Optical Illusions

BY MATTHEW LOCHTE & JAKE LOURIM

TV station values are impacted by a series of sobering conditions

this year. Yet there’s reason for optimism. This is the second in a series of stories on the performance of various media sectors.

AT SOME POINT IN THEIR LIVES, MOST KIDS BECOME FAMILIAR WITH the enthralling spectacle of a magic show. You’ve probably watched a magician go through the usual repertoire of tricks – the rabbit out of the hat, the never-ending handkerchief, the assistant sawed in half.

But one always stands out. The assistant lies down on a table, is covered with a black sheet and then is somehow miraculously levitated. The magician runs large rings over her floating body to show that there is nothing supporting her. To the untrained eye, it may seem as if the magicians can defy the laws of gravity and make someone float. Of course, this is all done with sleight of hand and smoke and mirrors. In a similar way, it is easy to become mesmerized by the stock market’s performance. As of the end of August, stock prices seemed to defy basic financial and valuation theories and continue to levitate upwards in the face of a pandemic; global economic recession; high unemployment; downward revisions to earnings; political standoffs; and social upheaval. Publicly traded companies in the local TV broadcast business haven’t enjoyed the same magical rise. There’s a sharp difference between investor sentiment in the broader markets and the stock prices of local television broadcasters. Is the broader market over-valued? Have the broadcasters been undervalued?

Let’s dig into some numbers and market conditions to get at those answers. To be sure, the impacts of the recession induced by COVID-19 vary by industry. Some companies – such as Netflix, Amazon and Zoom – have certainly profited from the stay-at-home era. Other industry sectors – such as restaurants and travel – have been hit particularly hard.

Local television broadcasters fall somewhere between the two ends of that spectrum. TV stations have been buoyed by increased viewing of entertainment and news, along with a tsunami of political ad spending. But there was a contraction of revenue from core advertisers – the ones who buy spot TV availabilities year-in and year-out.

To put things in perspective: the tech-heavy NASDAQ has rallied significantly this year, increasing 47.9% year over year for the first eight months of this year. It’s also up an incredible 52.9% in the five months since the March stay-at-home orders. The S&P 500 posted a similar but less dramatic rebound. It was up 19.6% and 35.4% for those two periods, respectively, compared with the same time last year.

However, the average stock price for “pure-play” television stocks – Gray Television, Sinclair Broadcasting, Nexstar, TEGNA and E.W. Scripps – shows a less buoyant return. An index of these companies’ stock prices as of Aug. 31, 2020 was $31.20. That’s up from the March 31 index of $20.59, but down 15.9% when compared with results for the first eight months of 2019.

Granted, Sinclair’s stock price has fared significantly worse than its peers due to COVID’s impact on its $9.6 billion regional sports network acquisition. But even when Sinclair is removed from the mix of companies, the average share price is still down 4.0% year-over-year.

While TV stocks have continued to rise since stay-at-home orders began in March, that growth has slowed, and the average of four broadcast price-earnings ratios (Gray, Nexstar, TEGNA and Sinclair) was 9.5 as of Aug. 31, lower than its level of 10.5 one year prior.

Sinclair’s price-earnings ratio fell from 12.8 to 5.2. TEGNA’s jumped from 7.5 to 11.4. However, the same two companies’ ratios of enterprise value to EBITDA (earnings before interest, taxes, depreciation and amortization) have remained fairly similar, settling at 8.8 on Aug. 31 compared to 8.4 on the same date in 2019. The ratio was 8.6 in 2018, and 9.1 in 2017.

M&A ACTIVITY RISES

Broadcast mergers and acquisitions resumed in the summer after a significantly quiet four-month period, and the deals that have occurred reflect the current economic hardships in their prices.

As of July 31, 2020, the average multiples for this year’s broadcast deals were down to: ■ 7.0x in the top 25 markets (lowest since 2015); ■ 7.1x in the 26th through 75th markets (lowest since at least 2009); ■ 7.7x in the rest (lowest since at least 2009).

That’s according to S&P Market Intelligence. The rise to $96 million in total TV transactions in July, more than the previous four months combined, was a welcome sight for the industry.

Why haven’t investors pushed broadcast television stocks to the highs seen in the broader market? Broadcasters are facing some unique challenges. Industries hit particularly hard by the pandemic this year are some of TV’s most significant advertisers – sectors like restaurants/dining, automobile sales, and travel and leisure.

There were large declines in core advertising, according to the April-June 2020 10-Q financial reports from Gray, Sinclair, Nexstar, TEGNA, and E.W. Scripps. Each company has a slightly different portfolio of reporting units and way of classifying revenues. But most experienced 30% to 40% declines in revenue over 2019 results.

The downward spirals came after relatively flat first-quarter

results. There was robust advertising on TV during January and February, followed by dramatic decreases in core advertising revenue in the second half of March.

WILL HISTORY REPEAT?

The more limited stock recovery of TV broadcasters, when compared with other industries, also has to do with another factor: investors may be looking to the past as a prologue to the future.

When the stock market crashed in the 2008 recession, publicly traded TV groups,

for the most part, endured a more severe stock market hit than the overall averages, and more severe than the revenue declines would have indicated.

An index of four publicly traded pure-play TV station owners (Gray, Sinclair, Nexstar, and TEGNA) closed 65.4% lower on Sept. 30, 2008 than one year earlier. That compared with a 22.6% decline in the NASDAQ and a 23.6% drop in the S&P 500.

At the TV index’s low point, at the end of March 2009, it had fallen 95.7% from its apex in May 2007. After an economic stimulus package was passed in early 2009, TV stocks began to rebound, but the index did not return to its pre-crash level until September 2013.

Similarly, local TV advertising revenue that was lost following the early 2000 dot.com bust and the 2008-2009 recession were slow to return and have never reached the highs seen at the turn of the millennium. Bond & Pecaro’s estimated total net local television advertising by year shows some clear trends. (See chart below.)

The decrease in local television advertis-

ing revenue from the 2000-2001 recession proved long-lasting. B&P estimates published in 2000 had net local TV advertising revenue across all markets at about $18.8 billion, and they projected that revenues would increase to approximately $23 billion by 2003.

Revenue forecasts were revised lower in 2001 and 2002.By 2003, B&P projected 2003 local TV net advertising at $17.6 billion, 20.0% below the level projected just prior to the dot-com bust. By the time the 2008 recession hit, industry forecasts for television advertising had just begun to approach the levels originally forecast in 2000.

The 2008 stock market crash and ensuing economic disruptions created ripple effects from which local TV station advertising never fully recovered. S&P Global Market Intelligence’s historical TV ad revenue data follows the same trajectory as those forecast by B&P, although they estimate gross rather than net advertising revenue.

In their estimate, total local TV advertising revenue began decreasing in 2007, consistent with the non-election year cycle, down 7.5% to $22.4 billion. In 2008, despite a presidential election and the Beijing Summer Olympics, television industry advertising revenue decreased 1.7% to $22.0 billion. As the crisis continued into 2009, gross local TV advertising revenue plummeted by 21.3% to $17.3 billion.

Given that history, investors have probably decided that other industries can provide more immediate returns.

And there’s another factor to consider: every year, more and more local advertising dollars have flowed to digital. Those gains, made at the expense of broadcasting during the pandemic, may be difficult to reverse in the coming years.

ON THE POSITIVE SIDE

Despite all those troubles, broadcast TV has some big reasons for optimism. The introduction of ATSC 3.0, also known as Next Gen TV, allows broadcasters to offer local advertisers targeted advertising and measurement, enabling local TV stations to better compete with digital rivals.

What’s more, political advertising has thus far been immune to COVID-19 and the recession this year. Over the first half of 2020, Nexstar, Gray, Sinclair, TEGNA, E.W. Scripps, Meredith and Entravision generated a total of $322 million in political advertising revenue. That’s up from $168 million during the same period in the midterm election year of 2018 and $141 million during the same period in 2016.

Even while local advertising dried up at times in 2020, TV groups maintained or raised their political forecasts, with TEGNA, for instance, revising its projection from $300 million to $370 million for the year. Political spending is expected to allow broadcasting companies to maintain relatively stable revenues in 2020, though there may likely be a contraction in the 2021 non-election year.

Another factor favoring local television

19,000,000 18,000,000 17,000,000 16,000,000 15,000,000 14,000,000 13,000,000 12,000,000 11,000,000 10,000,000

Local Broadcast Television Annual Net Advertising Revenue Estimates

000 2 2001 2002 2003 2004 2005 2006 2007 008 2 2009 10 20 11 20 12 20 13 20 14 20 15 20 16 20 17 20 18 20 19 20 2020

SOURCE: Bond &Pecaro

TV Station Group Stock Prices

Gray Sinclair Nexstar

TEGNA Average

1/31/07 1/31/09 5/31/13 1/31/16 4/30/18 8/31/20

POLARIZED TRENDS AT PLAY

STOCK PRICES INDICATE THAT THERE’S BEEN A REAL DISCONNECT BETWEEN Wall Street and Main Street this year. While the stock market has reached all-time highs, the economy remains in a recession and the unemployment rate is in the high single digits.

Why the dichotomy? There are three explanations: ■ While overall consumer spending has decreased in 2020, those with disposable income are finding the stock market to be a welcoming place for savings. ■ Monetary policies, such as interest-rate cuts, have fostered growth and reduced the attractiveness of holding cash and bonds. ■ The stock market is forward-looking, portending a healthy post-pandemic future for many corporations.

At the beginning of September, the S&P 500 price/earnings ratio was in the high 20s, soaring well above the ratio at any point this century other than a brief spike in 2009 and during the dot-com boom in the late 1990s, according to multipl.com. But while the S&P 500 performance may be an indication of a case of “irrational exuberance,” stocks in the broadcast market have settled down. That should calm worries about overvaluation for broadcast companies.

owners is the increasing share of broadcasters’ revenues coming from retransmission (distribution) fees paid by multichannel video program distributors (MVPDs) and over-the top providers. These fees have been rising dramatically and are forecast to continue to increase, albeit at a slower pace.

Retransmission revenues give broadcasters a stable and predictable revenue stream protected from the cyclicality of special sports events, like the Olympics, and political spending. Retransmission revenue has increased at a compound annual growth rate of 30% over the past 10 years. It grew by 5.8% to $10.9 billion in 2019, though that growth is projected to level off to only 1.0% in 2022, according to Kagan, a media research group within S&P Global Market Intelligence.

As of June 30, 2020, retransmission fees account for 55.9% of broadcast revenues for pure-play television companies, according to Kagan estimates. That’s up from 45.1% at the end of 2019’s second quarter.

As such, the future of television companies needs to be viewed in terms of the multiple revenue streams that supplement core advertising: political advertising, retransmission fees and a host of opportunities that ATSC 3.0 can generate.

Broadcasters don’t need to magically pull a rabbit out of the hat to sustain growth. While not levitating to the exuberant heights enjoyed by the broader markets, there are positive factors at play, as well as the Federal Reserve’s unprecedent monetary easing. Broadcast stocks seem conservatively valued relative to their prospects and poised for growth.

Matthew Lochte is a principal and Jake Lourim is an associate at Bond & Pecaro. Lochte can be reached at mattlochte@bondpecaro.com.

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