to buying the bank debt so we concentrated our effort on the equity, which we think represents a low priced, long dated option on the survival of the company outside of bankruptcy.
Based on our estimate of cash flow per stick and a range of valuation multiples, we get a range of zero to $1.50 per share.
We bought EMMS shares at $0.30. Our biggest risk is that the company fails to maintain its covenant requirements (there are maximum debt/ebitda thresholds that start at 6x in Feb 2010 and step down after that) and the banks force the company into bankruptcy. However, some points ot consider:
-Smulyan founded this company and will do everything in his power to keep control. His control is through supervoting class B shares, so he is at least economically aligned with common shareholders like us.
-The banks (DB and BofA) likely don't care to see more of their loans default, nor do they wish to become owners of more radio stations. They are already granting many waivers to EMMS (and to other radio companies) to help these companies navigate through tough times. Hopefully this continues.
-Radio trends are starting to stabilize, ie, getting less worse as evidenced by 2Q earnings.
-If forced into a corner, EMMS would likely sell some of its stations to repay debt. The price they can get is uncertain however, as a buyer would need bank financing.
So overall, we know that radio trends are awful and that EMMS is among the most levered of all the publicly traded radio companies. We also know they are in danger of tripping covenants and a few steps away from having to be forced sellers of some of their prized assets. However, with an upturn in the economy and advertising (69% of EMMS revs come from local ad sales like car dealerships), there might be just enough improvement to stave off bankruptcy. If EMMS can be a survivor, the stock is worth well over $1 per share and possibly a lot more (each $1 in stock price represents $37m in market cap, a small number compared to $60m in ebitda and almost $600m in EV).
