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May 30, 2007

Disney Radio Sale Set To Close

While Disney (DIS) shareholders digest the box office and stock market reaction to Pirates of the Caribbean: At World's End, the company announced details of the divestiture of most its radio business. According to press release issued Friday, on June 12th, DIS shareholders will receive .0766 shares of Citadel Broadcasting (CDL) for each share of DIS they own as of the close on June 6th. CDL is buying DIS's radio business including radio stations and the ABC Radio Network. DIS will continue to be involved in radio through its ownership of the Radio Disney and ESPN radio networks and a few stations operating with content from these networks.

CDL shares have performed poorly since announcing the acquisition of the DIS radio assets last year. CDL is essentially doubling down on radio as the DIS assets are as large as CDL's current business. CDL is paying an above market price for the DIS even after DIS agreed to a modest renegotiation of the deal terms. Compounding the troubles for CDL has been deteriorating advertising growth for the radio industry as it loses share to online advertising.

While CDL shares have worked steadily lower since mid-February, radio stocks as a group have actually performed fairly well, beating the market's return about 75% of the week's so far this year according to recent data from Credit Suisse. Consequently, I think it is possible that consummation of the DIS deal might allow CDL shares to perform relatively well for a few weeks. On the other hand, the newly issued and distributed CDL shares seem likely to be sold creating a near-term supply-demand imbalance. CDL is issuing approximately 150 million shares to DIS shareholders vs. 100 million currently outstanding. Given the vastly different investment profiles of DIS and CDL, it seems fair to assume that many individual and institutional DIS shareholders will be looking to sell their newly received CDL shares....

The new CDL will be a heavily leveraged company producing significant free cash flow that it intends to sue to pay an annual dividend. Analysts believe the current yield on new CDL shares could be around 5% representing about 50% of projected free cash flow. With station sales, excess free cash flow not paid as dividends, and modestly growing free cash flow, CDL could gradually delever over the next few years. The shares presently trade at around 10 times management's suggested pro forma 2008 EBITDA of $400 million with debt equal to 6 times pro forma EBITDA. This valuation is below the current multiples on other leading radio stocks.

CDL is not without risk given the secular challenges facing the radio industry but the financial leverage looks manageable and that can be a recipe for superior shareholder returns if management has a shareholder bias. CEO Farid Suleman has a good track record from his days at Infinity Broadcasting and owns 5 million shares. Forstmann Little is a controlling shareholder. Suleman and Forstmann Little should share the priorities of most shareholders.

New CDL reminds me a little of Regal Entertainment (RGC), which is also highly levered, pays a substantial dividend that supports the stock price, and has a significant controlling shareholder. I've done well with RGC, earning a total return in excess of 20% since the initial purchase in March 2006. I think new CDL could possibly do as well in the next year so as of now I plan to hold the CDL shares that client accounts will be receiving.

Posted by Steve Birenberg at May 30, 2007 09:55 AM in DIS