Description

Long 1 share MEG / Short .1249 shares NXST

After a long drawn out ordeal and battle for control of Media General (MEG), Nexstar Broadcasting has finally signed a definitive agreement for the purchase of Media General.  The terms of the deal entitle the owner of 1 share of MEG to $10.55 in cash, .1249 shares of NXST and 1 Contingent Value Right (CVR) tied to the value of wireless spectrum that MEG sells in the upcoming broadcast spectrum auction.  The spread between the workout price excluding the CVR and the current MEG price is currently $0 – we believe the CVR could be worth up to $4 / share, likely closer to $2-$3, but even if worthless the downside is $0 (excluding the time value of money for ~10 months).   Assuming that the market would put a 6% discount on MEG relative to the deal workout price, it’s safe to assume that there is $0.85 being put on the CVR given the current premium of $0.10.  Assuming a $2 value for the CVR upon close of the incentive auction, the ROI would be 20% assuming a year from now until the auction proceeds are paid – likely 2-3 months too long.  The return moves to 30% if the CVR is worth $3.   This is effectively a spectrum trade – in our opinion with lower risk than a STRP or GSAT given that the auction only has to successfully take place, rather than the added hurdle of gaining approval from the FCC for the wireless use of the spectrum.

Bpuri made a good call and wrote up MEG  back in October, 2015 and laid out the reason the initial Meredith and Nexstar bids undervalued Media General.  This is not a call at all on the fundamentals of NXST/MEG – in fact I would be long the combined company outside this trade given its trading north of a 25% FCF yield (ex taxes).  That aside, the agreed upon deal has seen the offer rise from the initial $14.50 to ~$16 + the CVR.  The combined company will run 171 full power broadcast stations in 100 markets, covering roughly 39% of the US population – below the FCC’s 40% regulatory threshold.   The company will have to sell off several stations, most likely Roanoke, Davenport, Ft. Wayne, Lafayette and Terre Haute where they overlap.   While the company expects that the deal will close in late Q3 or early Q4.  The gating factor in the closing of the deal is the completion of the FCC auction – which could take it through Q3.  The company has stated that it the FCC will continue to process applications during the auctions, but will not allow the transfer of licenses until after the auction is complete.   I am not going to go into too many details of the reverse or forward spectrum auction – because that would take thousands of pages – the FCC website has a host of info, as does this Greenhill presentation that walks through the mechanics and opening bids …

http://transition.fcc.gov/Daily_Releases/Daily_Business/2015/db0206/DOC-331911A2.pdf

This document lays out the opening bids for each station based upon the algorithms that take into consideration the station’s location, power, interference etc.

https://apps.fcc.gov/edocs_public/attachmatch/DA-15-1296A3.pdf

The filing deadline for participation in the reverse auction (broadcasters) was on January 12th and the forward auction deadline (wireless cos) is on February 9th.  The reverse side of the auction is slated to begin in May with the forward side to start 2 days after the completion of the reverse.   The broadcast participants can choose individual stations to either a) Go Off Air, Move to High-VHF frequency or c) Move to Low-VHF frequency.   The variables of how much money the stations end of up being paid for depends on the demand side of the equation, and what the ‘clearing target’ is (how much will be auctioned), and what the price / MHz is.  The most optimistic timing for the close of the auction is August – however it could be several months after that when the FCC approves the license transfer and the final proceeds are transferred to the broadcasters.  

MEG laid out at its investor day (slide is included in the prior MEG write-up by Bpuri) potential outcomes of its participation at the auction (p 56-57)

http://mediageneral.com/investor/presentations/conf_calls/2015/investorconferencemarch_2015.pdf

There are various options open to MEG depending on the station.  For example, the opening bid for KRON in San Francisco is $395 million, and the companies own valuation based on Broadcast Cash Flow is only $53 million.  In other stations like Springfield, MA, the station has high interference with Boston, and an opening bid value of $53 million, relative to $0 BCF.  Similarly, WCTX in Hartford, which has interference with both the Boston and New York markets, has an opening bid of $395 million relative to a BCF valuation of just $26 million.  The opening bids are just that – it is a declining bid auction so those numbers are not even close to realistic.  However, even fractions of those numbers, with 128 shares outstanding, and applying a 40% tax rate gets you to significant value.  The company estimated at the time that realistic valuations were $2.07 to $4.29 after tax for the stations it would participate with in the auction.   It is difficult to come to any real informed view of the total value of the auction proceeds for MEG given the large amount of variables – but suffice to should be worth more than $0.

In settling the CVR, MEG's net proceeds from spectrum sales will be: 1) cash payments from the FCC for disposition of spectrum of MEG and its JSA/SSA partners, less 2) transaction expenses, less 3) the broadcast cash flow of any stations which will cease operating as a result, times a multiple, less  4) taxes incurred on the disposition. On the call Wednesday to discuss the merger, MEG's CEO reaffirmed that their prior public statements placed a $2-4 per share after-tax value on their likely spectrum auction proceeds.

The setup for the trade is simple and as follows – you can effectively buy the CVR as a spectrum option for a rebate of $0.10 now.

The IRRs based on various CVR prices assuming a conservative 1 year duration (will likely be between 8-10 months) is:

Risks:

There are 3 main risks to this trade:

1. Auction is a failure, the FCC is unable to auction off the minimum threshold that is needed to pay for the costs of the auction, and there is no auction.  Downside is $0 – as this just renders the CVR worthless, but does not affect the other pieces of the trade

2. Deal gets blocked by the FCC.  This is highly unlikely, given that the threshold for US population coverage by a broadcaster is 40%, and this (even without the divesttiures) will only put the company at 39%.  If this happens – MEG and NXST would decouple, and would be hard to know the extent of the principal loss.  MEG in theory has other bidders, so one could argue the stock would have support.

3. Prohibitively poor debt capital markets prevent NXST from closing the transaction.  Same outcome as #2.

4. Timing gets dragged out from the auction – this is possible but would only affect the annualized IRRs, rather than put principal at risk.

Catalyst

Broadcast spectrum auction

Close of NXST/MEG deal