Broadcasters Should Evaluate Restructuring Alternatives

Kevin Shea

The radio and television broadcasting industries are in crisis mode. Broadcasters are struggling with plummeting advertising revenues, depressed operating margins, dwindling free cash flow, and increasing difficulties making interest payments and the most basic of capital expenditures.

In the history of recorded advertising spending – since World War II – never have there been two consecutive years during which advertising revenues have declined – that is until 2007 and 2008. Unless there is a miraculous recovery in the last quarter of this year, 2009 will mark an unprecedented third consecutive year of advertising revenue declines.  And Interpublic Group’s recently released advertising spending forecast doesn’t see a recovery until the second half of 2010.

The advertising recession is devastating virtually every broadcaster’s business.  All are being forced -- through no fault of management -- to consider some form of financial restructuring, most likely through a formal Chapter 11 reorganization or an out-of-court exchange of debt for equity. 

What options are available to troubled broadcasters?  Not many … and the time to act is now.  Unless operators act quickly, many won’t be able to survive until an advertising recovery … and instead of successfully restructuring, they will be liquidating.

With costs cut to the bone at the station and corporate level, the last, best tool to remain viable is some form of a financial restructuring which, at its simplest level, reduces or eliminates debt and interest expense in exchange for an issuance of equity to creditors.  This can provide the runway needed for good companies to fix their capital structures and emerge as stronger, more competitive players.  Key constituencies, such as customers, vendors, employees, and investors, typically support such moves.  Additionally, respected management teams can remain in place, with reset equity incentive plans, to rebuild value. 

How did we get to this point?  What has led to the financial crisis in broadcasting? The first impact of the advertising recession on broadcasters is to top-line revenues.  Total advertising revenues for radio broadcasters will have fallen approximately 20 percent between 2007 and 2009 and are expected to drop by a total of 27 percent over the four-year period ending 2011, according to Zenith Optimedia.   In 2009 alone, radio advertising revenue is projected to decline 14 percent, which translates into $2.7 billion less revenue for the industry. 

And the top-line impact is not even the most critical issue.  The real impact of the advertising recession on broadcasters is the precipitous decline in EBITDA (unlevered cash flow) and perilously high (and still climbing) leverage – as measured by the ratio of total debt to EBITDA.  Broadcasting EBITDA has fallen some 20 percent since 2007, while leverage ratios have jumped a full multiple in the past year to 7.5x EBITDA.



Radio and television broadcasting businesses are also characterized by high fixed costs, which have made radio, in particular, a historically attractive business for high financial leverage.  Radio stations have been popular targets for LBOs, leveraged recapitalizations and highly leveraged acquisitions.

However, high operating leverage coupled with a decline in advertising revenues presents a perilous situation for broadcasters. For every dollar of lost revenue, a broadcaster loses an average of 78 cents of cash flow – absent cost-cutting measures.  In response to decreasing revenues, radio owners and general managers have actively sought to cut operating costs and capital expenditures. As the graph below illustrates, these cost cutting efforts – since this is a high fixed cost business – are not sufficient to offset falling revenue. Since 2007, radio revenue has declined by 7 percent while operators have only been able stem station operating costs to a 1.0 percent increase.



Radio broadcasters have boldly added debt, supported by increasing cash flow, over the last several years. Rising interest rates (thru 2007) and higher total debt have driven down levered cash flow (EBITDA minus interest expense).  It appears inevitable that many broadcasters are now, or soon will, turn cash flow negative and begin depleting precious cash reserves.



Unfortunately, given that many operators have been aggressively cutting costs over the past year, further opportunities for significant cost savings -- without significantly altering station operations and damaging the “local quality” of a station and its long-term competitive profile and value -- are rare.  As revenue increased from FY2004 through FY2008 – albeit slightly - EBITDA margins have worsened from 36 percent in FY2004 to 26 percent in FY2009 YTD due to rising operating expenses and per-unit pricing pressure.



Financial restructuring for many operators appears inevitable
Historically, alternatives available to an over-leveraged station owner/operator included: go public; de-lever by selling a few underperforming properties; sell out completely, pay out the lenders and start over again after pocketing a reasonable gain; refinance with a new, more aggressive senior lender and/or issue a long dated subordinated note, preferably with a balloon payment at the end.

None of these options are available today.
The financial markets are all but closed to virtually all non-investment grade borrowers. The median S&P rating for radio broadcasters is CCC  -- junk status. Mergers and acquisitions activity is tepid, distressed and opportunistic at best.  Public company trading multiples are now approximately equal to the leverage for publicly traded broadcasters. This means that the equity for these radio broadcasters is all but wiped out.



What restructuring options are available to broadcasters today?
In the unfortunate event of a default under a credit agreement, broadcasters can work with lenders in several scenarios: waive or permanently amend the violated covenant; enter into a forbearance agreement that temporarily amends the violated covenant; or pursue a financial restructuring of the debt whereby the lender becomes the owner.

In a forbearance agreement – colloquially referred to as “kicking the can down the road” – the  offending covenant is loosened for a period of time – typically three to six quarters – in return for a high fee and a higher rate of interest paid to the lenders during such period. At the end of the forbearance period, the formerly violated covenant will typically return to its previous level - effectively deferring the inevitable – a financial restructuring. This is essentially a passive “wait and hope” approach to fixing a company’s capital structure.

A financial restructuring can take one of two forms; in-court or out-of-court.  An out-of-court restructuring or a pre-packaged Chapter 11 bankruptcy filing is generally the simpler and most expeditious form of restructuring; however this requires a strong relationship between management and lenders and a relatively simple capital structure.  If either of those ingredients is missing, then a complex Chapter 11 restructuring is the more likely route. 

In either case, the Company and its stakeholders would be well served by strong legal and financial advisors to help orchestrate the restructuring. 

The first companies to successfully de-lever will have a powerful pricing advantage against over-leveraged competitors, likely forcing these competitors into bankruptcy, and further accelerating the industry’s deleveraging process.  Time is of the essence.

-- Kevin Shea, Managing Director, Loughlin Meghji + Company

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