Local TV: Less Green in 2013

It’s not the end of the world, but the coming year will be tough for local broadcasters. The companies just racked up record political advertising in 2012. The NBC clan of stations enjoyed phenomenal ratings on the quadrennial summer games. And the broadcasters’ largest category of advertising – autos – grew at outsized rates as auto sales took off.

So, local TV is rolling off a peak. At least it is not falling off a cliff — that is, as long as the economy continues to expand.

Everyone knows political advertising spending shrinks to de minimis levels in an odd-digit year. Most investors focus on what is going on with the core of advertisers who continue to advertise every year. I am guessing core spot TV advertising will grow about 2.4% in 2013. In my scenario, because of the drop off in political, total spot TV advertising would fall close to 10%, which you can see in the table with my top-down calculations. With an offset from what are known as retransmission consent fees, I show a scenario for a 6.0% decline in local TV station revenue from spot TV and from retransmission fees.

Now, how did I come up with these numbers? Keep reading.

If the economy remains resilient, I look for broadcasters’ core business to hold up. Among the core advertisers, I expect:

  • Auto advertising should slow to more normal growth rates;
  • Telecom companies probably return to competitive advertising;
  • Other categories average out to growth rates slower than the expansion of nominal GDP.

Spending by auto makers and dealers is the linchpin for local broadcasters. The group probably represented over 20% of spot television revenues in 2012. Unit sales of cars and light trucks rose about 14% in 2012, based on figures from J.D. Power & Associates. Most broadcasters recorded advertising spending growth in excess of the unit growth as the ad spending in 2011 was dampened by the impacts of the Tohoku earthquake and tsunami on the Japanese automakers.

In 2013, JD Power & Associates forecasts an increase of around 4% for retail unit sales of cars and light trucks. I would assume that dealers will spend about the same amount per vehicle as in 2012. On top of that, it seems likely that local television stations will keep roughly the same market share of total advertising spending by auto dealers. On that basis, dealer spending with local television stations would gain by the same amount as the volume increase, about 4%. As can be seen in the table with the latest data from the dealers’ association, the amount spent per vehicle in 2007 was lower, which I think was a function of robust unit sales. Auto makers are also important buyers of local time, but I expect the dealer behavior may be a good indication of how others in the supply chain will spend on television.

The JD Power forecast did not take into account economic impacts from the Congressional budget battle and fiscal tightening.

Were there a slowdown in sales, I think the initial impact would be a short-term increase in auto advertising. If vehicle sales were to downshift suddenly, the existing supply would take longer to clear, so dealers would increase advertising in the short-term so they are not left with an oversupply of vehicles. Auto makers would step up incentives to manage inventory instead of immediately cutting production. Following a burst of marketing, advertising spend would be cut drastically over the course of the year. In 2009, dealer advertising spend dropped 29%, data from the National Automobile Dealers Association show, though local television did a little better by picking up share. This time around, I think television is not likely to pick up share because local television already has a high, 20% of dealer advertising dollars.

The Telecommunications segment is the second largest advertising category for broadcasters. Through June 2012, the Television Bureau of Advertising reported that telephone and cable companies had been slashing their local television advertising spend. Competition is the key driver of advertising spending among telephone, cable and mobile operators. For example, when Verizon Communications Inc. (VZ) was building its fiber-to-the-home infrastructure, the many local launches led to substantial local advertising. But currently, competition for pay television and internet customers appears moderate to me.

Beyond competition among wired operators is the possibility of consumers foregoing pay television for other video providers. Cable operators may want to use marketing to combat “cord-cutting”  but traditional television advertising does not reach those who move off the grid, so this form of competition would not benefit television advertising spend, I think.

Within wireless, I expect competition for Sprint customers in advance of Softbank’s proposed acquisition. AT&T Inc. (T) began touting its push-to-talk feature, a feature in which Sprint’s Nextel unit was once dominant. This could lead to local-level advertising as AT&T looks for local pockets of push-to-talk customers, who tend to be small businesses. Sprint should spend more trying to defend its customer base and to demonstrate to the Federal Communications Commission that it is being operated independently of Softbank pending the merger application.

If the FCC approves Sprint’s acquisition, Sprint would spend more at the national level, I think, but local broadcasters could expect to get some boost, too. However, Softbank’s application to buy Sprint was filed at the beginning of December, which means the FCC could take at least another five months cogitating. Also, the FCC routinely takes longer than its deadlines indicate.

My bottom line on the top line for Communication-category local television advertising is that it will be higher in 2013. I am guessing an increase of 5%.

The remainder of the categories in the top 10 of local television advertisers are much harder to assess. For the most part, competition within these segments takes place at the local level, and the decisions to place advertising will be made in or close to those markets. Still, in the case of schools, I believe that their advertising is likely to decline generally. Schools came on strong during the recession because higher unemployment made more people look at new schooling as a way to gain new skills. And in the case of legal services, advertising grew throughout the recession as people faced bankruptcy, lay-offs and other disruptions requiring legal help. Legal services advertising is likely to stabilize at the higher levels, I expect.

Beyond the category-specific challenges are more general challenges. All advertisers are finding alternatives to marketing on local television. Part of the reason is that internet platforms have made it easier to market local products and services online, especially on Google and Facebook while hundreds of internet marketing firms have sprung up to help.

Ratings are also an important issue for advertisers when they are deciding where to put marketing dollars. Pew Research Center Project for Excellence in Journalism published data on viewership of local television news in key timeslots, and concluded the averages were showing some stabilization in 2011, the last year covered by the data. News is a key product for local stations that represented over 45% of local television station revenues in 2010, according Radio Television Digital News Association surveys.

When I drilled into the Pew-published Nielsen numbers, though, the trend through 2011 seemed downward sloping, though with upward blips. The largest upward blip was in May 2011 when Osama bin Laden was killed, an event that I believe benefits all news. Local news would simply focus on the local men and women who serve, and the significance for local security. Late local news also had its best May showing in 2011.

The data also showed some ratings impact from the political cycle, I believe. The year following the 2008 presidential election showed a steep fall in total viewers across morning, evening and late news. Although 2010 was not a presidential year, the interest generated by the Tea Party probably supported interest in the local news product: in the July sweeps period, total viewership edged up for morning, evening and late news, and also increased slightly in late news in the November sweeps period.

So, local television faces a secular challenge separate from the course of the economy. Assessing the size of the secular ratings challenge requires some judgment calls. I would focus on evening and late news because both of those have viewership that is a multiple of local morning news. In late news, average viewership declined at a compounded rate of 1.8% per year from 2008 to 2011 in the July sweeps and 3.5% per year in the November sweeps. In evening news, average viewership declined at a compounded rate of 1.9% per year from 2008 to 2011 in the July sweeps and 3.8% per year in the November sweeps. The best ratings results were in evening news May sweeps, where average viewership declined at a compounded rate of only 0.3% per year from 2008 to 2011.

On the whole, it looks to me like total viewership of local news will shrink in the 1% to 2% annual range on average with less deterioration during election years. Under those conditions local television could have the ability to raise prices enough to offset the impact of audience erosion, I believe.

As a result of advertisers seeking alternatives and the rating pressures, I am guessing that the average increase in the remaining advertising categories would only be about 1% in 2013. This would encompass categories that are likely to continue to cut local TV spend, an example of which are movie studios that are trying to reach a younger audience than that reached by local TV. There are other categories that are likely to grow because local competition may be pushing small companies to increase advertising spending faster. I am guessing that the sum of all these stronger and weaker categories comes out to my number.

During a political year, politicians end up absorbing some advertising inventory that other advertisers wanted to buy. This crowding-out effect is the reason that simply deducting political advertising from the total advertising is not the right way to focus on the underlying trend of advertising for local TV. However, my estimate of the 2012 base stems from first half 2012 spending reported by Television Bureau of Advertising scaled up to account for the normal weighting of advertising to the second half. As with any estimation procedure, this is inexact, but it avoids the problem of accounting for crowding out.

There is even core political advertising.

Advocacy advertising goes on each year, but is quite volatile. In 2009, $664 million was spent on advocacy, according to Campaign Media Analysis Group. The range in other years from 2008 to 2011 was around $200 million to $400 million.  I believe the 2009 bounty was mainly driven by the debate all year on extending health insurance coverage to more people.

Advocacy will stir in 2013, though. The Newtown massacre and the push for gun control legislation should drive advertising spending on both sides of the issue. The need for tax revenues to improve the U.S. fiscal picture also could lead to corporate advocacy advertising to protect tax loopholes. As a consequence, I think advocacy could be $400 million, which would be slightly above the amount spent in 2008 when T. Boone Pickens was spending on his energy independence proposals. I have not included a separate amount for ballot initiatives, though there probably would be some spending.

As for campaign advertising, there will be little in 2013. There are only two gubernatorial races. One of those is Chris Christie’s race for re-election in New Jersey. Given that Newark mayor Cory Booker reportedly has decided to run for Senate instead of governor, the 2013 New Jersey gubernatorial race does not look like a winner for local TV stations. In Virginia, both Democrats and Republicans will be nominating new blood for governor in 2013, so there is more prospect for an advertising uplift. Currently, there are no ballot initiatives scheduled.

Olympics advertising is another factor that will lead to a decline in spot television advertising in 2013. The Games were a strong draw, with ratings exceeding expectations. The amount of local spot advertising sold with the Games is an amalgam of the local stations owned by NBCUniversal and all its affiliates. I found a fairly stable relationship between the number of households in a company’s NBC portfolio and the amount of Olympic revenue reported. Extending that relationship across all the NBC affiliates among the 25 largest broadcasting companies gave me an estimate of the total.

The Television Bureau of Advertising has not reported figures for political spending in 2012. I made an estimate of the final figure by adding $1 billion to the total spent in 2008, a 76% increase that reflects spending unleashed by the Super Political Action Committees (Super PACs) that were not active in 2008.

These top-down calculations lead me to conclude that spot television ads at local stations could fall by close to 10% in 2013.

 

Retransmission fees will make up for some of the ad drop.

The impact of the decline in advertising revenue will be softened to an extent by the growth of retransmission consent fees. Retransmission consent fees are fees that cable and satellite operators pay for the right to carry a station’s signal.

The leaders in retransmission consent fees, I believe, are Sinclair Broadcast Group Inc. (SBGI), Nexstar Broadcasting Group Inc. (NXST) and LIN Media (TVL). Nexstar is the only one that currently reports retransmission consent fees, which were 13% of revenue in 2011. Based on LIN Media discussion at the UBS media conference in December, I believe LIN Media’s retransmission consent fees also are about 13% of total revenues. Gannett Co. Inc. (GCI) and Belo Corp (BLC) were in the 9% to 10% range of revenues for 2011. NBCUniversal has not yet demanded much “retrans” from cable systems because of its ownership by Comcast Corp (CMCSA) so I think its local stations get less than an average proportion of their total revenue from retransmission fees. The average across the industry is probably around 11% in 2012, I think.

Retransmission consent fees probably will grow at double digit rates in 2013. A forecast by SNL Kagan showed a step up of 28% in 2013. The size of the forecast increase is large, but when the broadcasters obtain new contracts, they have gotten huge gains. For example, Nexstar Broadcasting renewed most of its multi-year retransmission consent agreement by the end of 2011. Retransmission consent fees rose 63% in the first nine months of 2012. Nexstar Broadcasting has told analysts that 2013 will be a year in which retransmission consent fees grow based mainly on escalators in contracts. This implies high single-digit increases at Nexstar Broadcasting, I think. But industry-wide growth will be fueled by CBS Corp (CBS), Gannett and others that have renewed contracts this year. Gannett expects growth of over 40% in 2013.

Once retransmission consent revenues are added in — assuming the SNL Kagan “retrans” growth rate is correct — broadcast revenues would decline about 6.0%. This calculation ignores internet revenues, but these remain a very small part of the revenue pie. The impact of growing online revenue would be very small, and reliable industry data are hard to find.

If revenues fall by a range of 6%, operating income would fall double-digit percentages, I expect.

Most of the costs in the television station business are fixed. The main cost that is variable in the short-term is the commission paid to local salespeople and to national rep firms. Some other costs can be cut, but effecting changes to station cost structures takes time.

“Reverse retrans” is a growing expense for stations.

Because the affiliates of the networks are getting money from pay TV operators, the networks are demanding compensation for their programming from affiliates. Networks like to call these fees reverse retrans. The networks cannot start charging reverse retrans until affiliation agreements expire, so the impact is spread over several years. Already, though, both Sinclair Broadcasting and Nexstar were hit with tough bargaining by Fox Broadcasting. CBS seeks roughly half of the retrans the affiliates get, demands the affiliates are resisting. Reverse retrans will increase industry-wide expenses in 2013, but the amounts will be less than what the affiliates gain in their own round-robin with the pay television distributors, I believe.

Will political come roaring back in 2014? Optimists would argue that a deeply divided nation bodes well for the broadcasters. Without a presidential election, though, political spending will look more like 2010 – also a divisive political year – than 2012. That is, industry revenues would remain below the records set in 2012, I think.

Incentive auctions are not a 2013 event.

The spectrum that broadcasters occupy has some of the best characteristics for delivering data. Incentive auctions are an attempt by the Federal Communications Commission to reclaim spectrum from the broadcasters and redistribute the spectrum to others to use for mobile broadband.

Essentially, the FCC would arrange a set of auctions that would pay some of the broadcasters to either leave broadcasting or to move their channels by sharing space with another broadcaster. When asked, all the publicly-quoted broadcasting companies have said they have no intention of exiting broadcasting. But the FCC’s auction proposal allows broadcasters to stay in business while still getting a payment for the spectrum they occupy if the broadcaster decides to share spectrum with another broadcaster.

I think many broadcasters would want to test the demand for their spectrum to see if the value exceeds the present value of the cash flows management feels it can produce.  There are many broadcasters that have little economic value because they are independents with tiny audiences. Broadcasters may have other reasons to stay on the air, of course, if they feel they are serving a social or spiritual function.

With the option to have both an ongoing business and a payment for part of the current spectrum, more broadcasters could be enticed into participating. It would make sense for broadcasters to seek payment for some of their spectrum if they are not making much money on the less used portion of spectrum. The digital side channels offered by broadcasters have few viewers and probably add very little economic value. If it appears demand for spectrum will be strong, broadcasters who make productive use of only part of their spectrum will want to know how much money they might get, I expect. Sharing spectrum creates its own problems and costs that would have to be weighed.

The success or failure of the auctions will come down to price. The incentive auction issues will brew in 2013, but the FCC does not expect to mount auctions until 2014.

Jake Newman

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A Fuzzy View of MOOCs

Venture capitalists are thinking about the future of college education. The founder of Udacity sees a distant future in which there are only 10 seats of higher learning in the world. Administrators at the almost 4,500 two- and four-year institutions in the U.S. could be wondering about consolidation. These are among the threads and threats that Udacity, Coursera and MITx are crystallizing as they try to crack the code of online universities.

For millennia, higher learning followed a tradition that is old as Socrates. The internet is probably the greatest advance ever in the dispersion of knowledge, so it is no wonder the experiments in online education attract so much attention from money men and women. Yet, after many years of internet growth, there has been no revolution in learning. The threshold question for investors should be: are there structural obstacles to online universities?

Education presents many challenges, but I want to focus on three that I see:

  • knowledge and learning are two very different things
  • using standardized assessment tools will work for some disciplines, but not others
  • each individual has intelligences that dominate their learning style and some of those intelligences are better adapted to learning online.

There are other issues, of course, such as certification, the value of an online education, and getting paid. If online universities present better ways to learn, though, I think the value eventually would be recognized. At scale, online teaching could be awesome.

As noted, knowledge is not learning. Learning is a complex process for which different tools are developmentally appropriate at different ages.

At younger ages, humans learn from concrete objects. Children need to use all their senses to get to know objects; they need to manipulate them; and they need to test their properties. According to Jean Piaget’s theory of cognitive development, the first three stages of development up to adolescence require humans to construct knowledge from direct experience, preferably with concrete objects.

We all develop at different speeds, but by puberty, in theory, our brains move from manipulating objects to manipulating concepts. Still, a hands-on, laboratory approach to teaching works far better for most people than simply reading a text in print or online – or listening to a lecture. If you read a text only once, then try to apply what you have read, you will make mistakes. After you try to convert theory to practice, then re-read the text, the background knowledge to the text becomes much clearer. My conclusion is that applying a concept to solving a problem is the best way to actually learn.

In order to work, the massive open online courses have to be grounded in a problem-solving pedagogy. It appears that the leaders in the field like Udacity give tough courses that present meaningful problems to force students to construct new learning. Venture capitalists would be wise to hire advisers to review the pedagogy behind the MOOCs they fund.

At the same time, I hypothesize that some subjects lend themselves to trial and error on the web in a fashion that allows learning to take place at a distance from a teacher. Math, finance and accounting are all disciplines with clear answers where trial and error is a mental exercise. Other disciplines such as experimental sciences require physical facilities and personal interaction with researchers in the field – the professors – so the student can create experimental things and learn from failed experiments.

In many disciplines, there are limits to the number of students that a teacher can assess.  Where technology allows, auto-grading overcomes those limits. Math, accounting and finance are all fields in which the answers to questions that students will be asked are clear. Human grading is unnecessary. I may be accused of being fuzzy here, but I believe there are many disciplines where human judgment is necessary.

The key issue for the online academies is what finance types like to call the “addressable market.” My preferred question is:  “Sure, you have a shiny, new product, but who will pay for it?” With internet products, though, consumers have to be trapped with free service first, so you ask who will use it first, and ask how you make money later.

In 2009, there were 20.4 million students enrolled in colleges in the United States served by 4,495 two- and four-year institutions. (The 2012 Statistical Abstract). The market beyond the United States is vast. By any measure, there is a lot of “who.”

Under the category of “I’m just saying…”: not all humans learn the same way, so online courses are not for everybody.

This brings me to Multiple Intelligences, a theory propounded by Howard Gardner of Harvard University. Gardner thought the idea of a single intelligence that can be measured by a test like the IQ test was wrong. Instead, Gardner hypothesized Multiple Intelligences.

This will seem extremely fuzzy, but that is an important point about academics and unproved theories.

In Gardner’s theory, these are the eight intelligences:

  • Logical
  • Linguistic
  • Interpersonal
  • Intrapersonal
  • Spatial
  • Musical
  • Kinesthetic
  • Naturalistic

Others theorists added “existential,” which is a spiritual kind of intelligence.

These are not mutually exclusive. If you were to take a MI quiz, you would be shown that you have different strengths of intelligence. In most cases, individuals will have a mix of intelligences, but one will be predominant. You can take an MI test here as an example.

Someone with a great deal of musical intelligence learns best when concepts are sung or put into rhythmic patterns, for example. Someone with strong kinesthetic intelligence learns best when asked to express a problem through dance or movement.

For my money, the interpersonal and intrapersonal divide is most important for online classes. Someone with strong interpersonal intelligence learns best working directly with other people. While there are ways to get groups together online, nothing can match the serendipity of groups that form spontaneously in a classroom. Indeed, economic clusters show there is intellectual benefit of proximity.

Someone who has strong intrapersonal intelligence might learn best by being left alone to study. They regulate their own pace, set their own goals and measure themselves against those goals without outside interference. I hypothesize that the people most likely to learn well from online classes are those with a strong intrapersonal intelligence.

If correct, the hypothesis would suggest that online learning would be good for a particular kind of student. But what percentage of the target population — let’s say the United States — happens to have a dominant intelligence that lends itself to online learning?

From the research available to me, it appears that Gardner studiously avoided measuring the prevalence of various intelligences in populations. The only population-wide results I have been able to find come from the online quizzes that people take for fun. The Birmingham Grid for Learning produced results for the United States based on 2.5 million test takers. What it shows is that the average scores put interpersonal slightly ahead of the intrapersonal.  There is no quality control for this, and people may be taking these tests multiple times. Also, the online test has no explanation for the scale, so it is not clear what the numbers mean.

The chart cannot answer the question “what is the addressable market.” But it does show there is a large group of people who lean on personal exchanges as part of their learning process. I hypothesize that this group would not learn well in a MOOC. Obviously, the actual size of the addressable market requires more research.

This is a fuzzy concept, agreed. But that is part of the point: there is a group of humans for whom fuzzy works better than the precision of an online course.

Proponents of MOOCs can fairly question whether old-line universities do an adequate job meeting the different learning needs of different intelligences. If the old-line universities do not do a better job than MOOCs, then they do have a problem. Hopefully, the competition will improve teaching for everyone.

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Clear Channel Communications: Values a Hurdle to Loan Renewal

  • Clear Channel Communications will not be able to pay down much net debt in the medium term
  • The group has steep maturities in 2014, but these appear manageable leaving the 2016 maturities as the biggest hurdle
  • Clear Channel Communications’ ability to clear the refinancing hurdle in 2016 without restructuring or other strategic options partly turns on whether secured lenders feel they have a cushion of value from the businesses
  • My base-case scenario of Clear Channel Communications’ operations to 2016 shows an improvement in Outdoor EBITDA that is offset by weaker medium-term radio results
  • Current enterprise valuation multiples are well below the peaks when the leveraged buyout was done, explaining much of the concern reflected in the low prices for Clear Channel Communications’  debt
  • If valuation multiples improve,  the company stands a better chance of refinancing or extending loans, but that also depends on banks’ risk appetite
  • The company’s financial management has been very creative, but in the end, I expect the secular problems faced by radio to hamper refinancing efforts

Clear Channel Communications (CCMO) has a history of showing its doubters that it can find ways of surviving, but the company is going to need help from market valuations to handle the heavy lifting of refinancing or extending its debt capital structure in 2016.

I am among the doubters myself, and view the debt leverage of the company as unsustainable. In other words, I believe Clear Channel Communications needs to restructure its debt at some point or sell a business at a high enough multiple to slice leverage. The trouble is, gross leverage is currently over 11 times, and no one is paying prices high enough to make a sale of its businesses deleveraging. Selling a business can repay debt, but if the seller loses real EBITDA, they could end up with higher leverage.

There are scenarios in which Clear Channel Communications could continue to muddle through. But I believe most of the scenarios depend on the ability of the company to convince banks to extend or refinance its bank loans due 2016. While I will not discuss the manifold possibilities in this article, I would be happy to discuss other scenarios offline.

The maturity schedule shows where the problem lies. The 2016 bank loans are the most difficult hurdle the company faces.

Radio is one of the reasons to be a doubter. Time spent listening per person to terrestrial radio is falling, according to data culled from Arbitron’s Radio Today.  Clear Channel Communications counters that total hours listening is increasing, but I believe that is only because the radio population is increasing.

More listening is occurring on smartphones. Clear Channel’s iheartradio has succeeded in attracting an audience. But the tricky part is getting advertisers to pay for that audience and pay enough to produce decent profitability. For Clear Channel’s radio business, this seems like the classic swap of digital dimes for analog dollars.

Clear Channel Communications also owns Clear Channel Outdoor Holdings Inc (CCO). I regard the outdoor advertising business as a stronger business than radio. It cannot be disintermediated by the internet. But the outdoor business is very cyclical, as was clear during the Great Recession. The cyclicality suggests to me that the companies in the industry do not deserve enterprise valuations like those in the last peak cycle. The prospect for dampened  valuations for Outdoor properties is part of the reason Lamar Advertising Inc. (LAMR) is considering converting to a REIT structure, I believe.

Still, Clear Channel Communications has been “banking” on Clear Channel Outdoor to get it through. At one time, it appeared that Clear Channel Communications would not be able to make it through 2014 without a debt restructuring. But the company raised funds at Clear Channel Outdoor. As a consequence, the maturity schedule is much improved and 2014 is no longer a redoubtable wall of debt repayments.

That source of funds is looking exhausted because the Clear Channel Outdoor senior leverage ratio was 3.24 times at the end of the second quarter. The Outdoor company’s bond indentures limit incurrence of senior debt if the incurrence would take gross senior debt leverage over 3.25 times, though there are exceptions.  The total gross debt leverage — which includes junior debt — was 6.1 times at the end of the second quarter. The outdoor company is limited from further debt issuance once total gross leverage is 6.5 times, again with limited exceptions. So, there is some, small amount of room for subordinated debt issuance. The room for debt issuance grows over time, which I discuss later.

Currently, the debt wall in 2016 is $12.1 billion, made up of $10.2 billion of bank loans coming due in January and $1.9 billion of bonds due in the latter half of that year.

For investors in Clear Channel Communication’s bonds and loans, the critical issues are how much cash the companies are generating and the eventual valuation of the key businesses.

I developed a scenario for business operations through 2016 to examine these issues. I do not call my scenarios “models” because I think to call something a model gives a false impression of precision and higher levels of certainty.  Besides, Clear Channel Communications does not report all the key performance indicators needed to run a model, so my numbers are educated guesses based on assumptions that I have benchmarked against reported results. Where possible, I have used data from competitors like Lamar Advertising to inform my judgment. I do not review estimates of  Wall Street analysts or check my scenarios with management, so the figures could look very different from models developed by others. Here, interested readers can review my base case assumptions.

This year is looking stronger for radio thanks to political revenue. The surge in spending by Super PACS should spill over to radio through election day, so political advertising could add around two percentage points of revenue growth, I reckon. That would tighten up inventory this year and make radio pricing firmer than it would otherwise be, so Cost per Thousand Impressions (CPMs) will be higher in 2012, as will be sell out.

Don’t get me wrong, I don’t have high hopes for the radio business over the longer term. Based on Arbitron data from its Radio Today series, I think the time spent listening per person by people 12 and up is in a downward trend of between 1.6% to 2.5% per year. While population growth could offset the impact, I think the size of the population listening to terrestrial radio is growing more slowly than the general population.

The main growth engine for Clear Channel Communications’ radio segment has been the national sales effort that produced rates of growth double that of local in the second quarter of 2012. Clear Channel Communications generated better growth than competitors in the most recent quarter because of a focus on getting more national advertisers to what is mainly a local media. On the programming side, Clear Channel Communications is trying to make radio more attractive to national advertisers by cutting local talent in favor of more national talent in key timeslots.

The company’s national drive points to one of the sensitivities of my scenario. As someone who believes that radio is a local media, I hate to say it, but Clear Channel Communications seems to be taking some share as a result of centralizing programming and selling harder to national advertisers.  As a result, I do assume that Clear Channel Communications steadily gains share, but in very small increments. In the longer run, I don’t think national advertisers are going to shift en masse to radio because other media provide national advertisers better and better targeting capabilities. If Clear Channel Communications is able to gain share faster — and control the costs of national talent — the company could do better than indicated by my scenario.

So the radio scenario looks like this:

I see a weak 2013 developing for radio because of the lack of political advertising and continued economic weakness. The growth rates in my scenario favor the even-year political cycles.

Outdoor advertising is highly cyclical and tends to be the advertising budget that is cut the soonest at signs of economic weakness. That said, all the billboard companies are replacing printed boards with digital boards because they can win new types of advertisers and simultaneously sell a single board to many advertisers.

The scenario for Americas Outdoor looks like this:

The lull in economic activity in 2012 trims the rates and occupancy for posters in particular and dampens advertiser enthusiasm for billboards. Even digital billboard occupancy weakens in the scenario. I think traditional display revenues could decline this year, but the decline is offset by the rapid expansion of the number of digital signs.

Longer term, traditional display revenues are likely to remain lackluster. Part of the reason is that the number of displays will shrink as they are replaced with digital displays. But I also think the rapid roll out of digital boards may play a role in weakening demand for nearby traditional displays.

Digital billboards promise stronger growth in the U.S. that will offset softer results in the traditional displays, I believe. The digital billboards can be sold to multiple advertisers. The advertisements themselves can be swapped very quickly, allowing for ads that are appropriate for the time of day or top-of-mind events, like the Olympics. As a consequence, the digital signs bring in a multiple of the revenue of the signs they replace. The signs have to be managed carefully, though, in order to avoid depressing the demand for the traditional boards.

In terms of assumptions, I factored in elevated installations through 2012 and then installations at levels closer to 2009 and 2010.

The International Outdoor business is more difficult than that of the U.S.  Stricter billboard regulation means billboards are a much smaller proportion of the total number of displays. Activity is heavily controlled by municipalities, public transport authorities and airports. Contracting conventions require greater installation expense upfront and sizeable minimum guarantees. As a result, the enterprise valuation multiples of the International Outdoor operators are always lower than multiples of U.S. Outdoor advertising operators.

Also, it is harder to get published performance indicators on international business than it is in the U.S.

And, with an ongoing Euro currency and financial crisis, getting a good handle on the European macroeconomic environment is impossible.

With those caveats, this is what the scenario looks like to me:

This year looks especially trying in International markets. Competitor J.C. Decaux SA (DEC FP) reports great strength in the UK but that softer pricing in Germany, the Netherlands and Eastern European countries dampened the firm’s guidance for the third quarter of 2012.

Yet, the Olympics in the U.K. is driving double digit advances in advertising revenue in that country, J.C. Decaux said. The U.K. represented around 9% of the international displays for Clear Channel Outdoor at the end of 2010, the last time reported. With the strong interest in Olympics advertising indicated by J.C. Decaux, I think International local currency revenues should grow in 2012. The impact of exchange rates on International revenues will be negative and swamp the local currency growth in 2012, I think.

In 2013, the austerity policies with which Euro zone governments are responding to the financial crisis makes me believe International Outdoor advertising will not grow. Handicapping the rebound is tricky, but it seems to me that Clear Channel Outdoor and other competitors will try to make up for lost pricing power in 2014 but only if the Euro zone is not in a deflationary spiral.

On top of the weak European economies, the currencies that count most to Clear Channel Outdoor’s international results also are weaker so far in 2012.

Clear Channel Communications also operates a media representation firm called Katz, for which there is very little visibility. I try to sketch a scenario for Katz.

I consolidated the cash flows from the scenarios to generate a view of potential debt repayments out of existing cash and cash flows. In the following table, I start with a measure of free cash flow and then reconcile the debt payments required, the sources of financing and existing cash. The end-of-period (EOP) cash I show deducts an amount of minimum cash below which I think the company would jeopardize operations, so I am measuring the evolution of excess cash available for repaying debt. Most of that minimum cash is a requirement under the indentures for Clear Channel Outdoor Holdings and subsidiaries to hold a combined $100 million in liquidity. Also, some of the cash is held overseas and cannot be easily repatriated to the U.S. without facing taxes, but my scenario does not reduce cash available in order to account for that.

The table tells a story of a company using its remaining cash and cash flow to repay bank loans and a small amount of bonds. But the debt repayments over the period are not enough to repair Clear Channel Communications’ balance sheet. Total gross leverage falls to 9.5 times as of the end of 2015 in this scenario, which remains too much leverage for this company to carry, I believe.

In 2014, the company would burn through its excess cash, based on the scenario. This is when roughly $1 billion of the firm’s Term Loan A comes due. Also, a $461 million legacy bond is due in September 2014. I assume Clear Channel Communications would issue an additional $500 million worth of secured debt. Even in difficult market conditions, I suspect that Clear Channel Communications could raise a small amount of secured bonds secured by collateral. By my reckoning, the company will have accumulated certain baskets available under its loan and bond agreements that permit the company to issue at least $2 billion of secured bonds.

The jump in cash flow in 2016 is an artifact of the scenario, which requires repayment of the bank loans at the end of January. But the company would not really save on interest expense except through a restructuring or a substantial sale of businesses. The question is whether the company will be able to refinance or would be forced into a restructuring.

In 2016, the company has to refinance $10.2 billion of bank loans and $1.9 billion of bonds. Are banks going to be willing to refinance?

Obviously, the risk appetite of investors will play a role in the company’s ability to refinance, but that is impossible to judge. As noted, if the scenario plays out, consolidated leverage would still be astronomical. Ultimately, I think it the most important factor will be valuation of the radio and outdoor businesses, and whether those valuations point to collateral values strong enough to support the amount of debt refinanced in the secured loan and bond markets.

Generally, when banks make a loan secured by collateral, they need collateral that exceeds the value of the loan so that if the borrower goes bust, they can sell the collateral and recover full value on the loans. When a bank is faced with a new loan, if the collateral values are less than the value of the loan, the bank should not make the loan. When faced with an existing loan that needs to be refinanced, there are additional considerations, but banks should still want an asset cushion. In reality, if the institution thinks the bond market will bail the bank out of the loan, they may get greedy and make a loan for the fees hoping bond issuance will be used to repay the loan early.

In Clear Channel Communications’ case, the bank loans are due at the end of January 2016. So, at that time I think banks would be looking at EBITDA expected in 2016 as the basis for valuation.

One of the assets owned by the company is the 89% stake in Clear Channel Outdoor Holdings. In order to capture that, I calculate the equity value after the subsidiary net debt is deducted. I have assumed a notional 50/50 split of the debt capital structure of the two Outdoor units.

For illustration, I use CURRENT Enterprise Valuation multiples based on EBITDA one year forward in order to capture the growth prospects of a company. I made an estimate of the market multiples based on competitors and consensus EBITDA. The figures I derived are in the table. The radio valuation is the highest one among the largest radio competitors. The valuation of U.S. Outdoor is based on Lamar Advertising Inc. The valuation of International Outdoor is based on J.C. Decaux. I have nothing to compare to Katz, but I view it as a lower-margin business, so I give the group a 7 times multiple as the best I would expect.

Another complication is that the domestic Clear Channel Outdoor is required to sweep excess cash to Clear Channel Communications. As of the end of the second quarter, Clear Channel Communications owed $712 million to Clear Channel Outdoor, but I think that could grow to $1.2 billion by the end of 2015. If Clear Channel Communications filed for bankruptcy, Clear Channel Outdoor would join the queue of unsecured creditors of Clear Channel Communications.

Based on the CURRENT multiples, the table shows that the total value available to unsecured creditors of Clear Channel Communications at the beginning of 2016 is less than the value of the debt by $2.3 billion. I think this means Clear Channel Communications would not be able to issue new, unsecured debt to repay any part of its bank loans unless it has substantially higher enterprise multiples. The market is a market of opinions though, so if Clear Channel Communications could find enough investors who believe the business is worth more, they might be able to raise some unsecured funds. My base case scenario constrains Clear Channel Communications to using the secured markets.

I would argue that the intercompany loan should not be given book value in valuing Clear Channel Outdoor. Because I discounted the value of the intercompany loan, the size of the valuation hole in the table is bigger. I believe creditors should place a recovery value on the intercompany loan because of the potential for distress in the 2016 timeframe. The market convention for unsecured recoveries is around 40% of face value, which is the valuation I use in the table.

If Clear Channel Communications cannot refinance in the unsecured bond market, the total amount of secured financing needed in 2016 is around $14.2 billion because of the bonds that are coming due. At current valuations, the assets would be worth about $611 million less than the secured debt to be raised.

The analysis is very sensitive to the Enterprise Multiple applied to the businesses. This is a critical issue for investors because Clear Channel Communications debt is highly leveraged to industry valuations. If industry valuations rise, investors will become more comfortable with Clear Channel Communications, potentially driving up the price of loans and bonds. Between now and 2016, I think there could be vicious volatility in the prices of Clear Channel Communications debt if market valuations for radio and outdoor businesses reach what I would regard as irrational levels.

A single turn increase in the value of all three businesses leads to a small, positive asset cushion (the column labeled EV + 1X in the table). Personally, I would not be comfortable with such a small asset cushion because of the inherent volatility of the asset values.

In the end, banks will be weighing a lot more than just the asset cushion. As already noted, whenever banks expect the bond market to refinance some or all of the bank loans, they are much more relaxed about the loans they make. When markets are dominated by greed, a lot of sins are covered. Will the “new normal” persist through 2015?

Likewise, lower valuations would make it that much harder to ignore the financial gore. Enterprise valuations of one turn lower result in assets worth $2.6 billion less than the secured debt in the scenario.

Well, what if the Outdoor subsidiary raises some funds and pays a dividend so that Clear Channel Communications could repay some bank loans?  By 2016, Clear Channel Outdoor will have more scope to raise funds, probably well over $1 billion. When I examined the scenario, though, I found that raising $1.1 billion of new debt at Clear Channel Outdoor would repay $980 million of debt at Clear Channel Communications (because of the partial dividend to minorities) while reducing the equity value of Clear Channel Outdoor to secured creditors of Clear Channel Communications. The net effect is an increase in the asset cushion of about $100 million, in my scenario.

Caveat lector: this is a static analysis. Enterprise valuations are not the only thing banks will consider. They will also look at structure. They will look at the cost of restructuring Clear Channel against the potential for kicking the can down the road. So, a lot will depend on the shape of the audio entertainment world in 2015 and the view of the future of the terrestrial radio business.

Clear Channel Communications has been restructuring its radio business, which may make the company look a better risk in 2015. The company has several initiatives underway. Clear Channel Communications has cut local talent in favor of national shows. At the same time, the group bulked up its ability to sell to national advertisers. If this initiative is more successful than I expect, the future of Clear Channel’s radio assets may look brighter.

Will valuations rebound by 2016?

Investors who buy Clear Channel Communications equity essentially are making that bet. Investors who are buying the bonds and the loans have to figure out how much they could recover in a restructuring. If there is a restructuring, I think the lower valuations should be used to guess at the recoveries. Additionally, investors would have to make assumptions about what payout would be given to unsecured bondholders as the price to smooth restructuring. And credit investors would have to develop a view as to when a restructuring would occur in order to figure out how long they would receive interest payments. These are issues I would be happy to discuss offline.

The Federal Reserve Board promise to hold rates near zero percent through late 2014 is one reason to think that sometime between now and 2016, reflation would support Enterprise Valuation multiples generally. As a confirmed radio doubter, I think radio valuations should be constrained by secular challenges. As for Outdoor, I think Lamar Advertising would not consider a REIT structure with its attendant high dividends if management thought retaining and reinvesting capital would produce higher valuations. Of course, Lamar Advertising could still decide not to convert.

As of August 20th, the bid price of the Term Loans due in 2016 was around 78. Under my base-case scenario, the collateral shortfall would only be about 4% based on current valuations, so investors are not putting much store in CURRENT enterprise valuation multiples. Of course, the comparison is inexact since there are costs of restructuring, and banks end up conceding some value to other creditors in a restructuring.

There is huge price leverage in this capital structure. External events like a sale of an Outdoor or a radio business could have a massive impact on the bond and loan valuations of Clear Channel Communications. Keep a sharp eye on M&A.

Also, Clear Channel Communications is sure to talk to banks about trying to extend its loans. My base case remains that banks would resist. 

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Trying to Stitch Together A Directories Parachute

Dex One Corp. (DEXO) and Supermedia Inc. (SPMD) are hoping that they can stitch together a bigger parachute and finally break the speed of their descent.

The two directories publishers announced a merger with the aim of saving money and strengthening the fabric of their business.

The companies have to overcome some obstacles to achieve the merger, though.  One is the approval of the banks for changes to their loans. In the case of the Supermedia loan, a change of control is an event of default that would allow the banks to demand repayment early. But both Dex One and Supermedia are looking for approval from the lenders to Dex One and Supermedia subsidiaries, not only to amend the loans, but also to extend their loans to 2016. As a condition to the merger, the merger agreement requires 100% approval of the loan amendments that Supermedia and Dex One will seek.

Dex One also wants to preserve the tax-savings potential embedded in Dex One’s accounts, but did not list this as a condition of the merger. The management stated that restrictions on transfers of the new stock will help preserve the tax status quo. Still, a filing on form 8K seems to recognize that the tax authorities could deem the merger a Dex One ownership change, so the Board of Directors could then eliminate the trading restrictions.

Dex One shareholders will end up with 60% of the combined company. Details of the merger announcement can found be in this 8K: dexo.8K.mna.8.21.12.

The merger is portrayed as a win for the lenders on the theory that the merger will make the combined companies stronger. If lenders agree with this view, then they have an incentive to approve the amended and extended loans, which would allow the merger to go ahead. I intend to spend some quality time with the financials of the two companies to see how the combined entity might perform.

In the meantime, I ask myself: can the two companies save as much on cash costs as they hope? The managements are looking for $150 million to $175 million of savings in 2015. Can they do it?

If you look at the Dex One-Supermedia map of the territory of two companies, it is obvious that they operate in different geographies. The sales and production capacity of each company is not duplicative of capacity of the other for the most part. There is a tiny amount of overlap where costs might easily be saved, but most territories are served by only one of the two.

The company has the greatest scope to cut overhead rather than production or selling costs, I think. Typically, a merger of equals could look for 30% to 40% reductions in general and administrative costs, I believe. Where there is no geographic overlap, though, some general and administrative expenses such as sales offices and information technology can only be cut as part of capacity reduction — or plain old efficiency that is not merger-related. Deducting a notional amount of real estate and IT expense, I come up with a potential for 26% reduction of 2011 General & Administrative expense related to the merger.

For production and distribution costs or cost of sales, the companies would need to negotiate price cuts with vendors. Given the geographic breadth of the companies, it could be difficult to find vendors capable of serving the two for even lower prices. So, I assume a 5% reduction.

Selling and support is fundamental to the ability of the companies to survive. Capacity would be cut as demand for services declines, of course, but I would not count that as savings from the merger. Sales people are in high demand, so there is little scope for cuts in per-unit incentive compensation. The amount spent on sales support also is important to retaining the best sales people. As a result, I assume a 5% cut in selling and support.

With these cash cost reductions, the company reaches a level within its targets.

Obviously, though, the cost savings are only one part of the merger equation.

A meaningful scenario for the sales of the companies will take more time to develop. Also, the companies said they would soon disclose their proposals to the bank lenders. With a scenario for the business and additional information about the bank proposal, I hope to make better judgments about the prospects for this merger. 

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An Aereo Pebble Thrown

 

·         In a pivotal skirmish, Aereo won a key legal promontory against the broadcast networks

·         Aereo may only be a pebble now, but combined with boulders like Netflix, Hulu and other video entertainment, it could attract enough subscribers to cause worries about strategic earth shifts within the pay television community

·         The true measure of Aereo’s potential to attract subscribers from pay television may only emerge in a few years once it expands beyond New York City and takes up the copyright fight in Appeals Circuits where the Cablevision decision does not rule

·         If Aereo’s venture capital sponsors think the addressable market and cost to reach that market point to profitable expansion, I think Barry Diller and friends will quickly lead another round of financing for this company and select additional test markets

·         The New York lawsuit continues, but I think the probabilities favor Aereo

 

The tiny online TV startup Aereo won a pivotal legal decision that clears the way for the company to expand its business, potentially take more subscribers from pay television operators, and try to disrupt the relationship between broadcasters and pay television operators.

The decision by the U.S. District Court for the Southern District of New York was procedural, as the Court refused to issue a preliminary injunction against Aereo. But this is a big legal win for Aereo, I believe, that will lead to Aereo to go back to its venture capital sponsors to seek more funding for more rapid expansion.

And Aereo is a service that, when added to Netflix (NFLX), Hulu and other sources of online video, finally makes cord-cutting a more viable option for a greater number of people.

 

Aereo is backed by IAC/Interactive Corp  (IAC), led by Barry Diller, as well as more traditional venture capitalists. The last funding round in February was for $20 million. The Court noted in its opinion that the money was expected to last six or seven months. After this decision, I think the company and sponsors will shoot for additional funding of several times that.

To me, there are two things that are important about Aereo:

·         Aereo’s service gives a subscriber in New York City access to over 20 free over-the-air channels over an internet connection, which lets a viewer watch programming as varied as NFL Football or the Academy Awards with their iPhone, iPad, computer or Apple TV or Roku set-top box. Support for other devices are “in the works,” says the company. Aereo also allows subscribers to record the broadcast shows. So, for $12 a month, a subscriber can replace these services from pay television: the broadcast tier, the DVR and the Slingbox.

·         Aereo doesn’t pay the over-the-air broadcasters anything.

If you want to skip to the Court case, jump to The Legal Weeds

Why does any of this matter?

Firstly, Aereo is just one pebble among the rocks that are shifting within the pay television environment. Among those other rocks is Netflix (NFLX), which offers a lot of programming, but does not directly compete with pay television for most viewers because its programming is rarely current season. Hulu has current season, but does not compete directly with pay television because it is not live. Aereo may be a pebble, but it is a live-TV pebble. And over-the-air networks still have the most live sports, which is a crucial distinction.

For $12 a month, how appealing is the service? In New York City, the service is by invitation only. Aereo had 3,500 customers, but they were all on a 90-day free trial up until June 2012, according to the Court.

Personally, I still believe people want to watch TV on TVs. Aereo needs Apple TV or Roku set-top boxes, so it requires additional equipment and set-up, which is not for everyone. 

Even then, Aereo might not match the performance of pay television. According to the Court’s description, the process of preparing a live stream for transmission requires six or seven seconds of programming to fill a random access memory buffer. If that is the time it takes before seeing the program, the vast majority of viewers would find that unacceptable, I believe. Indeed, the company’s FAQs state there is some latency. Still, Kathryn Boehret just reviewed the service without mentioning the latency, so the delay might not be objectionable.

 

I also believe the vast majority of households will not go without current cable shows. As your household grows, it becomes more difficult to do without all the channels for pre-teens, tweens and teens. Pop culture feeds off of channels like E!, MTV and Bravo. Other niche networks address the addictions of other members of a household. A lot of live sports already have migrated to cable programmers.

So, Aereo is more than a complement to pay television, but is not a substitute. Right now, the “addressable market” is hard to define, but the possible market includes hardy souls determined to find a way to cut the cord to cable. Whatever that market is, it is larger than the number of cord-cutters pay television suffers now, I believe.

The impact of a successful Aereo on advertising would be small, I think. As long as Aereo viewing can be measured and folded into the negotiation between the nets and advertisers, things would work out.

Secondly, as noted, Aereo is not paying the broadcasters anything. The pay television operators are paying the local broadcast stations for right to retransmit their signals. In New York, the biggest local stations are owned by the same companies that own the networks: CBS Corp. (CBS), ABC Television (DIS), NBCUniversal (CMCSA) and Fox Television (NWS). There are many other local stations getting cash from pay television operators.

If Aereo is able to expand, and the broadcasters continue to deliver their signal over-the-air for free, all pay television companies will face competitive pressure as the number of Aereo subscribers grows. If Aereo successfully attracts subscribers, these customers are likely to either drop pay television or forego a pay television subscription.

So, if Aereo succeeds, pay television companies would stiffen their resolve against paying more fees to over-the-air broadcasters, generating more carriage disputes, headlines, and volatility for investors. And if over-the-air digital signals can be turned into a service that hurts the network fee relationship with pay television, networks might again start talking about leaving the airwaves in favor of becoming cable channels.

A successful Aereo also might also lead broadcasters to seek help from the Federal Communications Commission (FCC). For example, I could imagine broadcasters arguing Aereo should fall under the copyright regulation governing pay television. 

I could also imagine the pay television operators seeking relief from the FCC from the rules governing retransmission consent.

Even though Aereo doesn’t pay for programming, it still faces high costs. The system is constructed to take advantage of the parameters of the Cablevision case, discussed below. As a result, Aereo designed its system so that each subscriber would control a single antenna, would watch a single digital stream and record his or her own digital file. The tuning, network storage and transmission capacity required are significant expenses. In the case of Cablevision’s own network DVR, Time Warner Cable reportedly is reluctant to offer the service because of the tax on network resources it would cause.

The Legal Weeds

Legal scholars may note that the decision was procedural. At this stage, the Court only had to decide whether to stop Aereo from providing its service while the case goes to trial. The Court said Aereo could continue to serve customers during the lawsuit.

Judge Alison Nathan went to great lengths to show why she thought the injunction-seeking broadcast networks were not likely to prevail with their current complaint. The legal analysis is required for injunctive relief, but the Court built a 52-page case that should help when the broadcast networks appeal. But the legal scope is limited to the copyright holders’ public performance right, which involves transmission of a work to the public.

The District Court followed precedents set by the Second Circuit Court of Appeals here in New York when it decided that it was okay for Cablevision Systems Corp (CVC) to offer DVR functionality from its servers instead of from a home-based DVR. Judge Nathan said: “…faithful application of Cablevision requires the conclusion that Plaintiffs are unlikely to succeed on the merits of their public performance claim.”

In the Cablevision case, the Second Circuit said its interpretation was governed by what happens between the cable company and the customer — the downstream transmission — not what happens between the programming network and Cablevision — the upstream transmission. While the upstream transmission is a transmission to the public, the downstream transmission is one-to-one because of the way Cablevision designed the system.

Aereo's Antenna: Only One Subscriber Can Use an Antenna At a Time.

Fundamentally, Aereo’s service was designed to fit the Cablevision legal precedent. Every customer has his or her own tiny antenna that captures the programming. When a customer wants to watch the show live, the program is encoded for internet transmission and sent to the subscriber while it is temporarily stored on a hard drive. When a customer wants to record a show, it is encoded and sent to a hard drive.

So, Aereo can continue to expand its service in Second-Circuit-land without an injunction. But the broadcast networks will quickly appeal this decision.

Will Aereo win at full trial and appeal? The networks could end up trying other arguments and evidence to convince the District Court. Still, I feel that the networks would have deployed their best case to win an injunction because they have to show they are likely to prevail before the court can issue the injunction. If they put their best forward in seeking an injunction, then what is left to convince the District Court? It seems to me the probabilities favor Aereo. Caveat lector: I am not a lawyer.

Outside of Second-Circuit-land, there appear to be few legal precedents that deal with the advanced state of the technology. In 2009, the Solicitor General of the U.S. argued that the Supreme Court should not hear the Cablevision case because there were no conflicts with other Appeals Circuits. As a result, broadcasters may win a round when Aereo expands and they sue in another Circuit.

Meanwhile, Aereo told the U.S. District Court that the company might expand outside of New York in the coming 12 months. I think broadcast networks would do their utmost to stop Aereo from expanding in another jurisdiction, but it is unclear whether they would have much success.

Copyright holders other than the broadcast networks are likely to get involved. The 800-pound-gorilla (almost literally) is the National Football League, which jealously guards its rights across internet and mobile platforms. The District Court found that Aereo was not streaming because it was transmitting unique files, not master copies. But that will not stop the NFL from suing somebody once Aereo subscribers can see NFL games on their computer or mobile or tablet.

With this win, Aereo will try to expand the service, I think. The venture capitalists who have supported the business so far have modeled the addressable market and the ability of the company to gain operating leverage as it grows. To judge how disruptive Aereo may be, let’s keep an eye on the next round of venture financing. The bigger the round, the better the business model looks to those who know Aereo’s target market and costs to reach that market.

Beyond the risk to networks’ business is the irony that Diller, who created Fox Television, is creating a new model that takes Fox for free, eroding networks pricing power just as pay television operators up their resistance to fee demands

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Start Spreadin’ the News (Valuation)

Start Spreadin’ the News
We’re Splittin’ Today
I don’t want to be a part of it,
New Co, New Co…
Apologies to John Kander and Fred Ebb

• The announcement of a spin of News Corp’s publishing business triggered a run up in the stock
• Given the amount of the stock’s move, there is little additional value that would be unlocked through the spin-off unless investors are willing to pay full price for the collection of operating businesses plus investments
• A discount is likely to weigh on the Entertainment capital structure and the “full price” for Publishing is low, I think
• If there are signs that News Corp. limits share buybacks while working through the spin-off, the group’s stock will suffer
• There is additional debt capacity, but I think Murdoch is more likely to use debt capacity for M&A than for stock buybacks

The equity market jumped for joy when Rupert Murdoch decided to split his empire into two separately capitalized companies. In my judgment, Ms. Market (and arbitrageurs) did a good job of capturing most of the value that the operating businesses and the attached investments might have once they start trading.

What comes next for the stock depends on key decisions management and the Board of Directors will make about acquisition/divestiture strategy, capital structures and whether Murdoch sustains stock buybacks beyond the $5 billion program that is already underway.

Valuation is not the only issue in play, of course, but I already blogged my thoughts on other themes like family succession here. For the journalists who might not want to be a part of New Co, I think Murdoch still is committed to newspapers, so keep an eye on what strength is built into the Publishing capital structure.

When I look at valuation, I take a capital structure point of view, meaning I use enterprise valuations and back out equity valuations from those. And when I look at News Corp Entertainment and News Corp Publishing, I see two conglomerates instead of one. That is, the separation may make it easier to value the two parts, but each continues to be a mix of businesses that deserve different valuations based on their growth attributes. On top of that, there are equity investments with various potential outcomes that would affect valuation.

The Entertainment company will be much like media conglomerates Walt Disney and NBCUniversal that have cable programming, film and television together, but without the theme parks. News Corp. continues to have pay television in its empire with Sky Italia and the various pay television investments.

As noted in my earlier piece, the pay television investments in Australia will be part of the Publishing business. I am not satisfied with the geographic explanation for including pay television with Publishing and have my own theory for why Australian pay television should be treated differently from the rest of Asia-Pacific, including Sky Network in New Zealand. Please see here.

Publishing also is a conglomerate of sorts, but is dominated by newspapers. The difference at News Corp is that the newspapers span the English-speaking world, making for valuation challenges because of the different characteristics of the markets. I can only hope for much more financial clarity once the company is spun out.

Any sum-of-the-parts is extremely sensitive to the multiples chosen. For Entertainment, I selected a multiple for Cable Channels that is more like a Scripps Interactive Inc. than a Discovery Communications Inc; a multiple for Film that is below where Dreamworks Animation SKG Inc. trades; a multiple for television equal to CBS Corp.; and a multiple for Sky Italia in the middle of the pay-television range.

A sum-of-the-parts also presumes that stand-alone valuations are valid. The blended multiple comes out to 8.2 times, which is my current estimate for The Walt Disney Co. I don’t think investors would pay the same multiple for the News Corp. Entertainment company that they pay for Disney, so I hypothesized a conglomerate discount of 10%. Under those conditions, Entertainment would still have a higher multiple than Time Warner Inc.

Within Publishing, for newspapers, I used what I regard as the highest multiple for U.S. newspapers that is reasonable over a cycle; for inserts, I used the Valassis Communications Inc. multiple; for books, I discounted the HarperCollins multiple by at least one turn because of its consumer focus; finally, I gave a valuation to “other” based on what News Corp. paid for Wireless Generation, a company that develops education tools. The blended multiple is skewed because I attached value to “other” at a time when it is EBITDA negative.

The way I see it, the Publishing capital structure will be a big influence on the equity value of the company. The newspapers in Publishing have powerful brands and are diversified geographically, so they could support some level of debt. But if News Corp. does layer some debt on the Publishing business – say $1 billion — the group risks a debt rating of junk, which would hurt its ability to issue new bonds to use to fund acquisitions. It all comes down to how risky do the rating agencies think the News Corp Publishing business is and what kind of cash flow does the Australian pay-television business produce?

Also, I think most of the pension deficit of News Corp. is attributable to the Publishing side of the business because the newer businesses usually do not have defined benefit pension plans where companies are liable for future funding. As of the end of the last fiscal year, the pension deficit was $480 million, which represents almost half of turn of leverage for the Publishing company — even after tax-effecting the liability.

So, I am assuming Publishing is given a clean balance sheet.

I am guessing that Publishing would get $3 billion in cash, given where things stand today. My reasoning, as explained in my earlier piece, is that Publishing already has a $1.9 billion potential acquisition in train. In other words, if the acquisition were to be completed before the spin-off, Publishing would get about $1.1 billion of cash and the newly acquired Consolidated Media Holdings Ltd.

In addition, Publishing needs cash for acquisitions. Murdoch has said he wants the group to be the most ambitious newspaper group in the world. Acquisitions are like Viagra to managements, it piques the vitality. But acquisitions are a turn-off for investors.

I think Murdoch wants to expand the digital education business very rapidly. Not only are Charter schools growing quickly – and their need for tools – but online learning is one of the hottest new trends across higher education, and News Corp. does not yet have a way of playing in that field.

Rumor has it Murdoch wants to buy the Los Angeles Times, but I don’t think a local U.S. metropolitan newspaper is his target. Such an acquisition would be a signal to the market to sell.

News Corp. also has investments that have some value to shareholders. In the case of BSky, I used a current value. For NDS, I used the price Cisco is reportedly going to pay. For others, I have calculated a value based on the March-ended reported valuations. Then I applied a tax rate to an estimated gain.

There is no telling what the future values will be, nor whether shareholders will ever see any of the value. So, the tax-effected value should not be viewed as the amount the market would pay to own these investments as part of News Corp. I think a discount of 15% is probably appropriate.

Putting it all together, I think the run up in the stock has captured most of the value that can be gained from the spin-off of the Publishing company. I believe that investors would not be willing to pay full market value for all of the businesses and investments that are locked up in the News Corp. empire. With the discounts indicated, there are mid-single-digit-percentage gains left.

If the market does impose heavy discounts on the sum-of-the-parts, I think the Board of Directors will still see a need for share buybacks. Historically, Murdoch has not been a consistent buyer of his company’s stock; the current attachment to share buybacks started when Murdoch could not use the company’s cash to buy BSky. Could Murdoch husband the cash again? I think it is likely that share buybacks will be smaller if Murdoch is becoming more ambitious with acquisitions.

If the News Corp. debt is allocated to Entertainment, I think the company could have as much as $5 billion of additional debt capacity at its current debt rating. Of course, if the company aggressively issues debt to buyback shares, that would be a surprise to the rating agencies that could trigger rating action sooner, though the Entertainment company would still be investment grade, I expect.

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Splitting Heirs at News Corp

In the News Corp split, valuation is the key driver. Valuation requires some further analysis beyond live blogging the News Corp analysts’ conference call, so I will wade into the valuation weeds in a later posting. For now, some initial thoughts.

Aside from valuation, there are three themes that I think will emerge that will over time. They are:

  • Family succession
  • Acquisitions
  • Debt capacity at each company

Family Succession

Scion Lachlan moved back to Australia and married an Australian model. Could life be better? Yes, if he could control all the assets in Australia plus the publishing business. Guess what? All the Australian assets are included in the publishing business, including its stake in Foxtel, a subscription TV service. Should News Corp be successful in acquiring Consolidated Media Holdings in Australia, it too will be part of publishing.

As a result, I think it is a fair bet that Lachlan will be heading up the “Publishing” business. Meanwhile, Rupert already claimed the CEO position of the Entertainment business. Son James is in the wings, waiting for the phone hacking scandal to abate.

Acquisitions

I am of the view that well-played acquisitions can have a positive role in business strategy. But I also believe in the Curse of the Media Mogul, which is the drive for acquisitions for acquisitions’ sake. And when you get to Rupert’s age, acquisitions can seem like business Viagra, a way of boosting vitality of the business as well as the management.

Both Publishing and Entertainment will be pursuing acquisitions aggressively, I think. In particular, I think Rupert sees the digital education market as ripe for growth because of the expansion of Charter Schools in the U.S. that are open to adopting new tools such as those provided by Wireless Generation. This would be good news for shareholders because the size of acquisitions would be small, so Publishing could still pursue share buybacks, depending on capitalization.

But I also think the immediate investor reaction to acquisitions will be negative, fearing that the acquisitions will be large and would leave no room for share buybacks. The largest addressable market in education is textbooks, but I don’t think Rupert wants to get into textbooks.

Debt Capacity

My initial view is that Publishing would be debt-free and have at least $3 billion in cash. Existing bond indentures may prevent a transfer that would remove asset protection for bondholders, but I need to review the indentures before I can tell. If Rupert wants Publishing to use some of its debt capacity, it could simply issue new debt.

Publishing should have the financial liability for the hacking scandal, which reports suggest would be $1 billion. Publishing would also have to fund the acquisition of Consolidated Media Holdings Ltd., which is valued at around US$1.9 billion. Between these two alone, $3 billion in cash is needed, or Publishing would need to retain excess capacity to raise new debt.

A key question is whether Publishing would be rate investment grade. Management did not address this, but it will be an important consideration as the Board of Directors decides what is the right capital structure for Publishing. Because publishing is such a tough business, it would not take much leverage to cause Publishing to be rated junk, reducing access to debt capital markets.

The Entertainment has most of the EBITDA and can carry the entire News Corp debt while remaining investment grade, I believe. Based on latest-twelve-month numbers, my initial estimate is that Entertainment would have gross leverage of around 2.5 times if all debt is allocated to Entertainment.

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Charge for the Site Brigade

In its first ever Analysts’ Day last month, Gannett laid out a business Blitzkrieg across its operating units. Confident of winning its secular battles, management detailed bullish consolidated financial expectations for the next four years. Gannett’s battle plan includes:

  • Building a more meaningful business out of USA Today Sports Media;
  • Creating a group to expand Gannett’s marketing services;
  • Managing its printing needs and services;
  • And charging newspaper readers for what they consume on the web.

All this translated into long term guidance of 2% to 4% revenue growth per year for four years. Oh, and the Board of Directors boosted the dividend 150% and resumed modest share buybacks.

Equity and credit investors have turned more positive on the company – partly because of the concerted effort to turn the newspapers around, but also because of the buoyancy of the broadcasting business in a phenomenal election year.

I came away thinking most about Gannett enlisting in the charge for the site brigade. Gannett’s battle plan is impressive in its ambition and is sure to get other newspapers thinking about adopting models for charging for their content delivered over the web. In summary, my thoughts are:

  • Gannett is raising subscription prices for all subscribers, not just adding a digital tier, I believe.
  • Gannett will be better off with the additional subscription revenues, but I expect more push-back from subscribers than suggested by the company’s financial model.
  • Online display advertising is small enough at U.S. Community Publishing that the loss of ad revenue is a minor factor.

For updated comments on the overall direction of the company, please see: Credit Directionality. For comments on credit valuation, please see: Valuation.

Within the U.S. Community Publishing business, management presented three lofty goals that are in the table. The actions are supposed to add $100 million of operating income to U.S. Community Publishing in a “steady state.” On an adjusted basis, that would be a 17% step-up in operating income for the newspaper business as a whole from that of 2011, a significant improvement.

In order to get to that bottom line impact, Gannett has to make its new strategy of charging for web content a big success. The New York Times has had some success, so why not Gannett?

My take is that Gannett is using its new content strategy to raise prices on all of its newspaper products. Management does not describe its strategy that way, but I do not think the company can hit its target of a 25% increase in subscription revenues without raising prices for its current subscribers. Unlike Gannett management, though, I think there will be more disruption to subscribers than management expects.

Now, I have been advocating charging for content for several years. To me, charging for content is the right way to go because it can help stem the tide of subscribers to the free sites as long as there are few substitutes. Gannett publishes in many towns where there are few substitutes to get the truly local news.

Investors tend to focus on the national name brand draw of The Times as a reason for paying for web content. I agree that The Times is better known, but for people in Fort Collins, Colorado, The Coloradoan has something that The Times does not, which is hyperlocal coverage of their town, taxes and schools. Gannett’s papers often have much less competition than that found in larger cities where people turn to The Times and multiple local broadcast web sites, bloggers and other sources besides the local newspaper. The competitive moat is eroding for local newspapers, to be sure, as individual bloggers and corporate efforts like AOL’s Patch network expand their coverage. Also, news feeds of Facebook and other social networking sites redefine what counts as local news and how people find it.

But Gannett’s new pricing strategy is very aggressive, I find. First, the company is raising prices on single copies sold at newsstands and boxes by 30% to 100%. I view this as a pricing umbrella that the company is raising because I think the second strand of its strategy is to raise the prices current subscribers are paying as well.

The huge price increase on single copies could produce a 32% lift in single-copy revenue in 2012, I reckon, based on an assumed average 75% price increase. But single-copy would only increase U.S. Community Publishing total circulation revenue about 8% in 2012 – ignoring other moving parts — because single copies are not as important as home delivery. In other words, the single-copy price increase is nowhere near enough to produce the goal of a 25% increase in subscription revenue. Management explicitly included the single-copy hike in the “subscription” revenue target.

Gannett said the mammoth single-copy price hike would have a big impact on the volume of single-copy sales, and I include the Gannett volume guidance in my estimate. I had to make a guess as to when the price increase would be imposed, and I assume the single-copy price increases are part of the overall pricing strategy that will see digital pricing introduced throughout the company in phases through 2012. Because I think single-copy sales volume in 2013 and beyond would also decline in line with overall trends, the single-copy revenue in 2013 would be up 16%, I think and revert in 2014 unless there are more price increases.

Far more important is: how big a price hike do print subscribers face? The company is careful not to characterize the new pricing as a price increase, but it seemed very clear that print subscribers will no longer be able to take just the print version of their local newspaper. Instead, they will have to pay for “all access” – print and digital – or digital only. Nowhere can I find an option for print at the newspapers that converted.

It could be that the company allows subscribers who are under existing print subscription plans to get all access without paying more. But it seems unlikely because they need to increase the price when the subscriber gets an expanded product, not later when their subscription renews. As a consequence, it seems as though print subscribers will have an incentive to hold off on a new subscription until their current subscription expires. Indeed, during the Analysts’ Day, management said there would be a lag between the time the subscription changes take effect and when the “steady-state” $100 million is meant to fall to the bottom line because of the time it takes for existing subscriptions to roll off.

I tried to figure out how big the average price increase would have to be if Gannett is to achieve a 25% step-up in circulation revenue in 2013 from 2011. The answer I came up with was that an average price increase of between 30% and 45% — and closer to 45% — might be needed. The calculation uses the company’s notion that the volume of daily newspapers sold would fall by five to six percentage points faster than trend. For Sunday, I used management’s notion that Sunday circulation volume was flat. One explanation for the answer I get is that management thinks the trend in daily volume is much better than I think it is. As a result, management probably believes a smaller price hike would be needed to hit the battle plan.

I don’t have a direct way of measuring the actual price increases, so I compared newspapers that have Gannett’s new pricing plans with some other Gannett newspapers that haven’t put up the paywall and still allow print-only subscribers. The smallest price jump from daily print to “daily all access” is 27% and the largest is 47%. In Sunday, the range is even larger. Gannett wants subscribers to continue to take the Sunday print newspaper: in most cases, the Sunday paper plus digital access is the same as digital only.

But think about it: when a print-only subscriber is called on to renew, they could be faced with huge price increases for daily or Sunday-only. The subscriber may not have internet at home; may have narrowband at home; or may hate reading a newspaper on a screen. There seems to be no way around paying for digital access. Our beloved cable companies call this a “buy-through”: to get the value-added channels, you have to take the broadcast channels first. Gannett could face consumer backlash on this issue if it is not handled well.

While I firmly believe there are fewer substitutes to Gannett’s local coverage, huge price hikes will drive readers away, I fear. People who subscribe out of habit would consider cancelling, I’m sure. In markets where local broadcast stations serve the community, more local news would be available from broadcast websites not owned by Gannett.  And let’s not forget that more and more people only care about the local news that is in their Facebook or other social network feed.

Gannett’s calculus relies partly on an expansion of its Sunday circulation, I think. The publisher claims it has been successful in increasing Sunday circulation at some newspapers, but the company’s own data shows that Sunday circulation volume was off 1.5% in 2011. Perhaps the reason for the historical Sunday volume decline was single-copy, but it is unclear.  Perhaps the hope is that the huge single-copy price hike will corral subscribers to subscribe instead? If that is driving the Sunday circulation expectation, that would be a transient benefit in 2012 and 2013, I think.

The company also anticipates gaining new subscribers to the digital plans. There is sure to be a group of avid readers who currently read the newspaper content for free. But how many are there and can they be converted to paying subscribers?

The number of unique visitors to Gannett’s local newspapers was probably around 17 million in December 2011, I figure, based on the corporate-wide audience that includes USA Today, broadcasting and U.S. Community Publishing. The American Press Institute did a study in 2009 that showed about 10% of the unique visitors to U.S. newspaper sites were hardcore readers and another 15% were “incidental loyalists.” If true for Gannett, there are about 1.7 million hardcore readers and 2.6 million are “incidental loyalists.” The “incidental loyalists” are unlikely to pay, leaving the hardcore readers as the most likely audience. In the case of The New York Times, it seems to me that around 6% of the hardcore, non-print readers converted so far. If none of Gannett’s hardcore readers were also print subscribers, that would work out to a lift of only 3% to the current print subscriber base.  I think many already are print subscribers, so the potential lift is smaller. We’ll have to see if Gannett’s hyperlocal online product has greater value to its readers than The New York Times national focus has for Times online readers.

The hardcore audience that converts will help, but not enough to produce long-term subscriber growth in the target range of 1% to 3%, I think. On their own, daily print subscription and single-copy volume likely would continue to shrink at around 4% a year, I believe.

Also, I think the experience of The New York Times shows that the ability to capture meaningful new subscribers is when the paywall first goes up. You can’t count on a lot of growth in that base in subsequent years, I believe.

If Gannett’s pricing does end up guiding daily print subscribers to convert to Sunday-only home delivery, there would be some cost savings. Newsprint is a variable cost, but it would take longer to realize savings in distribution because a daily distribution network would be needed for some time to come. I have not tried to calculate the cost side of the equation.

What of the impact on advertising, you ask? Advertising was an important factor for The New York Times. But after I try to separate how much of Gannett’s online display ads come from USA Today, from other digital assets, from U.K.-based Newsquest and finally from the U.S. Community Publishing, I find U.S. Community Publishing is a very small contributor. The main reason is a disclosure by Gannett that $154 million of revenue related to products of CareerBuilder and Classified Ventures was posted to the publishing segment. For the online display advertising that remains, I assume the vast majority comes from USA Today. Classified ads are not sold by the cost-per-thousand, so classified revenue to U.S. Community Publishing should be protected. Also, I found that classified ads are freely available to non-subscribers.

There are a bunch of reasons management can cite for me being off base. I have had to make estimates of U.S. Community Publishing home delivery and single-copy volumes as well as the U.S. Community Publishing circulation revenues and pricing.  I have benchmarked the estimates against available data, but they remain only estimates. I made the estimates using all the data I could find, but these can only be regarded as good faith efforts.

McClatchy has to be thinking about this again. The company just announced that its CEO, Gary Pruitt, is moving on to the Associated Press in July. Pruitt had always erred on the side of maximizing traffic and advertising revenue rather than charging for content. I suspect the new CEO, Pat Talamantes, will follow the same route, but may start more experiments with charging.

More importantly, The New York Times will watch to see if Gannett can get its ask from subscribers. If Gannett does better than I suspect, then The Times is sure to take that as a signal to raise its subscription prices.

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A Monster Valuation For CareerBuilder?

As print classified advertising continues to collapse, the newspaper partners who jointly own CareerBuilder are delighted they can offer advertisers access to the biggest paid online job site.

Despite double-digit revenue growth at most job listing sites in 2011, though, market valuations of the sites crumbled. The job market has improved throughout the year and Robert Half International has at least been a market-performer. But the recruitment market is changing because LinkedIn is becoming an important recruiting tool and talent management companies that offer software-as-a-service have recruiting tools, too.

Now, Tribune sold part of its shares of CareerBuilder just weeks before the collapse of Lehman Brothers. The 10% stake went to Gannett for $135 million. Tribune, Gannett and McClatchy all remain owners in the business, with McClatchy winning the prize for the most likely to sell – because of a debt overhang.

But I think it is time to question whether CareerBuilder is worth what investors might think, or indeed, what McClatchy carries the investment at on its balance sheet.

The strands of my argument are:

  • the values of job sites have collapsed since the Tribune sale
  • if the collapse of  job sites’ values is mainly due to disruption to the recruiting business from  LinkedIn, Indeed.com, Taleo, Kenexa and others, these companies will disrupt the business model for all the job sites.

Effectively, Tribune’s sale put a $1.35 bln enterprise value on CareerBuilder. The planet was already in the credit crunch and the Great Recession, though network revenues of CareerBuilder only slid 6% in 2008 compared to a 10% North American revenue fall at Monster. In 2009, it became even clearer that job sites were highly cyclical: CareerBuilder network revenues dropped 26% and Monster North American revenues cratered 36%. Arguably, web job listings were gaining from a shift from print to online job listings, but that did not offset dropping demand.

Since Tribune sold part of its stake in CareerBuilder, Monster’s equity market capitalization has fallen by close to 60%. Monster’s enterprise valuation multiple, based on 2012 consensus EBITDA, is 5 times. Dice Holdings, which has job sites dedicated to particular professions, has an enterprise valuation of 6.3 times.

CareerBuilder has been doing better than Monster in North America, but only management knows how much better because the only data point that CareerBuilder releases is its total network revenues. Total network revenue combines the sales that CareerBuilder makes on its own with those sold by its newspaper partners. Monster also derives a large part of its business from other countries while CareerBuilder has said its international business is small, though growing rapidly. Both Monster and CareerBuilder claim to be taking share from the other in North America. If this is a share game, this is not a great business.

The recruitment market is rapidly evolving, and I think it is evolving away from listings for which companies pay a fee. In some segments, Companies and internal and external recruiters that troll the internet can use LinkedIn to attract talent. LinkedIn’s recruiting business is now half of its sales and is growing faster than its other segments. Kenexa is a talent management company that last fall partnered with LinkedIn to give recruiters a way use LinkedIn to allow companies to offer streamlined applications, which means more candidates and less need to spray the United States with paid job listings.

As corporations begin using cloud-based talent management systems, I think it also becomes easier for them to deliver their own, integrated listings/applications via search engines. Some of these search engines like Indeed.com are blazing a trail of pay-for-performance so companies don’t have to pay for each listing. Indeed.com has more unique visitors than CareerBuilder and Monster combined. Alexa.com shows the traffic trends favor Indeed.com.

McClatchy has a 15% stake in CareerBuilder, an investment that it carries at a value of $225 million at the end of the third quarter 2011. The value is based on equity accounting and so reflects initial investments and income retained at CareerBuilder, not the market value.

McClatchy is very happy with the stake, I’m sure. But the company needs to cut its combined load of debt and pension obligations. As a result, management makes it very clear that selling CareerBuilder shares is something it will consider. At the same time, it is not in any rush to sell because its only large debt obligation in the next few years is $92 million due in 2014. The liquidity crunch comes in 2017 when $1.2 billion of debt is due.

The problem with waiting is CareerBuilder needs to change its business as the market evolves. The hottest talent management companies are those that offer software-as-a-service and that have a suite of applications for recruiting to compensation, performance reviews and continuous learning; the buzz word is Human Capital Management. SuccessFactors offers HCM in the cloud on a subscription basis and just sold itself to SAP for $3.4 bln or over 8 times expected revenues. Just days after SAP announced its purchase, SuccessFactors paid 11 times revenue for a company called Jobs2Web that indexes corporate job sites so that the listings can be accessed by search engines. I think the trend toward indexing means companies no longer need to pay for job postings, but instead optimize their sites and listings to gain traction with search engines.

CareerBuilder is offering its own Talent Network that indexes a company’s career site and exposes job listings to search engines. If a company can pay to have all of its job-listings distributed without paying a per-listing fee, that sounds like CareerBuilder is competing against its own job-listing sales force.

CareerBuilder has also entered the software-as-a-service race. I think it will have a hard time competing in the hyper-competitive market for talent-oriented software-as-a-service. Perhaps its job-matching technology will give CareerBuilder some comparative advantage.

So what might CareerBuilder be worth now?

If CareerBuilder is better positioned than Monster, I think the starting point should be the enterprise valuation of Dice Holdings, which is 6.3 times. The network revenues are about 10% higher in 2012, I surmise.  I also have a “dicey” guess about what part that CareerBuilder sells directly. Although management stated dollar figures for 2010, the figures appear inconsistent with the amounts that Gannett reports from its sales of ads through CareerBuilder and Classified Ventures. I think the EBITDA margin on the direct sales will be higher than margins posted by Monster, though spending on new services could be hurting margins. The EBITDA margin for CareerBuilder on ads sold by Gannett, Tribune and McClatchy should be low, I believe. International is also a guess, but based on patterns in Monster’s international business. Altogether, the EBITDA looks about right to me given the amount of Digital Segment EBITDA reported by Gannett; if it were much larger, it would not leave room for EBITDA from ShopLocal and PointRoll. CareerBuilder is consolidated into the Digital Segment.

The valuation multiples are also my views of the current market. We do not know how much cash CareerBuilder has, but between dividends, spending to keep up with the “Saas” competitors and international expansion, I suspect cash will not accumulate on the balance sheet.  For McClatchy’s stake, all this adds up to $140 million, which I think would be a disappointment. What McClatchy actually would receive depends on what the shareholder agreement says.

This valuation could be criticized. Among the counterarguments: Microsoft sold a 4% stake back to CareerBuilder for $85 million in the first quarter of 2011. The stake was a redeemable security and CareerBuilder repurchased the stake at book value, based on Gannett’s disclosures. In other words, it appears to me that redemption at book value was required in 2013. At the same time, CareerBuilder got an extension of three years exclusivity in the MSN jobs portal, but I cannot find any mention of what CareerBuilder would pay for the exclusivity. CareerBuilder may have received some value in exchange for the early redemption.

Another “inconvenient truth” is that Monster Worldwide paid $225 million for HotJobs in February 2010, which may have been close to a double-digit Enterprise Value multiple. But Monster had plenty of opportunity to cut out costs that made the property more valuable to them.

I should also note that if I split network sales into direct and newspaper sales based on a management discussion in March 2011 for results of 2010, the split is more like 84% direct and 16% newspaper. Using that split, EBITDA rises about $9 million and the total valuation reaches $1 billion.

All told, it looks like CareerBuilder could have a current market value of $1 billion or less. What the future holds is anyone’s guess, but CareerBuilder will have to work very hard to remain relevant in a world where competitors are changing the rules of the game. If CareerBuilder meets the challenges, then I will be the first to admit that I was wrong.

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Belo’s Auld Lang Loan

Should old indentures be forgot?

Belo got a new revolving bank agreement that, despite its junk debt rating, does not give collateral to the banks. The result is better than bondholders can usually expect; for lack of collateral covering the bank loans, bondholders have a better legal position if there ever is a bankruptcy. Especially investors in Belo’s 2016 bonds because they have a guarantee from subsidiaries. Still, the banks will remain ahead in the pecking order in a bankruptcy because they have a senior guarantee from operating subsidiaries where the 2016s have a subordinated guarantee.

The new credit agreement is for $200 million, almost the same as Belo’s old bank facility. The new agreement goes to August 2016, three and a half years longer than the old agreement.

The new agreement also gives Belo a lot more flexibility to use its cash flow for dividends and share buybacks, and to raise new debt to enter the acquisition fray. More on that in a minute.

The spread Belo is paying is higher than that of Sinclair Broadcast Group, which I think reflects the fact that the banks are not getting collateral. I estimated leverage based on an average of 2011 and 2012 EBITDA and pro forma for acquisitions because I think loan pricing will bake in those expectations.

Once upon a time, when Belo was young and investment grade, it entered an indenture. Like so many investment grade indentures, this 1997 agreement said that if the company or its subsidiaries mortgage property, then the bondholders also get a lien on the property. Unlike so many indentures with loopholes the size of Cowboys Stadium, Belo’s indenture covered the field. If liens were put on any asset – not just “principal property” – Belo would have to give bondholders a lien, too. By my calculation, Belo’s carve out would allow liens for borrowing of up to $51 million.

Banks do not want to share collateral, so loans are most often structured to get around the negative pledge language found in investment-grade bond indentures. So, liens are placed on any and all assets not covered by the bond indentures. Since Belo’s indenture covers any asset broadly, that wasn’t an option.

The new loan agreement also reveals some of management’s priorities for use of cash flow, and it looks to me like acquisitions are a key element.

Junk-company bank documents always restrict management’s uses of free cash flow. But each bank agreement is a hard fought negotiation shaped by company push versus bank shove. Where the bank agreement becomes less restrictive, it is because of the company push.

The big change is the amount that Belo can spend on acquisitions. Belo was limited to an acquisition smaller than $65 million each year when leverage is below 5 times. Belo already missed three deals in the $200 million plus range this year, and it appears that the company wants to get back into the race for stations. Now, as long as an acquisition does not push the total leverage ratio above 5 times, Belo will be able to do an acquisition without a dollar limit.

In order to triangulate the size of possible acquisitions, I set up scenarios starting with possible purchase multiples and debt-weight. The multiples Belo would have to pay would depend a lot on the network affiliation of the stations and the size of the markets. Belo’s strategy focuses on major networks in mid-sized and larger markets, so the multiples could be double digits. If the funding for an acquisition required Belo to increase its debt load by 60%, the company easily gets too close to the 5 times for comfort, so I think $500 million probably is the practical limit.

And, in order to maximize dividends and share buybacks, Belo would need to keep leverage below 4.5 times. Under the old bank agreement, the company could not buy back shares and could only make $8 million of dividend payments each quarter. Now, Belo can pay dividends and buyback shares for a combined total of $100 million under conditions that include pro forma leverage below 4.5 times and keeping total cash and available bank borrowing of more than $75 million. Based on that additional constraint, the practical limit on acquisitions is more like $400 million.

I think Belo would seek stations in markets where it already has a major network, so acquisitions are likely to be smaller and for manageable multiples.

Belo also obtained the flexibility to buyback its bonds, but I view this as a rain-check. Before the company could only use around $26 mln to repurchase bonds. Now, Belo can buyback its 2013 bonds without limitation, and can buyback its other bonds as long as it keeps combined cash and bank availability of $75 million and would meet the financial covenants. Management has made clear it won’t buy back bonds unless the price of the bonds is low enough to generate a positive return. Belo would wait for bond prices to fall, I think.