Friday, November 10, 2017

Entercom: CBS Radio Reverse Morris Trust

Entercom Communications (ETM) is the fourth largest terrestrial radio group in the country with 125 AM/FM stations in 28 markets, its well run but family controlled and operates in mostly middle tier cities.  Next week, Entercom is completing a transformational merger where they will merge with CBS Radio's 117 stations, primarily in the largest markets, via a reverse morris trust structure.  The combined company will be the second largest radio company behind iHeart (IHRT) but with a significantly better balance sheet.  Reverse morris trusts tend to be interesting for a few reasons:
  1. The company splitting off the division typically offers shares in the new combined entity at a discount, here CBS is offering shares in the new ETM at a 7% discount in an exchange offer.
  2. Due to the above discount and the mechanics of the split-off, there is some technical selling pressure on the smaller company.  Former CBS shareholders will own 72% of the new ETM and pre-deal ETM already has limited float due to its controlled status, the result is a short interest in pre-deal ETM over 50% currently.
  3. Most RMTs I've seen feature significant strategic rationale (plenty of easy cost synergies) and a fair amount of leverage, in combination they often lead to great investment results if the deal rationale is correct and management is competent.  I believe both are in place here.
In the deal prospectus, the combined company lays out the case for radio and potentially why it's not a dying industry:
  • Highest, most stable reach of any media, reaching 93% of all adults across the United States.
  • Radio listenership has remained stable over the past 10 years, growing from 234 million listeners in 2008 to 247 million listeners in 2016.
  • Time spent listening to the radio has been relatively stable since 2014 (me: but must be down from 2008?) according to Nielsen's Total Audience Report.
  • Radio offers a cost-efficient way for advertisers to reach a broad diverse audience.
This is all somewhat surprising to me and not sure I entirely buy it?  Satellite, streaming services and podcasts all provide more engaging and tailored content to listeners, but it's possible that many people still enjoy free radio that's programmed to cater to a broad audience taste.  To this point, Entercom has historically been growing revenues at mid-single digits despite the negative industry headlines.  CBS Radio on the other hand, with its more heavy emphasis on news programming and sports talk radio (which I think has been particularly disrupted by podcasts?), has been declining mid-single digits in recent years.  Another disruption to think about is less on radio medium itself, and more on the advertising model in general, any media company reliant primarily on ad spend is in competition with Facebook and Google, both of which have a better mousetrap to offer advertisers.

With all that out of the way, the radio business does produce a healthy amount of cash as its generally asset light.  I've been burned before by taking management estimates in proxy's at face value, especially rosy ones in declining industries, but here's what management put forward as the 5 year outlook for the new ETM:
After the merger takes place, there will be 142 million shares, at today's price of $10.55/share that's a proforma market cap of about $1.5B, the company will have $1.8B in debt, for an EV/EBITDA multiple of 6.8x using the 2017 EBITDA number above (2018's $542MM seems bold, but would be closer to 6x).  Comparing Entercom to peers it looks somewhat cheap, IHRT and CMLS are both distressed, I don't have their bond prices handy but I'm guessing the EV's are inflated taking their debt at face value as both will likely be restructured in the coming year.
But I'd still argue that a 6-6.8x EBITDA multiple is a bit low for this type of business, especially if you believe management's estimates are achievable.  I'm skeptical of the revenue growth forecasts, but the below synergies seem fairly reasonable as there will be a lot of overlap between the two organizations.
Management is well regarded, Joseph Field started Entercom in 1968 and still remains on the board, he was a buyer of shares in May and June as the stock slid down to $9.65-$10.25.  His son, David, runs the company today, the Field family is relinquishing formal control of the company through their super voting shares, but will still control about 25% of the vote post merger and 8% economic ownership.

In summary, a marginally cheap business with some technical factors artificially putting pressure on the stock price that should start to unwind in the next few weeks.

Disclosure: I own shares of CBS (exchanging for ETM) and ETM


  1. thank you for your thoughts. i agree the stock looks cheap and its extreme valuation has been accentuated since the exchange offer was announced.

    is there any word from management about a buyback after the exchange is completed?
    are you thinking of holding onto ETM after the exhange?

    1. They have a $100MM buyback plan for after the exchange is completed, but I think it's a several year buyback, not something that they'd exhaust quickly. I'm primarily interested in the exchange offer, but do own some ETM outright, sometimes I end up buying for a short term catalyst and hold long term as the situation unfolds, we'll see with this one.

    2. Hey MDC -- thank you for the awesome idea. Could you kindly provide some color on the relative attractiveness of exchanging CBS for ETM vs buying ETM straight up? Is it just the additional discount to an ETM share price already depressed by factors you discussed? If so, why not solely go long CBS? Thanks again.

    3. The exchange offer will be oversubscribed, there's an odd-lot provision to avoid proration, but otherwise you'll likely get prorated and its hard to tell how much. So to avoid proration, I bought 99 shares and some ETM to make a full sized position for me. But I get yelled at if I overly emphasize the odd lot loophole.

    4. Rightly so :P odd lot deal flow completely collapsed over the past few years :)

    5. Yes and no. I haven't done any real analysis, but seems like a lot of the old odd lot tender situations are still there but now are structured as dutch auctions? From the company's perspective, I still don't think it matters, but there's no upside for me, I blog to share ideas both ways.

  2. Oh yikes I should have mentioned I knew of that, pardon me! Yeah, I was curious if there were other reasons, but all makes sense now. Thank you.

  3. Hi MDC,

    obviously the "pressure on the stock price that should start to unwind in the next few weeks"
    didn't do just that. But there is a huge short interest of over 48%.
    Do you expect some kind of short squeeze at some point?

    Thanks for you articles!

    1. I believe the short interest you're quoting is off the old share count number before the deal closed?

      A short squeeze is unlikely because many of the shorts were probably long CBS going into the deal, exchanged, closed out their shorts with new ETM shares and thus won't need to buy shares in the open market.

      While this isn't my highest conviction idea, mostly involved for the exchange and reverse morris trust aspects than the business itself, I don't think its fair to say it "didn't do just that", some patience is required as these trading dynamics work themselves out. Probably shouldn't have put a specific timeframe on it.

      Thanks for reading.

    2. Thanks for you answer.
      I looked it up here
      and Yahoo says 123.62% of float short, but I guess you are totally right.

      Don't get me wrong, I didn't mean to criticize you and I am certainly not that short term oriented. But I am glad to hear your opinion since your blog is one of my weekly must reads.

  4. Any thoughts on ETM now that they've reported Q4 and provided a little color about 2018 and beyond? Stock is back down to 10 and Field Sr. is buying again.

    1. I saw the insider purchases last week, very encouraging. What's also interesting is Liberty Media's bid for IHRT, I believe they're valuing the company at 8x EBITDA and must see some potential in the traditional radio industry. With IHRT and CMLS both getting restructured, maybe we see some more rationale competitors in the market? The last few weeks there's been stories about advertisers pulling back from some of the big tech firms, could they "re-discover" radio? I did read the transcript of the latest earnings call, not sure I love management pegging their stock to $14 at the same valuation Liberty is trying to acquire IHRT, but I think that's a pretty good near term bogey. Also encouraged that they've bought back quite a bit of stock already and increased their buyback guidance as well. I feel comfortable continuing to own it.

  5. According to mgmt a 8x multiple gives the stock a $14 share price. However, Yahoo Finance lists ETM's EV/EBITDA at 30. Am I missing something, or is mgmt using a very misleading Mkt.Cap/EBITDA number to value their stock?


    1. Without spending too much time on it, I'd guess Yahoo is using TTM EBITDA numbers that don't incorporate the CBS merger.

  6. Any thoughts after the recent 30% decrease?

    1. Here's a well written short thesis, been right so far:

      It's hard to tell if the company is right, they're just taking short term pain while repositioning the company going forward, or if this is really is the declining business it appears to be? The Field family sure has purchased a lot of stock in recent months, 30% higher as you point out now, rare to see someone reach into their pocket that significantly to buy stock. I had a smallish position, smaller now, but still holding as of today.