TEGNA Inc. (NYSE: TGNA) to a target price of $21. TEGNA has transformed itself over the past several years into a pure-play local television station broadcast company. The company spun off its legacy newspaper publishing business in June 2015, sold other noncore digital businesses in December 2016, spun off Cars.com in June 2017, and sold CareerBuilder in July 2017.
While COVID-19 has impacted TEGNA’s core advertising revenue stream, subscription revenue growth has been robust in 2020 due to the repricing of the subscriber base. TEGNA has also benefited from strong political advertising growth, with many stations strategically located in battleground states, and with political ad revenue even exceeding management’s rosy predictions. As the company has generated higher subscription revenue from contract step-ups and new digital distribution licensing, it is also investing in digital expansion. The wild card for TEGNA is the prospect of local television broadcast industry consolidation (where the company may be either a buyer or seller), following the lifting of the FCC’s local station ownership rules. TEGNA’s strategic plan calls for continued aggressive station acquisitions as the local broadcast station market consolidates, though we think that COVID-19 may slow M&A in the near term.
TEGNA reported 3Q20 results on November 9. Third-quarter revenue rose 34% year-over-year to $738 million, driven by record political advertising. Revenue benefited from strong 31.5% growth in subscription revenue and recent station acquisitions. Political advertising jumped to $116.5 million in 3Q20 from $18.1 million in the same period last year. Since 3Q19 was an off-cycle political year, better comparisons are with previous political cycles in 3Q18 and 3Q16, when political advertising totaled $60.4 million and $38 million, respectively, still far less than in 3Q20. While heightened interest in the 2020 presidential election was likely a primary factor in the remarkable growth in political advertising, we also believe that the third-quarter results validate management’s strategy of acquiring local television stations in political battleground states in order to boost biennial political revenue. The strong subscription revenue growth was due to step-up retransmission rate increases that reflected the approximately 50% of the subscriber base that was repriced to a higher level in 4Q19. We note that this will lap in 4Q20. Core advertising and marketing services revenue was flat year-over-year, which was probably the best that could be expected given the impact of the pandemic. However, core advertising revenue did recover sequentially from the COVID-19 trough in 2Q, and benefited from recent station acquisitions. Excluding political advertising, consolidated revenue grew 14% from the prior year.
Adjusted EBITDA rose 65% from the prior year to $259 million, driven by high-margin political and subscription revenue, combined with cost savings. The adjusted EBITDA margin expanded by almost seven percentage points to 35.1%. Non-GAAP diluted EPS nearly doubled to $0.53 from $0.27 in 3Q19, and GAAP EPS nearly tripled to $0.60 from $0.22.
EARNINGS & GROWTH ANALYSIS
While the advertising market has begun to recover from COVID-19, the next few quarters are uncertain amid surging COVID cases in the U.S., which could negatively impact consumer spending and advertising. Positives include the higher repricing of 85% of the company’s subscriber base in 2020 due to contract renewals and a robust presidential-year political advertising season in 3Q/4Q.
The 2016 newspaper publishing spinoff and the 2017 Cars.com and CareerBuilder divestitures signaled that TEGNA management had gone all-in as a pure-play local television broadcaster. Recent station acquisitions reinforce this strategic focus. While the company abandoned digital sites Cars.com and CareerBuilder, it is investing and building out digital channels that are directly related to its local station business, as well as digital advertising capabilities with its TEGNA Marketing Solutions and Premion businesses. Meanwhile, political advertising continues to ramp up, reflecting increasingly polarized U.S. politics and the 2010 Supreme Court Citizens United decision, which has enabled more money to flow into political campaigns. Management expected a bumper political ad spending year in 2020, and has already exceeded its rosy guidance of $370 million, with actual booked political advertising of $395 million through Election Day. This exceeds 2018 political advertising revenue of $234 million by 70%. Management expects political ad revenue to comprise more than 50% of combined 2019-2020 revenue.
CEO Dave Lougee has outlined TEGNA’s growth strategy. TEGNA seeks to remain a ‘best-in-class’ operator in its local television markets as it continues to grow share. The company will also pursue disciplined M&A, as exemplified by its multiple station acquisitions in 2019. In addition, it will continue to diversify its revenue base through new initiatives in areas adjacent to its traditional linear cable television channel business. These include building its ‘multi-platform business,’ which we take to mean growing digital, mobile and OTT revenue streams and digital advertising services platforms like Premion OTT.
As with all media companies, TEGNA’s primary strategy is to produce and air popular innovative content. The company’s localized presence in its markets inflects this strategy toward content of local interest, particularly news and sports programming. The company’s large base of stations also enables general interest content to be syndicated across its station network. The company is also leveraging its digital presence to increase audience engagement. Initiatives include search engine optimization, a unified content deployment and management system across local markets, and partnerships with digital audience aggregators, including social media giants Facebook, Snapchat, and Twitter. The company is also expanding its station presence on OTT aggregators including Roku and Amazon Fire TV. New organic growth initiatives include intelligent ad automation services, advertising performance attribution, and the piloting and adoption of new broadcast viewing standards to support advanced services like 4K high dynamic range resolution, mobile, second screen, 3D audio, virtual reality, and advanced advertising. Of course, the company also maintains a disciplined station acquisition strategy.
Revenue is fairly evenly divided between the two main revenue streams, Advertising & Marketing Services and Subscriptions; however, in the political off-year of 2019, Subscription revenue grew at almost double the rate of A&M revenue. Subscription fees are ramping up for companies like TEGNA that have many network affiliates. The company has executed pay-TV distribution agreements, repricing its subscriber base higher. A third revenue stream comes from over-the top (OTT) subscription fees. Management has stated that the unit subscriber economics of the new OTT services are equal to, or better than, those of traditional cable, which is in line with what we have heard from other industry sources. Finally, TEGNA has started its own OTT advertising services division, called Premion, one more developing revenue source.
Recent regulatory changes have spurred M&A in the local television segment. The FCC eased media ownership restrictions with the restoration, in April 2017, of the UHF discount. In November 2017, it drove the final nail into the regulatory coffin by lifting the ban on owning multiple top-rated local television broadcast stations, and on owning television broadcast stations along with either newspapers or radio stations. However, the FCC killed the large Sinclair Broadcast/Tribune Media merger. In short, although the regulatory environment is probably the most benign it has been in years, it is still not ‘anything goes.’ TEGNA had taken a more measured M&A approach, picking up individual broadcast stations here and there, but the opportunity in the Nexstar forced sale was too good to pass up. TEGNA’s largest 2019 acquisition, the Nexstar deal, with 11 stations, closed in September 2019.
FINANCIAL STRENGTH & DIVIDEND
Our financial strength rating on TEGNA is Medium-Low, the second-lowest point on our five-point scale. At the end of 3Q20, total debt was $3.9 billion. The company completed another $1 billion debt refinancing in January 2020. After recent refinancings, all of the company’s debt is long term. It had $165 million in cash and $950 in unused capacity under its revolving credit agreement at the end of October 31.Trailing 12-month free cash flow more than doubled to $553 million in 3Q20.
The company’s net debt/EBITDA leverage ratio is 4.38-times and has been falling. Management intends to devote cash flow to deleveraging, achieving a leverage ratio of 4.2-times by the end of 2020, well within the ratio of 5.5 in its restrictive financial covenant. Adjusted EBITDA covered interest expense by a factor of 5.0 in 3Q20, up from 3.4 in 2019. S&P downgraded TEGNA by a notch to BB- with a negative outlook in April 2020. On September 10, 2019, in conjunction with the $1.1 billion debt offering, Moody’s downgraded TEGNA by one notch to Ba3 with a stable outlook. The two agencies agree on their ratings if not on their outlooks.
In May 2017, TEGNA cut its quarterly dividend in half, to $0.07 per share, or $0.28 annually, for a yield of about 1.9%. Our dividend estimates are $0.28 for both 2020 and 2021.
MANAGEMENT & RISKS
The 2019 Nexstar transaction presents TEGNA with the usual integration risks, though we think these will be modest as TEGNA has been through multiple television station integrations before.
Investors in TEGNA face numerous other risks. While TEGNA’s television stations are often leaders in their local markets, the company’s chief source of revenue, advertising, depends on program ratings. A significant portion of this programming is outside TEGNA’s control, since it is provided by its national network affiliate partners CBS, NBC, and ABC. TEGNA’s relationships with its network partners as well as with cable and DBS satellite programming distributors are critical to its success.
The broadcasting and digital media businesses depend on advertising spending, making revenue highly sensitive to changes in the economic cycle. TEGNA’s local television station business is also subject to changes in political advertising spending. While the general trend in political ad spending has been higher, the political campaign cycle leads to boom years, such as 2020, followed by bust years with little or no political advertising.
Broadcast television’s share of the media audience has been in a long-term secular decline as eyeballs and dollars move to digital advertising and cord cutting accelerates. Further, the process of media audience fragmentation is accelerating, with the digital video streaming and mobile gaining ground against traditional media platforms. Television audiences themselves are also fragmenting, as cable channels have proliferated, DVR use has increased, and over-the top streaming services have become more popular. Mitigating this risk is the critical need of many large advertisers to reach a mass audience that only broadcast television can deliver. The company also faces the usual entertainment-industry risks, including the hit-or-miss nature of creative programming and local station ownership regulations.
TEGNA is a pure-play local television broadcasting and related digital media company. The Broadcasting segment comprises 62 local television stations and four radio stations in 51 markets, covering about 39% of the U.S. TEGNA has the largest independent group of television network local affiliate stations in the top 25 U.S. television markets. Each month the company reaches 50 million on-air and 35 million digital viewers. It also manages the largest NBC and CBS affiliate station groups, and the fourth-largest ABC affiliate station group.
Our valuation analysis has several components, including a peer group comparison and an analysis of historical multiples. TGNA shares are down 10.5% year-to-date on a total-return basis, compared to a 4.5% gain for the S&P Midcap 400 Index and a 22.6% gain for the S&P 400 Media & Entertainment Industry Group Index. The stock’s trailing enterprise value/sales multiple of 2.6 is above the peer group median of 2.0. The forward EV/EBITDA multiple of 8.5 is 7% above the peer average, equal to the average premium over the last two years. We are maintaining our BUY rating on TGNA to a target price of $21.
On November 24 at midday, BUY-rated TGNA traded at $14.82, up $0.34.