A Different Kind of Contract

LCM’s interest in contracts doesn’t only focus on agreements between companies and customers. LCM talks about those types of contracts here. Really anytime a contract says “we’ll pay you $5,” or some other made-up  amount, and LCM digs in and finds that it needs to pay , say, $4 or something dramatically less for the contract, that could be interesting. Buyout or merger agreements sometimes fall into this bucket.

Back in early 2022, a broadcast media company and two private equity firms agreed to a deal. The PE firms would take the broadcast company private.

The broadcast venture primarily runs local affiliates for the large networks – NBC, CBS, ABC, Fox, but also houses some related businesses – some owned stations and some online over-the-top advertising activities. It was previously married to a print publishing company, but they split in 2015 and this half went off to focus on publishing content on screens. (The combined company had been a previous LCM investment.)

The parties agreed to terms and went to work getting the deal through the regulatory sausage factory. As part of the deal, the group agreed to divest some local stations in Texas to fall in-line with previous regulatory objections. Part of the deal also contemplated merging the broadcast company’s over-the-top advertising venture with one of the buyout group’s own operations.

The deal attracted a good amount of attention on Capitol Hill. Media deals often do this. When deals attract political “attention,” it usually means politicians trying to murder the deal. This was the case here.

The DOJ and FTC (for international deals) are the usual antitrust gatekeepers. The DOJ concluded its antitrust review in early February without taking any action – essentially blessing the transaction. Shares had been trading at a healthy discount to the deal price before then. Price jumped up on the announcement.

The “nays” in Washington couldn’t stomach this result.

From there, a conversation probably went something like this: Some politician, we’ll call her “Karen,” made a fuss about the deal, about all the jobs that might be lost.

Karen: “Are you kidding me? The DOJ has spent a year stonewalling this deal! Requesting truckloads of documents! How can THIS be the outcome?! How can they let the deal through?!

Senate intern: “I don’t know Ms. Karen, should we spend some time trying to figure out how to improve housing markets so that they’re affordable or, maybe, fund Social Security?”

Karen: “NO! Give me options for this!”

Senate intern: “um, well, the FCC hasn’t finished looking at the deal…”

Karen: “OK, OK, that’s… something. But we can’t risk the FCC looking at the deal and giving it a pass like the $#&!ing DOJ...”

So, shortly after the DOJ let the deal through, more than a year after the deal was proposed, the FCC sent the deal to an administrative hearing through its Media Bureau. The action is not subject to any sort of immediate timeframe.

I use the same tactic when my kids ask for ice cream for the 100th time in a day and I tell them “we’ll think about it later.” Spoiler: there is no “later.” So, the deal “lives” in regulatory purgatory. The parties have no idea when they might get a resolution or if that resolution will be favorable.

The company and the PE group have protested, but it looks like the deal will slip past the recently extended deadline the parties gave themselves to close. LCM does not expect them to extend the deal again. Neither do other investors.

The gang of shareholders just in the stock for the merger bolted. Shares dropped like a stone, falling nearly 20% on the news. The distance between the deal price and the market price for shares blew up from about 12% to 28%. Broadcast TV isn’t exactly a flashy industry, so there’s no equally flashy gang of public market investors waiting in the wings to swoop in and pump the shares.

So, what happens now?

Several other parties had been interested in purchasing the broadcast company. They’re probably still interested. The deal environment, though, is crap. Interest rates are pretty important to any deal financed with lots of debt – like this one and they are much higher today than when the deal was struck. Other potential buyers face much higher funding costs making a deal alternative tricky.

The more likely outcome, for the time being, is that the company continues on its own, continues growing and resumes buying back shares. The company has long-term contracts with its current content suppliers (the Networks) in place. Its viewers are captive – many are already online, but most local content along with content geared for likely-voting older viewers is still accessed through the TV. Its customers (advertisers) are also somewhat captive – if they want access to local eyeballs, the most effective way to do that is still through TV. So, while the business will leak some viewers online, mostly, it will carry on.

A significant chunk of the company’s revenue comes from political advertising. That spikes every two years with the election cycle. Last year, a midterm year, political ad spending shot 50% higher than the previous midterm and exceeded 2020, a presidential year. The company made hay. Revenue came pouring in and rolled right through to higher cash flow. Continued political polarization and tight races in large states have, so far, more than offset any declining viewership due to eyeballs shifting online or fading viewing populations.

So, the business case is intact, despite the nearly busted deal. What about the price?

The company has continued to pay a dividend while under contract for the deal, but had suspended its buyback efforts when it announced the buyout. Given the field day it had serving ads in 2022, it is likely to resume this campaign should the deal finally, actually, fall through. It had been returning capital to shareholders at about a 12% rate including both dividends and buybacks. It’s generating enough cash to push this even higher.

The combination of broken, short-term expectations of the Merger Investor crowd, the structural tailwinds featured in the business and the juicy cash flow served by the company, LCM believes offer an enticing investment opportunity.