Sinclair Broadcasting (SBGI) – Everything’s Good Except the Price
One of the great debates among fundamental investors, whether they are value investors or whether they should be value investors, is the question of bottom-up or top-down. The top-down approach involves examining the economic outlook, the state of the financial markets, and the trends among the sectors, in order to determine the best stocks in the best sectors, taking into account the markets and the economy. The proponents of this view look upon this method as providing three additional checks on the right decision. The bottom-up investors describe it instead as three more ways to make a mistake. Furthermore, what if the economy points one way and the market points another, as is often the case? What if the sector is richly priced but an individual stock has been left behind? Most value investors definitely fall into the bottom-up category, and so do I.
However, I have considered my habit of finding companies that come in pairs, and as such I am willing to concede that if a particular stock is attractive, then other similar stocks are at least worthy of consideration. I suppose you could call it the mountain climbing approach: bottom to top to bottom. In that vein, I thought I would examine Sinclair Broadcasting Group (SBGI), which, like Belo Corp, is a geographically diverse television broadcaster that has suffered from large noncash impairments and is now seeing stabilization in its operations that is allowing it to deleverage.
Sinclair Broadcasting owns 58 stations in 35 markets, most of which are network affiliates. The company has also chosen to diversify into various other ventures, such as a television broadcasting equipment company, a security alarm service provider, a sign maker, and some real estate speculations. Damodaran, in his Damodaran on Valuation, concludes that the market tends to punish diversified companies and that investors are more or less capable of diversifying on their own, particularly where, as here, there is hardly any possibility of vertical integration. As a result, the market was cheered when the company announced recently that they would be divesting some of its noncore assets, as well as reinstating its dividend. Their bonds, though rated firmly in the junk area, trade roughly at par. Their debts are still ample, and I can see them devoting much of their free cash flow towards paying them down in future, dividend or no.
Apart from large goodwill writeoffs, they have been profitable for the last five years, and revenues have recovered since the 2008 and 2009 slump, assisted by political advertising. Sinclair’s current market cap is $1.04 billion, which, as I shall calculate later, is approximately 13 times their annual free cash flows, which I would not consider cheap, particularly as those cash flows may be earmarked for debt repayment and as such, under a curious paradox of valuation methods, may not be considered free.
The following is my estimate of their free cash flows. Like many companies in the current economy, Sinclair Group has been able to produce some excess depreciation. Their free cash flows have been remarkably stable despite the economic volatility. As for their 2010 year to date figures, the company has reported that 2010 was an excellent period, buoyed by the Super Bowl, a rebound in automotive advertisements, and an unusually vitriolic election season. However, they have not published the full set of financial statements, and also such a good quarter may serve to distort rather than inform our investment views, so I have not included it.
2010 ytd. | 2009 | 2008 | 2007 | |
Sales | 542 | 656 | 754 | 718 |
Reported operating income | 159 | -111 | -288 | 159 |
Noncash or nonrecurring expenses: | ||||
Goodwill/license impairments | 0 | 250 | 463 | 0 |
Excess depreciation | 3 | 36 | 15 | 57 |
Other nonrecurring gains | 0 | 5 | 3 | 0 |
Adjusted operating cash flow | 162 | 180 | 193 | 216 |
Net interest expense | 88 | 80 | 87 | 100 |
ASC 470-20 effect* | 4 | 9 | 10 | 6 |
Net interest expense and interest coverage ratio | 84, 1.93x | 71, 2.54x | 77, 2.51x | 94, 2.30x |
Pretax free cash flow | 78 | 109 | 116 | 122 |
After 38% tax rate | 48.36 | 67.6 | 71.9 | 75.6 |
*ASC 470-20 requires companies that issue convertible debts that may be settled in cash, of which Sinclair Group has three separate convertible issues, to record the value of the convertible debt in two pieces, the debt component based on the value of a similar nonconvertible debt, and the equity component being the remainder of the face value of the bonds. This equity component must be amortized over the life of the convertible bonds, and most companies record this amortization as an interest expense. I have already made my views on this accounting rule clear: This rule obscures, rather than clarifies, financial statements, requires companies to record an expense that does not exist to amortize an asset that never existed, and does not even appropriately value the conversion privilege, which should be assessed using option pricing, because of its linear assumptions and complete disregard of price movements; the conversion price of the bonds is above 20 and the current share price of Sinclair Group is a mere 12 and change.
At any rate, I expect full year 2010 results apart from the unusually good political advertising season to be somewhere in the mid to high 70 million in free cash flows. If we call it 77, that is a free cash flow multiple of 13.5x, or a yield of 7.4%. As I stated, the company has also announced the resumption of its 48 cent per year dividend, which will consume $38.5 million per year, leaving $40 million per year to pay down debts with. Considering that Sinclair Group has over $1.1 billion in debts, and their interest coverage is somewhat worrisome at roughly 2x, they may be working at debt repayment for some time.
So, where does that leave us? Sinclair Broadcasting has a fairly robust operation and a debt level that is high but manageable, and has shown recent improvement in its operation–not that the wise value investor would project any kind of trend from these improvements. However, the price to free cash flow yield for the company is too high, in my view, especially considering that some of their free cash flow is to be used to pay down debt, which has a comparatively low after-tax return. Other than that, it is in much the same situation as our attractive-looking Belo Corp, and if there is a significant pullback in prices (unlikely in the current market but still possible if some of the optimism is bled out), it should constitute a very attractive purchase. But as things stand, the price is too high.
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