Tribune Media Continues To Trade At Massive Discount

TRCO HeadlineOverview: I like Tribune Media Company at $36. I’ve owned it for almost a year and I continue to believe that it is trading at a substantial discount. Tribune is asset rich and is beginning to monetize its real estate assets. The company continues to build WGN as the total audience is up 51% y/y. WGN has three very promising original series’ which will drive audience growth. The potential monetization of spectrum could represent a cash flow boost, although there is much speculation about demand and price per market. The company operates in markets such as New York and Hartford where demand is likely to be strong. A sum of the parts valuation shows lots of value.

Market Overview

The United States broadcasting market has produced moderate growth in recent years and is expected to produce slightly lower rates of growth over the next decade. The United States is easily the largest global market for broadcasting and much of this is due to the investment in content and the popularity of this content abroad. Growth is driven by advertising and subscriptions growth, with advertising being very strong despite the trends which are moving advertising revenues into digital spheres. The broadcasting TV market has produced a 2.2% CAGR over the last five years. It is expected to slow to 1.2% over the next five years.

The value of Tribunes 42 owned or operated broadcast television stations is largely dictated by the quality of the content. Content quality is determined by total audience to make the product marketable to advertising businesses. WGN is thriving in this area with their Outsiders and Underground original series’. The rise in popularity of downloading programs, both legally and illegally, is having an impact on the market.

Cable networks are direct competitors of television broadcasters for viewership, advertising dollars and TV ratings. Cable television programming has historically been the largest rival to major broadcasters in terms of total viewership. Viewers who subscribe to the expanding range of alternative television content providers, which include basic and premium cable packages consisting of hundreds of unique programming options, are likely to reduce viewership of traditional broadcast programming. The number of cable TV subscriptions is expected to decrease in 2017. However, this negative trend will likely not have a large effect on broadcasters. Many people, myself included, have cut the cord and have purchased an HD antenna enabling us to watch traditional broadcast programming.

Economic Drivers

The major driver in broadcasting growth is disposable income which is affected by labor market growth, unemployment and interest rate changes. In addition, disposable income is a key determinant of retail sales and expenditures on other goods and services which can directly influence advertising expenditure on TV. Per capital disposable income is expected to increase in 2017.

Changes in the Market

In the last five years, operators in the television broadcasting industry have undergone structural changes to contend with stagnating revenues. Broadcast revenue is largely dependent on sales of advertising spots, which are determined by their advertisers’ corporate profit and the disposable incomes of their viewers. Although advertising expenditure has increased along with rising disposable income and corporate profit in the last five years, the media landscape has become increasingly competitive. Consumers are shifting towards online media for their news and entertainment, prompting advertisers to shift their spending away from traditional television broadcasting. In addition, platforms like Hulu and Netflix directly compete with industry broadcasters to provide new content.

Media Fragmentation

Advertising expenditure has recovered strongly since the financial crisis. However, advertisers now have a wider range of channels to reach their audiences. Historically, advertising and marketing has been spread across broadcast television, radio and cable, print media, and direct mail marketing. The advent of the internet and social media has dramatically boosted media access through social networks, streaming platforms, RSS feeds and podcasts. Advertisers have realized the power of online media, which allows for targeted ad campaigns that were impossible with previous forms of broad-based advertising. Social media networks can tailor ads to specific demographics, attracting a greater portion of advertising budgets. Over the same period, people have adopted digital video recorders (DVR) and on-demand programming. Together, they have decreased audiences attention to TV commercials which has lowered the price that advertisers are willing to pay broadcast networks for ad time. Services like Netflix, Hulu and cable-free subscription packages from HBO and Showtime enable more content variety and viewer control. The accelerating media competition will be a headwind to the broadcast industry’s growth prospects.

Broadcast TV Networks

Broadcast TV networks are composed of TV stations that release the same programming through several stations (i.e affiliates). This strategy saves time and cuts costs associated with programming for separate stations which allows broadcasters to negotiate better prices for advertising to a mass audience. The bulk of airtime is made up of programming developed for national broadcasting but certain time slots are designated for local or regional programming.

Next Ten Years

Broadcasters are now receiving monetary compensation from cable operators through retransmission fees. Demanding payments for the retransmission of content has forced cable operators to charge more for their packages. This revenue stream has reduced volatility for broadcasters because cable contracts are typically renewed annually.

Rising advertisement spending and disposable income will support the industry over the next decade. Total US advertising expense is expected to grow at an annualized 4.4% over the next decade. Competition from new media that allows advertisers to target specific audiences for less will make attracting TV broadcasting ad revenue more difficult.

The major development in the industry over the next decade will be interactive TV. This change will customize viewing experiences for audiences. By making TV interactive, broadcasters will be able to offer advertisers a more direct way of selling products and services to targeted audiences. Broadcasters will have features that allow a viewer to order a product in a commercial just with a click of the remote. Features like this may not be received well by online streaming audiences who prefer zero commercials. This opportunity has the potential to boost ad revenues and could possibly take market share away from social media platforms.

Tribune Media Segment Overview

Television and Entertainment

This is the larger of the two segments and includes Tribunes 42 broadcasting stations. This segment accounts for 85% of Tribunes revenues. A breakdown of this segment is shown below.

TRCO TV Seg

The primary drivers of the business are advertising and retransmission fees. As Tribune operates in some of the best quality broadcasting markets, it supports advertising revenue to grow modestly going forward. TRCO owns or operate local television stations in each of the nation’s top five markets and seven of the top ten markets by population. Tribunes stations and local news reach is approximately 50 million U.S. households in the aggregate, representing approximately 44% of all U.S. households.

The business owns a national general entertainment cable network, WGN America, which is distributed to more than 80 million households nationally. In 2013 the company created Tribune Studios to source and produce original and exclusive content for WGN America and local television stations. Tribune Studios provides alternatives to acquired programming across a variety of segments. WGN has three hit series’, Underground, Outsiders, and Salem. These three are helping drive retransmission fees and audience growth. The table below presents WGN’s lineup of series. This table does not include Salem as it is their newest series.WGN

Digital and Data Segment

The Digital and Data segment is comprised of a company named Gracenote. The company provides music, video, sports, and auto metadata to users who are often brands.

Gracenote Music

Gracenote Music is one of the largest sources of music data in the world, featuring music data for more than 235 million tracks, which helps power over a billion mobile devices including smart phones, tablets and laptops and many of the world’s most popular streaming. Music data includes a variety of content such as artist name, album name, track name, music genre, origin, era, tempo, mood, as well as album cover art and artist imagery. Gracenote Music derives the majority of its revenue from licensing its music data, software and services in the B2B segment to music services and to Tier 1 suppliers to the world’s leading automakers.

Gracenote Video

The video segment provides data around TV shows and movies, such as descriptions, genres, cast and crew details, actor long- and short-form biographies, imagery, TV schedules and listings, TV episode and season information and unique program IDs. Gracenote Video derives the majority of its revenue from cable, satellite, online, consumer electronics and other business-to-business (“B2B”) channels.

Gracenote Sports

The sports segment provides live data and statistics from over 4,500 leagues and competitions, such as the National Football League, Major League Baseball, National Basketball Association, National Hockey League, Premier League, F1, Bundesliga, Tour de France, Wimbledon and the Olympics, among others.

Gracenote Automotive

Gracenote Auto provides Automatic Content Recognition (ACR) technology into any car’s audio system to identify music playing from various sources including AM/FM and satellite radio, CDs or streaming services and deliver relevant metadata and cover art. In December 2015, Gracenote launched its first audio technology, Gracenote Dynamic EQ, designed to help automakers and OEMs automatically tune connected car audio systems to the optimal equalizer settings for individual songs based on genre, mood and release date.

Today, data powers the algorithms that make movie and music recommendations possible for popular on-demand video and streaming music services. Demand for data has grown from consumers, and therefore distributors. Gracenote has a large variety of distributors including companies that deliver music, video and sports content to consumers through devices, platforms and applications. Gracenote is uniquely positioned to take advantage of this increased demand for entertainment data as it provides data on a large scale in the four largest entertainment categories – TV, movies, music, and sports.

Real Estate

Tribune owns the majority of the real estate and facilities used in the operations of the business. The real estate portfolio comprises 74 properties after its recent sales. In April, TRCO entered into an agreement to sell a property in Pennsylvania. On May 5th, TRCO entered into agreement for the sale of the north block of the LA Times Square property and the Olympic Printing Plant facility in LA. (A previously agreement for the sale of the LA Times Square property was terminated in Q1’16). It is estimated that the entire real estate portfolio is worth between $1 billion and $1.1 billion. Management has estimated it at $1 billion and said on August 30th that the recent sales are in line with this valuation.

Investments

Tribune holds a variety of investments in broadcasting and digital assets. The two large investments that produce the most cash flows are in the TV Food Network and CareerBuilder. Tribune owns 31% of the TV Food Network and 32% of CareerBuilder.

TV Food Network

The TV Food Network has two television networks, The Food Network and the Cooking Channel. TRCO’s partner in TV Food Network is Scripps Networks Interactive, Inc. (“Scripps”), which owns a 69% interest in TV Food Network and operates the networks on behalf of the partnership. Food Network programming is divided into a daytime block known as “Food Network in the Kitchen” and a primetime lineup branded as “Food Network Nighttime”. “In the Kitchen” is dedicated to instructional cooking programs, while “Nighttime” features food-related entertainment programs, such as cooking competitions and reality TV shows. As of February 2016, Food Network is available to approximately 97,652,000 pay television households (83.9% of households with television) in the United States. The Cooking Channel focuses on providing content around food information and instructional cooking. As of February 2016, Cooking Channel is available to approximately 63,772,000 pay television households (54.8% of households with television) in the United States.

CareerBuilder

CareerBuilder.com, is the largest job website in North America on the basis of traffic and revenue. CareerBuilder offers a variety of services including talent management software, recruiting platforms, and employee retention solutions. CareerBuilder operates in over 65 markets and operates websites in the United States, Europe, Canada, Asia and South America. Tribune’s partners in CareerBuilder are TEGNA Inc. and The McClatchy Company, which together own a 68% interest in CareerBuilder.

Financial Overview

On February 24, 2016 Tribune announced a massive $400 million buyback. As of August 5, 2016 they had purchased $96 million. Once completed, this buyback program will allow management to repurchase over 13% of the company. Repurchase programs of this size cannot go unnoticed by investors due to the sheer size. Actions speak louder than words and management is taking advantage of an undervalued stock. Additionally, shareholders are getting paid to wait for the market to understand the story. The stock yields about 2.8% which is very generous.

Tribune’s broadcasting business will be supported by the strong markets they operate in. Owning or operating affiliates in seven of the top ten markets will help generate continued advertising growth.

TRCO Estimates

The broadcasting business provides a stable operating environment. However, political spending drives advertising revenues which is reflected in the 2016 and 2018 estimates. The amount of political spending as been a bit disappointing during the presidential campaigns. Neither candidate is spending as much as anticipated. The distribution between traditional media and social media is as expected.

Tribune Media is a sum of the parts story. The company has two primary segments in broadcasting and digital but also holds many valuable assets. These assets are being undervalued by the market. As the company begins to monetize some and grow others, I believe the market will notice the massive discount the company currently trades at.

TRCO SOTP

A sum of the parts valuation indicates the stock is worth $64. This represents 80% upside. There is an ongoing FCC spectrum auction that should be over in the next 6 weeks. The spectrum market has support from cord-cutters purchasing HD antennas to watch broadcasting stations. There continues to be a lack of spectrum in the market and I expect this to continue. The outcome of this auction could be a near term catalyst for the stock.

I have owned the stock for almost a year and as of today, it is a loss (Average price about $37). I continue to believe the stock is trading at a massive discount. I am comfortable with the valuations of their investments and the real estate portfolio. It doesn’t appear that they have many level 3 investments which gives me confidence in the $1 billion valuation they have placed on the real estate portfolio. I continue to like the 2.8% dividend yield and the large repurchase program in place. I believe the market will begin to see the value in this company in the next 12 months.

Disclosure


Long TRCO

 

 

 

Liberty Global’s LiLAC Group

Liberty-Global-470x260LiLAC was spun off as a tracking stock from Liberty Global last year. LiLAC is a provider of video, broadband Internet, fixed-line telephone and mobile services. After being spun off, it acquired Cable & Wireless, who owns a combination of cable and mobile assets in the Caribbean. LiLAC previously held large market share in the Chile and Puerto Rico markets and now looks to expand. Liberty Global is looking to acquire an array of cable assets in Latin America as they have done in Europe. With their acquisition of C&W it looks like they are on their way. Creating the LiLAC tracking stock gives management focus as well as a currency with which to potentially execute acquisitions.

Cable & Wireless Acquisition

Prior to being acquired by Liberty, CWC acquired Columbus Networks, a Caribbean cable operator owned by Canadian entrepreneurs and John Malone. Cable & Wireless paid 12.3x EBITDA for Columbus before any synergies. Columbus was growing EBITDA at 15% a year with a presence in predominantly Caribbean countries such as Trinidad, Jamaica, and Barbados. What was interesting about the combination is this would effectively give the combined entity a quad play in many of the countries in which they competed. It is very valuable to be able to have a mobile and fixed infrastructure presence as it reduces churn and creates an incremental, potentially low cost position. When you think about a mobile only player trying to compete against a fixed-mobile operator, the mobile only player should have structurally higher costs as they have to depend on expensive spectrum to transmit data. The combined hybrid player can use a fixed infrastructure presence to offload bits via Wifi at a much lower cost. In markets where the combined Cable & Wireless did not have a fixed infrastructure presence, they have started to selectively deploy the cable infrastructure in these markets being able to leverage the competitive video product. Cable & Wireless has continued the differentiation of their video product through exclusive rights to key sports content such as the Premier League and additional sports and high definition content. When looking at cable assets in the Caribbean region compared to the US or Europe there are a couple of key factors that make the Caribbean substantially more attractive: you have substantially lower penetration of services (around 40% penetration in the Caribbean) providing for a much higher and longer growth runway and the competitive landscape is much more benign especially with broadband given the very limited fiber overbuild. In addition to the consumer platform, the combination of Cable & Wireless and Columbus Networks strengthened the B2B firepower of the combined entity. Given the increased reach of the combined entity into the region as well as critical subsea fiber and backhaul, this combination creates a more compelling telco supplier for enterprises with multiple offices in multiple regions. CWC identified $125 million in synergies from the Columbus Networks combination, Liberty Global believes it can harvest additional synergies both from the Columbus Networks integration as well as from the combination of LiLAC with CWC. Given Liberty Global’s track record in harvesting synergies in previous acquisitions, the subscale nature of LiLAC, and the vast scale of Liberty Global, there should be some level of incremental synergy from items such as the rationalization of overlapping corporate costs and increased purchasing power leading to lower costs. Financially, the combined CWC and Columbus have historically grown revenue high single digits and EBITDA low double digits (not including any synergies). The CWC acquisition gives Liberty Global a significant quad play offering in a growing market. LiLAC is also in good position to acquire assets and continue to consolidate the Latin American market. A potential target would be Millicom. The former head of LiLAC’s Chilean business now runs Millicom. I believe there is a good possibility that John Malone goes after Millicom in the next 12 months.

John Malone

John Malone is a legend in the cable television industry. He became CEO of TCI in 1973 and more recently was CEO of Liberty Media. Liberty Global was spun out of Liberty Media in 2004 and merged with United Globalcom in 2005, shortly after UGC came out of bankruptcy. The company is structured so that Malone has voting control. It has three classes of stock: Class A shares get 1 vote, Class B shares get 10, and Class C shares get none. Malone owns 1% of Class A shares, 85.8% of Class B shares, and 3.5% of Class C shares. John Malone has a terrific track record of allocating capital. I believe the market is discounting the earnings power of the evolving LiLAC Group.

Chile 

The Chile market represents about 28% of LiLAC’s EBITDA. LiLAC’s Chile segment is called VTR. It has been showing very strong growth and has a long runway as penetration remains low.

VTR Growth

VTR’s network is a complete hybrid fiber coaxial network which can attain broadband speeds comparable to high speed cable networks in the US and Europe. They offer speeds up to 160 mb/s. This is much better service than its competitors. Additionally, they offer triple play packages that are far superior.

VTR Bundle

VTR’s biggest competitor is Movistar. As you can see, the pricing for the bundle is about the same but the broadband speed is more than twice as fast. VTR has existing infrastructure that gives them this competitive advantage. As VTR continues to add revenue generating units (RGU), I believe incremental revenues will drop straight to the bottom line.

Chile Broadband Market

VTR Internet

The broadband market in Chile is a duopoly with Movistar and VTR. Combined they have over 75% of the market. We know that VTR is far superior to Movistar. The overall broadband market is growing rapidly with a 12% CAGR over the last decade. VTR has kept its share of the market and has attained double digit broadband growth.

Puerto Rico

Liberty has entered into the Puerto Rico by way of mostly mergers and acquisitions. They are now the largest cable provider in PR. Puerto Rico accounts for about 12% of EBITDA. Similar to Chile, Liberty has key competitive advantages in PR with existing infrastructures allowing them to offer superior services while minimizing costs.

Broadband Market

Lib PR MKT

The broadband market in PR is also a duopoly. However, I believe Liberty has an even bigger advantage against Claro Puerto. Liberty offers speeds up to 200 mb/s where Claro fastest is 20 mb/s. The market continues to grow but not as fast as Chile. The pricing of their broadband has room to move higher. I believe Liberty is focused on stealing more market share from Claro so they can dominate the market. Having access to 80% of the homes in PR gives them a long runway for growth. The fiber deep hybrid-fiber-coaxial cable infrastructure that Liberty has is dominant compared to Claro’s DSL-infrastructure. I don’t see how Claro will be able to compete.

Bundles

Puerto Rico has a very strong bundling rate at 47%. This is the same rate as Chile. The triple play offering in PR outguns Claro or Dish. The broadband is four times as fast and it is priced less than Claro.

PR Bundle

The penetration in Puerto Rico is very low. It is expected to increase 100 basis points each year. This is a terrific opportunity for Liberty. Given that they have a first-class bundle, I expect them to capture the majority of new customers. With limited competition and access to most of the island, Liberty has pricing power. Anyone who wants fast broadband will use Liberty as there is no other option. As the demand for data and streaming increase, broadband will become more important. Liberty’s broadband is 10x faster than Claro’s and this is a long-term advantage.

Economy

It is not a big secret that Puerto Rico’s economy has been struggling. The American territory has stagnated since 2011. The economy has been depending on tourism and even that has now stagnated due to zika concerns. Governor Alejandro Garcia Padilla has said that the debt of PR is now too large to pay. The House of Representatives passed the Puerto Rico Oversight, Management, and Economic Stability Act, a bill meant to help Puerto Rico restructure its debt and prevent the island from being sued for defaulting on bond payments. I believe this will be positive in the long-term. John Malone was well aware of the issues in Puerto Rico when he decided to enter the market. He knew that economic activity might be slow for a period of time. Economic activity is already begin to tick higher now that Congress has passed the law. Puerto Rico has a bright future and as the economy recovers, it will benefit Liberty’s RGU’s.

Demand For High Speed Data

I expect high-single digit residential broadband revenue growth on the back of 1) Increasing broadband penetration from a 40% footprint penetration today, to closer to 50%-60% 5 – 7 years from now, and 2) Mid-single digit growth in data ARPU, driven by a mix-shift towards higher speed tiers and modest inflationary pricing increases. Broadband sells for near 100% incremental EBITDA margins excluding subscriber acquisition costs and is a much more attractive business than video as there are no programming expenses.

The Federal Communications Commission (FCC) actively monitors broadband and video pricing in Puerto Rico. Liberty will have to be careful about price increases in PR because of the FCC. Price increases would also open the door to new competitors. Data usage demand is expected to grow at a 36% CAGR over the next five years. In the last couple years, customers have been demanding more data due to bandwidth-intensive applications. Today there are multiple devices in most homes and we are spending more time on these devices. Demand for streaming HD movies and shows is not going to slow down. It will likely accelerate which will drive customers towards higher priced broadband options like Liberty.

Liberty has acquired terrific businesses in Latin America and the Caribbean. These acquisitions will allow them to scale their business cost effectively and meet demand. Liberty has the only hybrid fiber coaxial network in the markets it competes in. The current DOCSIS 3.0 technology is capable of providing downstream speeds of up to 1 gbps. The fastest speeds they offer today are 200 mb/s which is 10x faster than their competitors. LiLAC can increase broadband speed significantly with minimal costs. The only way their competitors could have similar broadband speeds would be to spend billions on network infrastructure. I do not believe there is a way to do this with a positive ROIC. Google is attempting to do this in the US and it is going horribly. You can read about it here, here, and here. Cable companies like Liberty have a monopoly on high speed broadband. Data can only be transported so fast using wireless technologies. There is major demand for wireless data do to its convenience. However, as more people use wireless data platforms, the traffic slows down the speed of the service. Due to the direction of technological applications, we will see more people turn to high speed broadband over the next decade.

Barriers To Entry

The industry is characterized by increasing barriers to entry. Smaller ISPs can often purchase data capacity from larger ISPs or internet backbone providers at wholesale prices and then sell these services to consumers. This is often the case with smaller companies, which do not have the resources to invest in infrastructure and networks. However, smaller ISPs are usually subject to lower margins and often depend on regulators to set competitive access pricing.

For ISPs that seek to have national coverage and be a major player, barriers to entry can be substantial. As a non-incumbent operator, competitors must either build a copper or fiber network, which is prohibitively expensive for entrants with limited access to capital. Accordingly, most new entrants will invest in “last mile” services, which connect business or residential customers to the internet via a larger ISP or backbone carrier’s infrastructure. On the other hand, new entrants with limited capital are unlikely to succeed in regions without existing network infrastructure.

Risks

The primary risks are related to the Latin American macroeconomic environment and political environment. Currency movements will impact profitability. LiLAC is a levered equity as most Malone businesses are. The cost of capital is relatively high indicating that moderate to accelerated growth is a must. There is a risk that incumbent operators in Chile/Puerto Rico will seek to overbuild Liberty’s infrastructure with fiber which would result in increased competition. However, due to the fact that this option is prohibitively expensive, it is unlikely. Finally, LILAK is a tracking stock, therefore holders will not be legally entitled to the assets associated with the tracker which could lead to a discount to intrinsic value.

Valuation

The valuation of LiLAC looks to be very reasonable. The stock appears to be trading at about 6.8x EBITDA. This is dirt cheap when looking at some of its peers.

LiLAC Estimates

2017 will be the first full year of financials inclusive of the CWC merger. In the years following, I expect a moderate 5-7% revenue growth with EBITDA margins around 45%. Depending on synergies, EBITDA margins could be closer to 46-48%.

LILAK SOTP

Looking at LiLAC another way, I performed a sum-of-the-parts analysis. It appears that the market is undervaluing the business. The long-term competitive advantages of the business provide a terrific moat. As I have mentioned previously, I am not relying heavily on forecasts or valuations. My forecasts are biased and therefore they are often wrong. Valuations are being run on every company by computers everyday with the most accurate information available. The biggest advantage I have is understanding a particular business better than most and focusing on pieces of information being overlooked by the market. In this circumstance, I believe the market is overlooking the value of the existing fiber coaxial infrastructure. Their competitors are at a huge disadvantage and building an infrastructure is not really an option. This should pave the way for solid growth for a long period of time. I have taken a position in LILAK this week under $28 a share. I believe LILAK will outperform the market over the next ten years.

Disclosure


Long LILAK