Broadcasting is a boring business. But, given the right assets and management, it can be immensely profitable. I think Nexstar Media Group is a quality business poised to generate significant returns going forward. Although I am not buying in size at the current $79 price, I will be looking to buy under $70.
Nexstar is the largest local television station owner in America, with nearly 200 stations. These stations televise network media (ABC, CBS, FOX, NBC).
The company generates revenue through the following activities:
- Selling advertising on the channels it broadcasts
- Digital advertising on its local station websites, among other things
- Political advertising which takes place mainly in even-years
- Distribution (retransmission) fees for allowing multichannel video programming distributors (MVPDs), such as cable or satellite companies, to provide network channels to their customers
At first glance, it looks like Nexstar is just another melting ice cube in a dying industry. We know that people are cutting the cord and spending less time watching linear TV. However, Nexstar has significant pricing power in one of its main revenue streams (distribution) that will more than make up for a slowly declining core advertising business. Furthermore, most of Nextstar’s revenue is resilient against both economic downturns and changing consumer preferences.
Distribution, digital, other, trade, and political advertising revenue, representing between 55-60% of total revenues, are largely predictable. Let’s discuss the big one: distribution.
Retransmission consent is a legal requirement that MVPDs pay local broadcasters to carry those broadcasters’ channels. Every 2-3 years, broadcasters such as Nexstar renegotiate the fees they charge to MVPDs. They tie these fees to the number of subscribers the MVPDs have. Although MVPD subscribers are falling, Nexstar is able to consistently negotiate higher fees per subscriber to more than make up for lost viewership. According to the CEO, “we will continue to see substantial growth in retrans, something approximating 80% to 100% growth over a 6- year period.”
Competitive Dynamics of Increasing Distribution Revenue
I believe Nexstar will be able to achieve its goal of substantially increasing distribution revenue for three major reasons.
- Nexstar delivers outsized viewership relative to the fees it demands
Broadcasters deliver content that captures nearly 35% of the MVPD audience but only receive 15-20% of the cable companies’ content spend in return. Over time, this gap should close with broadcasters demanding a share of content spend commensurate with the value they deliver. Networks draw large audiences primarily because they broadcast local news and live sporting events, such as the NFL. Although there is risk that the NFL broadcasts more games on streaming platforms, there are important reasons why this threat is ultimately far removed and why Nexstar is insulated.
First, according to CEO Perry Sook, there is a public policy element to keeping the NFL exclusive. Local television stations provide local news in the public interest. CNN, The New York Times, and even Twitter do not accurately tell you what is happening in your small locality. Without significant sports-based revenues, operating and maintaining local television stations just for local news does not make economic sense. This public policy concern may act as a barrier to the NFL leaving its current model in a fashion untenable for broadcasters.
Second, the NFL does not need to and cannot profitably change its current distribution model quickly. It has the highest viewership on a per game basis of any sport precisely because it is available on widely distributed network television. Furthermore, since the NFL is exclusively on local networks (except for a handful of games on cable networks and Amazon), it has substantial bargaining power during contract renewals with those networks. Locking games behind paid services such as Amazon Prime, a direct-to-consumer offering, or cable channels only reduces viewership. Not only will fewer people be watching the games, the NFL will also have to charge less per viewer to the networks because it is reducing the exclusivity of its own product. Essentially, the NFL gives up pricing power over networks anytime it gives away a game to a cable channel or streaming platform. I believe the current economics of streaming are such that the NFL is much better off milking networks for as long as possible and holding off on major pivots to online. As a result, the NFL risk is distant, slow to rear its head, and ultimately insulted by Nextar’s increasing distribution fees.
2. Nexstar is the structural first-mover in the industry negotiation cycle
Nexstar operates a full negotiating cycle ahead of competitors. This means that Nexstar is able to approach fee escalations from a place of strength. MVPDs are more able to concede fee raises when they have a full budget. Nexstar’s position is the polar opposite of the last broadcaster who comes in as the content budgets run dry.
3. Broadcasters like Nexstar have more negotiating leverage during renewals as a result of business economics
Broadcasters hold major leverage in the form of walking away from negotiations. When a broadcaster walks away, they “blackout” all network television from the cable or satellite operator’s customers. You may have seen your cable company run advertisements warning you of ABC or FOX’s decision to pull their broadcasting. The ultimate reality is that consumers deal directly with their MVPDs and pay them hundreds of dollars per year for content access. As a result, when meaningful network content leaves the platform, they simply cancel their service. The reality is that both sides, broadcasters and MVPDs, lose out from lower subscribers. However, MVPDs lose full-life subscriber income for a temporary blackout in a part of their content offering.
Think about it this way:
If Nexstar content is 20% of your total content costs and it asks for a 15% increase in a new contract, your total content costs as a cable or satellite operator go up 3% overall. However, if you hold out for a 12% increase, you risk losing a meaningful number of your subscribers because a full 35% of your viewership derives from this content. Network content is to linear TV what Friends and The Office are to Netflix. Essentially, you risk losing substantially more revenue than costs you might save. Furthermore, MVPDs have massive scale economies, meaning incremental revenue losses result in disproportionate profit losses. Indeed, aggressive cost management for an MVPD resulting in increased subscriber churn is a largely value-negative proposition, as was the case in the AT&T dispute with Nexstar last year. This is doubly true for broadband and cable companies who have shifted their revenue models toward broadband and primarily seek to cash flow their cable businesses for as long as possible. In those cases, it is much better to hold a customer at a lower profit margin than to shed a customer for a slightly higher profit margin on the remaining subscribers.
One of the things I dislike about my current holdings is that the management teams are not anything special. This is not the case with Nexstar. The CEO, Perry Sook, has led the company from a $300m market cap to something well over $3b. He was one of the first to focus on aggressively negotiating distribution revenues.Based on his interactions on conference calls, Sook also seems highly focused on cost-saving without resorting to massive layoffs. What this tells me is that he is focused on creating a excellent, highly productivity work culture while holding people accountable. This is different from companies who never worry about costs (like big tech companies) or companies that are constantly shifting their workforce and reducing productivity as a result (IT companies).
Behind this excellent operational ability, he and his CFO are great capital allocators. Sook successfully built a broadcasting empire through serial, accretive acquisitions. Under his leadership, Nexstar is now at the FCC cap for station ownership and is the largest player in the industry. Having reached an apparent limit, he and the CFO have made clear their plans to aggressively delever, maintain the dividend, and engage in buybacks when appropriate. Given the FCC ownership limitation and Perry Sook’s 5% stake in the business, I expect Nexstar to stick to its word of delevering and returning capital to shareholders prudently.
The business, as it stands, delivers excellent returns as modeled in the valuation section below. However, Nexstar also has “options” that can generate great upside if realized and no loss if not realized.
First, the FCC may increase its station ownership cap. Although this is unlikely, an incremental increase in the cap would allow Nexstar to increase revenue through accretive acquisitions that reach more markets.
Second, Nexstar may effectively capitalize on its digital revenue. The CEO targets a doubling of digital revenue and the creation of a local-ad ecosystem in the next five years. Although I do not account for such a stark rise in my analysis, an increase of this digital revenue segment can be a long-term boon for the company.
Third, Nexstar has a large ownership stake in Food Network and owns real estate assets, both of which can be further monetized or sold at a premium. The company also owns WGN America. Nexstar also has plans to launch a newscast program on WGN America using its preexisting local journalist force and studio assets. This endeavor is therefore profitable from day one and may prove to be a source of revenue going forward if the programming catches on.
Finally, Nexstar has ATSC 3.0 assets that are capable of providing higher definition video and audio signal and other interactive content directly to customers. These may be monetized years down the road.
Because the company generates so much levered free cash flow, it provides a strong margin of safety in the worst-case scenario.
Let’s assume the company will miss consensus revenue estimates by over $1.3b and stay that way for two full years. Given that Nexstar already reported Q1 numbers, these low revenue numbers are next to impossible to square mathematically. But we will do it anyways to prove the point.
Furthermore, let’s assume that there is zero equity value in the business today and no dividends. We will take the implied enterprise value that comes with that assumption and assume it going forward. Here is what we get:
(Drag and Drop the images in a different tab to zoom in.)
In our LBO model, we assume there is zero equity to start and keep the implied EV the same throughout the valuation period. Even under this depressed revenue scenario, levered free cash flow alone is enough to generate over a 3% IRR on the current investment. To put it in another way: imagine you overpaid $80/shr on a company currently trading at $80/shr. Even in a depressed revenue scenario, that company still generates enough cumulative cash flow to provide a positive return on such a gross over-payment.
When we more toward consensus revenue estimates and a run-rate 8x EBITDA multiple (lower by .5x than the median historic multiple and lower than the current multiple), we see major upside. I project long-term revenues assuming a secular 3%/yr decline in core advertising, a 90% increase in distribution revenue over 7 years (compared to management’s 80-100% projected increase in 6), a 30% increase in digital revenue over 7 years (compared to management’s 100% projected increase in 5), and a flat political advertising revenue of $100m year starting in year 7 (compared to a historic run-rate of $250m in peak years and $50m in non-peak years).
Here, we are looking at 18% IRR. Even with a 7x forward EBITDA multiple assumption, we still see 15% implied IRR over a 10-year period.
This excludes dividends, buybacks, and capital structure management. I also assumed a 30% tax rate, Distribution Revenues and Digital Revenues do not double over the next 5-6 years as the CEO asserts, and inflated SG&A and working capital. Clearly, there is large upside in the base case and a very low probability of permanent capital impairment in the bear case.
Overall, Nexstar has a predictable and simple business with excellent management, high free cash flow, and significant downside protection at today’s valuation. It is on my radar and will be a sizable buy for me at under $70 per share.