Sinclair Broadcasting (SBGI) has been added to Northlake’s individual stock portfolio.  We expect transformational acquisitions to increase the company’s free cash flow by 25-50% over the next two years.  Free cash flow per share could average $6-7 on a pro forma basis for the 2017/2018 TV station cycle.  We believe this will drive the shares into the $50s, up at least 25%.

SBGI is one the largest owners and operators of local TV stations in the US.  The company presently owns 173 stations in 81 different markets.  Most of these stations are affiliates of the big four networks: ABC, CBS, FOX, and NBC.  SBGI also owns the Tennis Channel and is developing a sports network and news network for distribution via cable and online.  Tennis and the developing networks should provide a small boost to long-term growth but the local TV station business remains dominant.

Merger activity is being driven by deregulation of broadcast TV ownership rules at the Federal Communications Commission (FCC).  Just last week, the FCC reinstated the discount for UHF stations that was put in place last fall by the Obama Administration’s FCC.  We expect the FCC to lead further deregulation of TV broadcast ownership over the balance of 2017 including elimination of the restriction on owning two of the top four stations in a single market, dropping the eight voices rule, and either increasing the ownership cap from the current 39% of US households or leading Congress to increase the cap.  For now, elimination of the UHF discount is good enough to trigger industry consolidation.  The company has been operating at the cap, restricting highly accretive station acquisitions.  With the UHF discount reestablished, SBGI sits with upper 20% household reach, allowing for transformational acquisitions for SBGI and the industry.

We recently returned from meetings with broadcasting companies, regulatory experts, and industry analysts at the National Association of Broadcasters (NAB) annual convention.  Our meetings included a group meeting with SBGI and a chance one-on-one meeting with the company’s CEO.  SBGI is incredibly bullish on the new regulatory environment and sees the company heading toward close to national reach for its TV stations.  Management sees national reach as a game changer for advertising sales and the company’s negotiating position with cable, satellite, and OTT service providers and the big four networks.  In addition, national reach creates a blue sky opportunity to use spectrum under the new ASTC 3.0 broadcasting standard to develop new revenue streams.

SBGI and Nexstar Media Group (NXST) are likely to pursue transformative acquisitions to achieve close to national scale.  Both companies will also aggressively pursue acquisitions in existing markets should the FCC allow.  At NAB, it was apparent from many broadcasters that operating multiple stations in a single market offers the highest synergies.  Presently, speculation surrounds SBGI attempting to purchase Tribune Media (TRCO).  TRCO owns TV stations in very large markets, while SBGI is primarily in small and midsize markets.  We expect SBGI to announce a deal to purchase TRCO within the next month.  TRCO will give SBGI the national scale it seeks.  Even with the reinstated UHF discount, SBGI/TRCO would be over the current cap at 44% reach.  We expect the FCC would give the company a waiver pending a complete review of all TV station ownership rules. SBGI could also divest certain stations as part of the deal to remain below the current 39% cap.

SBGI and the local TV station business do face secular challenges.  TV ratings are under consistent pressure, which impacts advertising sales.  Competition for ad dollars from online businesses, especially Facebook and Google, is fierce and local TV is losing market share.  The industry also faces cost pressures as the big four networks charge their affiliates more and more for the rights to broadcast their programming.  This pressures margins and slows the growth in net retransmission revenue, the biggest driver of growth for the industry over the past five years.  Relaxation of ownership rules that set up SBGI, NXST, and other industry participants to grow via transformative and accretive acquisitions is the antidote to the slow or non-existent organic growth of the TV station business.

As mergers occur and the industry consolidates, we expect investors to revalue upward the very high free cash flow per share produced by TV station owners.  Many media companies trade at free cash flow yields of 5-10%, while a pro forma SBGI/TRCO would be trading at a yield of 15-20%.  Should investors value SBGI at a 12% free cash flow yield, the shares could rise to $54.

SBGI is widely held by clients of Northlake Capital Management, LLC, including in Steve Birenberg’s personal accounts.  Steve is sole proprietor of Northlake, a registered investment advisor.  Northlake’s regulatory filings can be found at www.sec.gov.  SBGI is a net long position in the Entermedia Funds.  Steve is portfolio manager and managing partner of Entermedia, long/short equity hedge funds focused on media, entertainment, leisure, communications, and related technologies.