Gray Television: Divesting But Appears Undervalued (NYSE:GTN)

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The recent acquisition of television station WPGA in Macon and divestiture of KNIN indicate that Gray Television, Inc. (NYSE:GTN) is taking action to reshape its balance sheet. Besides, considering the expertise of the company in the M&A space, we may see further divestitures or inorganic growth to enhance future FCF margins. Additionally, the fact that Gray operates the first or second television broadcasting stations in certain local markets will most likely enhance operating margin growth at a larger pace than peers. Even taking into account the total amount of debt, or rising competition from penetrating digital platforms, GTN does look undervalued.

Gray Television – Overview

Gray Television has the largest number of high-quality television stations and digital assets in the United States and operates in the multimedia and entertainment sector with Georgia as its base. Currently, its geographic breadth covers more than 130 markets that comprise approximately 30% of television stations in the United States; 79 of them are made up of the most recognized television stations in the country.

As for any company of this nature, income is mostly through payment for advertising space within its programming and, to a lesser extent, through subscriptions and various access fees for its platforms. Gray Television has programming agreements with some of the most important television networks recognized in the United States and globally – for example, ABC, Fox, and CBS.

The operations are divided into two reportable segments, corresponding to production activities and transmission of content. For the reasons mentioned above, through the transmission segment, the company receives a significantly higher revenue than the programming segment dedicated primarily to the production of recording and filming content and others.

Appears Well Positioned For Growth

The current growth strategy for this company aims mainly to maintain its positioning in terms of its geographical breadth of operations and recognition as well as positioning within these markets. It is good to add in this sense that during the last year, according to the corresponding registration institutions, Gray Television operated in 79 of the 113 markets, with the largest audience, while within the remaining number, it also maintained second place in more than 20 regional markets.

In this regard, it is worth noting that in the last presentation a few months ago, management noted significant undervaluation of Broadcast Retrans. Also, considering the beneficial outlook given about revenue growth, I believe that Gray Television will most likely continue to offer business growth.

An Experienced M&A Player, Inorganic FCF Growth May Trend Higher

In my view, the company will most likely continue with its acquisition strategy which is part of the competitive environment within the television market in the United States and was a fundamental point of support in the last 10 years to achieve the aforementioned expansion towards more than 100 regional markets, in which it currently maintains its operations.

I also believe that recent acquisitions of the television station WPGA in Macon, Georgia market, and the divestiture of KNIN may bring cash in hand and incoming FCF growth from new synergies. The following information is taken from the most recent quarterly release.

On May 1, 2023, we completed the transaction with Marquee Broadcasting, Inc. through which we sold television station KNIN in the Boise, Idaho market for $6 million, and purchased television station WPGA in the Macon, Georgia market (DMA 126) for $6 million. As a result, Gray’s television station portfolio now includes 102 markets with the first and/or second highest rated television station. The disposal of television station KNIN resulted in a loss of approximately $14 million in the 2023 six-month period. Source: 10-Q

Expected To Generate Higher Operating Margins Than Peers

I believe that Gray will most likely enjoy economies of scale as stations are added to the portfolio. The company appears to own some of the best TV broadcasting stations in the local market, which offer better operating margins than other peers in the market. As a result, I believe that Gray may also find better financing and more demand for the stock.

We believe there are significant advantages in operating the #1 or #2 television broadcasting stations in a local market. Strong audience and market share allow us to enhance our advertising revenue through price discipline and leadership.

Our high-quality station group allows us to generate higher operating margins, which allows us additional opportunities to reinvest in our business to further strengthen our network and local news ratings. Source: 10-k

Investors May Have To Study Carefully The Total Amount Of Debt

As of June 30, 2023, Gray Television reported cash of about $36 million, accounts receivable of $329 million, and total current assets of close to $512 million. With current liabilities of about $357 million, the implied current ratio is larger than 1x, so I am not worried about any liquidity issues in the coming years.

Property and equipment are close to $1.574 billion, with broadcast licenses of $5.320 billion, goodwill close to $2.660 billion, and investments in broadcasting and technology companies close to $108 million. Total assets stood at about $10.810 billion, which implied an asset/liability ratio of more than 1x. I believe that the balance sheet remains stable, but investors may have to study carefully the total amount of debt, which is not at all small.

Short-term liabilities don’t really seem large. The largest liabilities are long-term liabilities. Largest short-term liabilities include accounts payable of $33 million and employee compensation and benefits of $71 million. Long-term liabilities include long-term debt of about $6.197 billion and program broadcast obligations of $1 million. Finally, total liabilities are equal to $8.1 billion.

The assessment of the long-term debt shows that term loans include interest rates of about 7.1% and 6.6%. With these figures in mind, I believe that the cost of debt and the cost of capital would most likely be larger than this rate.

Borrowings under the 2021 Term Loan, 2019 Term Loan 2017 Term Loan and the Revolving Credit Facility bear interest, at our option, at either the London Interbank Offered Rate or the Base Rate, in each case, plus an applicable margin. As of December 31, 2022, the interest rate on the balance outstanding under the 2021 Term Loan, 2019 Term Loan and the 2017 Term Loan were 7.1%, 6.6% and 6.6%, respectively. Source: 10-k

DCF Valuation

The protection of future cash flow statements that I designed included 2032 net income of close to $328 million, depreciation worth $308 million, amortization of intangible assets close to $782 million, and amortization of deferred loan costs worth $39 million. My numbers are in line with the growth of the global broadcasting and cable TV market growth, but I also took into account inorganic growth.

The global broadcasting & cable TV market size was valued at USD 332.59 billion in 2022 and is expected to expand at a compound annual growth rate of 3.9% from 2023 to 2030. Source: Broadcasting & Cable TV Market

Additionally, with amortization of restricted stock awards worth $60 million, amortization of program broadcast rights of $106 million, and changes in payments on program broadcast obligations worth -$110 million, I also included common stock contributed to 401k plan of $23 million.

With changes in accounts receivable of close to -$70 million, changes in income tax receivable or prepaid worth $127 million, and changes in benefits and pension costs of $51 million, I obtained net cash provided by operating activities worth $1.448 billion. Finally, taking into account purchases of property and equipment of close to -$743 million, 2032 FCF would be $705 million.

For the DCF model, I included an EV/FCF of about 15.5x and a WACC of 10%, which implied a net present value close to $7.1055 billion. Adding cash of $36 million, and subtracting debt, the equity value would stand at close to $1.055 billion. Finally, I forecast a price close to $10.955 per share, with an internal rate of return close to 8.155%.

GTN reported an EV/FCF close to 16x and 30x, so I believe that a conservative EV/FCF exit multiple could stand at close to 15x-16x. In my view, the exit multiple used in the cash flow model appears reasonable.

Risks

Competition within this industry relates to attracting audiences, agreements for transmission licenses, and the disputes for advertising spaces within television channels. In this sense, the majority position in the markets in which Gray Television participates gives the company a great margin for negotiation over the programming of its channels, which includes network programs or the reprogramming of old successful programs. Regarding the audience, even though the data and preferences of the users are known and worked on, this is the most arbitrary aspect of the competition since it is never possible to predict what reception a new program or change in programming will have.

Finally, regarding advertising, in addition to competition from other companies in the sector, competition comes mainly from the current largest digital channels such as Google (GOOG) Ads and Facebook (META). I also believe that other digital platforms and streaming outlets out there could harm the business model of Gray Television, Inc. There are many streaming services available.

Streaming services are literally a dime a dozen these days. And although most of us have heard of, and likely use, the big five (Netflix (NFLX), Amazon Prime Video (AMZN), Hulu, Disney+ (DIS), and HBO Max), there are even more streaming services than that. Especially if you’re into live TV streaming, you can choose from a growing list of streaming options like Philo, Fubo, Sling TV, Hulu + Live TV, and more. Source: Streaming-Services

Among the risks that stand out in Gray Television’s annual report, we must consider the high concentration that it maintains in the income from channels affiliated with certain programming companies due to the payment of advertising spaces within them. Along with this factor, it stands out that the company currently has a considerable debt situation, and the inability to meet its obligations in this regard naturally means a risk in terms of financing future operations.

In addition to the risks involved in maintaining an open acquisition strategy in a highly consolidated market such as television in the United States, it must be added that the birth and proliferation of other forms of entertainment consumption on digital platforms means a risk in the displacement of traditional consumer behaviors and the use of television in general.

The company reported a significant amount of debt, which involves a significant amount of risks. First, debt holders may block certain acquisition opportunities, and may also restrict certain activities that they consider risky. Additionally, it may happen that Gray does not find new debt investors, or the new debt conditions received are not as good as expected. As a result, we may see a reduction in the FCF margins. Management offered a certain explanation about these matters in the last annual report.

Our ability to service our significant financial obligations depends on our ability to generate significant cash flow. This is partially subject to general economic, financial, competitive, legislative, regulatory, and other factors that are beyond our control. We cannot assure you that our business will generate cash flow from operations, that future borrowings will be available to us under our Senior Credit Facility or any other credit facilities, or that we will be able to complete any necessary financings, in amounts sufficient to enable us to fund our operations or pay our debts and other obligations, or to fund other liquidity needs. Source: 10-k

My Takeaway

Gray Television owns some of the most popular broadcasting stations in certain regions in the United States, which may explain why the company delivers better operating margin than peers. Besides, I believe that the recent acquisition of television station WPGA in Macon, Georgia market, and divestiture of KNIN could reshape the balance sheet and the cash flow statements in the coming quarters, and enhance the stock valuation. I also think that further divestitures and M&A activity, if approved by debt holders, will most likely bring synergies and leverage reduction. Yes, I found many risks mainly from the total amount of debt and competition from large digital channels. With that, I believe that the investors who don’t mind the debt and want to be long-term buyers will most likely follow Gray.