Dealing with tight credit; Part II

In the first section of our 3rd Annual RBR/TVBR Financial Roundtable, the panelists had discussed the current tightness in the credit markets, what deals are still being financed and whether we are facing a recession, among other things.

If you missed it, read part I here.

As the discussion continued, the panelists turned to HD Radio, public companies going private and other front burner issues for broadcasters.

This year our panelists were: Jeff Kilrea (JK), Co-President, CapitalSource Finance; Jim Downey (JD), Manager, Pacific Media Capital LLC; and Bruce Levy (BL), Managing Director, Media and Communications Investment Banking, Wachovia Securities Inc. They were questioned by Jack Messmer (JM), Executive Editor, RBR/TVBR, and Mark Fratrik (MF), Vice President, BIA Financial Network.

MF: Let's quickly switch to HD Radio.  Jim made some mention of that.  How much of that do you put into your future plans when lending to radio operators and what's your general feeling towards HD Radio?

JK: When looking at ancillary revenue streams they are very on the come.  We're not going to factor those into our underwriting guidelines.  I guess I would view those as an added benefit to the credit that we are underwriting, but it's not something we're going to leverage prior to the realization of that beneficial cash flow stream.

JD: I agree completely.  It's something that I would like to see happen, but the installed traditional radio base is over 600 million units and I doubt there's even 20 million HD Radios installed.  A couple high-end manufacturers are offering them as options and now Ford is offering them as options, but until you get to critical mass it's not going to have any commercial impact.

MF: Any more positive look towards AM Radio because of HD Radio, or is that still too far down the road to actually take into your modeling?

JD: Ah, it's far down the road and also the FM's will have additional streams.  I don't know whether you'll get people to push the button switching from AM to FM more often or not.  I will probably sort of expect them just to stay on the FM band if there are three or four streams per traditional broadcaster per signal.

MF: Good point.

JM: Let me ask a more general question than going forward for radio.  What would make everyone a little more confident in the radio business?

BL: At the end of the day it's pretty basic.  Radio has got to reinvent itself from the standpoint of something that the end user really believes in and the advertiser wants to put advertising dollars against.  There was some abuse of that three or four years ago when the spot load got very, very high, which obviously brought in competition to the tune of the iPod and satellite radio.  At some level that rebinding of that relationship needs to happen.  Once it happens and there is some stability on the bottom line of the radio companies, then we can build from there.  I think that is the big $64 million question-when is that going to happen?  When are we going to see some stability?  When we do see that what is the growth trajectory going forward?  Any growth from that perspective is going to retain additional capital for the industry.  We haven't seen, I don't believe, that negative growth flatten out at this stage.

JK: We underwrite the radio business a lot like we underwrite some of our other businesses and growth in the sector really is one of the key drivers.  That is one of the things that we always all liked about the radio and even television business was that it was a demonstrated higher than normal growth industry or growth business.  You could count on 5-8% annual growth in ad spending and we just haven't seen that level of growth given the competitive dynamic over the past few years.  While we're not getting the growth, we still like the business for all the fundamental reasons - the barriers to entry, the high cash flow margins etc. but we're just not seeing that in the business right now.  So, as Bruce said, the industry has to reinvent itself and make it relevant again to the advertising industry.  Until that time comes and you see more liquidity in the marketplace it's going to be a tough row to hoe in the industry.

JD: I think the biggest benefit would be if oil dropped back to $30 a barrel.  That's not something that anybody in this industry has control over.  I guess I'd just like to make a comment that the single biggest success story in the media space in the past decade arguably is Google.  You look at them, similar to radio they give away their product to the end user. Your request list is there for free and subtly on the side are these ads that you don't really notice, but you can pick up if you want to.  I wish radio would emulate that-but you've got to sort of cut down on the amount of ads and put them into the programming that brings the listeners to the station.  Put them in the programming in a way that's less intrusive.  If they do that I think they've got a better long-term product because at the end of the day it's free and consumers love that.

MF: Do you think the privatization of some of the larger groups, assuming that they do go through, will benefit radio much or at all?

JK: I'm not sure at the end of the day if whether they go through will have any material impact in the short-term on the industry, no.

MF: Anybody disagree with that or wants to echo it also?

JD: If you look back to the LBO wave of 1980s-and almost every grocery store operator went through a leveraged buyout-did the grocery story business benefit, at least from a consumer's perspective or an investors perspective?  I don't know.  I think the long-term outcome is questionable.

MF: You all have heard the scenario that since they don't have to answer to the 23-year-old equity analyst every quarter that they can think more long term and not auction off their spots for very low rates just to bring quick revenues. 

JK: I think that with privatization they'll still be beholding, whether it's not to the 23-year-old analyst it's the 23-year-old banker who's got covenants that he wants to talk about every quarter that we might or not be breaching.  They will still be accountable to some party.

MF: Good point.

JD: I agree completely.

JM: Another radio issue is the Portable People Meter.  Does anyone think that's going to have an impact in the larger markets or are you taking a wait and see view on that?

JD: Long term, more accurate information is a good thing for the industry.  The transition may be a little painful, but again long term, more accurate information on listenership is a good thing for the industry.

MF: I wonder also, since PPMs  are only in the larger markets, or will be for the near term, whether or not it may have any impact on advertising, selling or buying in a small market.  Have you guys heard anything from any of your clients worrying about that or benefiting from that?

JK: I have heard conflicting views from our smaller market guys.  Like Jim said, more information is better.  More information at least allows advertisers to rationalize their buys.  It's all on the come and I'm taking a wait and see approach.

MF: I was going to ask also about performance royalties, whether or not the potential of broadcasters having to actually pay artists for airing their songs, whether or not that's a big concern on your part or are you confident that the NAB will stop that?

BL: I would hope that the NAB can stop that.  I think it's absolutely insane for people to expect that to happen, just given that radio did nothing but more than promote the industry for years and years and years and it's essentially free advertising for the record label.  For them to come back and say now you owe us some fees is kind of ludicrous and I would hope that that ends quickly.  If it doesn't, it's not exactly like radio operators are minting tons of cash flow right now, so it would not be a good thing for the industry if it comes to roost.

JD: I agree with that. There shouldn't be a new layer of economic transfer between radio and providers of their content when they're having trouble monetizing their distribution of that content.  It's just not appropriate right now.

JM: We talked about how the credit market is tighter right now.  Can somebody quantify that?  Can you look back of how it's changed from a year ago as far as the debt and equity mix and is there mezzanine available to fill the gap, or do you just have to come up with a lot more equity now?

BL: It's funny, I know Jeff and I have been doing this for 20 years so I can actually give you the 20-year history and I know Jeff can too, but I think at the end of the day it's really, as Jeff said, it's about growth.  As soon as the industry, both radio and television, shows growth it's going to attain more and more liquidity.  If you look back last year it's almost kind of irrelevant because the debt levels which were being offered in the market a year ago, if we look back and we're honest with ourselves, the kind of offers we gave to clients we should be ashamed of ourselves because they were substantially greater than where the industry should be adequately capitalized.  You have to go back to almost 1989 to look at kind of the leverage levels that we were laying out, you know the double-digit leverage levels in this industry.  I think we're going to come back, but when the markets do come back they're going to come back at a very conservative level.  You look at 2001 and even go to 1991, the leverage levels that the market afforded these industries were kind of below six times.  In some cases below five times, depending on the diversity of cash flow and then they kind of build from there.  Really it's just as the market has more confidence in the growth that the market can be more excited about leverage.  I don't want to say never, because that's a long time, but I would hope that the industry has learned its lesson from the previous years high leveraging and that we won't get those levels anytime soon.  I can assure you it's not going to be during my career, the rest of my career.

JK: Well one thing that I would add and I completely agree with all of Bruce's comments is what needs to happen is that we need to narrow the gap between the bid and the ask between buyers and sellers.  We have a lot of owners today whose basis in the television and radio stations are anywhere from 10 to 14 times broadcast cash flow.  The days of lenders putting eight times, nine times leverage on a property are gone.  The private equity guys can't make the math work when it involves putting 50% of the capital structure in the form of equity capital.  Now you know Bruce referenced 2001, I think when we had trading multiples at nine and tens times.  People said that that was depressed and once again that comes to growth but we were in kind of a slow growth period at that point.  With multiples in the nine to ten range you could actually make the math work.  We as lenders are now looking at five even to six times multiples of broadcast cash flow.  That can make some sense from a debt perspective and from an equity perspective.

JD: I agree with both Bruce and Jeff's comments.  There's been one sort of off-setting trend for capital structures where lenders are wanting to stay at no more than six or seven times cash flow.  There is a conscious sort of preferred equity that's coming in, in some cases available at a return in the high teens or low 20s that comes first in liquidation preference to common equity and that's been plugging the gap in some deals that we've seen lately.  Generally speaking there's been a dearth of fresh equity, particularly in radio space.

JM: Let me ask each of you to explain where your particular lending sweet spot is.  What kind of deals you're interested in doing? I think the smaller deals would probably be with Jim, so let's start with him.

JD: Our sweet spot would be from 10 to 30 million, structured either as a stretch single lien deal, and by that I mean one that a traditional bank lender or finance company couldn't quite do, but we can see the economic reasons to go a little deeper.  The other over all category is second lien where we'll come behind the first lien lender.  We like to be the only second lien lender when we do that and there needs to be a story to the credit for us to be eager to do that something like hidden asset value.  That could be a tower or a signal that's in a turnaround situation or a TV station that's independent that can get a network affiliation or some divestiture that's in the pipeline.  Those are our two sweet spots.  Again stretch single lien or a second lien where there's a clear story that will generate a deleveraging event.

JK: CapitalSource is looking to provide senior credit facilities. Predominately we will do some single lien structures like Jim more in uni-traunch fashion.  We're looking at businesses probably more in the mature phase that have anywhere from $5 million in EBITDA to $25 million in EBITDA.  We will lend, multiples are somewhat difficult to predict these days.  Each deal is viewed independently of the other and that would include things like management team, private equity sponsor, market and things like that.  We've been focusing our efforts, well, where we're getting the most bang for our buck lately is in television.  There seems to be more opportunities in television, but primarily senior debt.

JM: Okay and Bruce you'll lend us a billion bucks right?

BL: Yeah I'll lend you a billion bucks.  I would say if your deal is probably north of $150 million would be our sweet spot, both senior and mezzanine and high yield transactions are kind of where we underwrite to.  Obviously the bigger the transaction the better and our sweet spot has been in the, I should quantify that with a middle market focus, so $500 million to a billion five is probably our sweetest spot and that's kind of where we've been marketed.

JM: Is there any lending left for single station, single market deals or does everybody want a story that's going to go beyond that to provide you with some more flows of revenues from different markets and different stations to reduce the risk?

JK: I think everybody, I mean while you still can get select-I mean select ,emphasize SELECT-single station opportunities done in today's marketplace I think all lenders are looking for that valuable spread of risk and diversified asset pool as a means of quantifying any investment decision.  While it can get done, my preference is to have multiple properties as part of any transactional structure.

JD: We've done a couple of single asset, single market deals, but each of them had features that gave the customer flexibility, whether it's an asset sale or a quick boost in cash flow from cost savings or revenue enhancement.  If somebody comes in, I have seen a business plan where they just want to buy with a 70/30 debt/equity spread and there's no real change in the performance-that just doesn't work with a single asset, single market deal.

BL: In summary, I guess you could probably get very attractive spreads on very well diverse broadcast cash flow streams today.  The market for the single station deals is very, very difficult and the hedge funds have been, I guess, have been thinking about that, but the returns to them to do that are substantial and make the economics very difficult for a buyer of a single station asset.

MF: Given this uncertainty and concern about radio and somewhat less for television, what are the possibilities for new companies, first time borrowers?  What do you have to see in a first time borrower to even answer their phone call?

JK: What I want to see in a first time borrower, and we will make accommodations for people that fit in that class, is that they've had operational experience at some point down the road and specifically, probably operational experience in somewhat of a leveraged environment.  That's something I would look at.  I would also secondarily look at allegiance with a private equity sponsor that has experience in that specific sector, whether it be radio or television.

JD: I'm echoing what Jeff just said.  The buyer or operator needs to have a very clear picture of, and be able to express it, of how they are going to add value based on their background and their experience.  Then they need to persuade an equity backer that they can do it, again with their expertise.  With those two pieces in place you could borrow the money to buy a station.

JM: Did Bruce want to comment on that?  It would take a pretty big first time buyer but I suppose there are first time buyers who come in after some really large major market properties.

BL: I guess I would just echo what the other panelists have said.  We obviously are looking to back really good management teams with good equity support all the time.  I think the only reason we haven't done a lot of first time buyer deals recently is because there haven't been a lot of first time buyer deals.  So if there is an opportunity to buy a big group of assets and back a really good operator we would obviously look to the track record of that operator and look to the equity sponsorship of that operator and make our decision based on those two criteria.

JM: How important is the exit scenario and right now with the way the public markets are is there an exit scenario for most of these new deals?

JK: One of the compelling exits in this business has always been market liquidity, swapping one private equity firm to another.  I still use that as part of my analysis but I recognize that given the lack of trading activity the value that I can put behind that might be a little bit less.  You do compare that to other industries or other sectors that we finance where cash flow is the primary means for exit and the asset can pay down the debt as quickly as you can and take yourself out that way.   Given the higher leverage multiples we put on radio and television, even the debt repayment doesn't necessarily get you there at the end of five years, but what it does do is it puts you in a very comfortable leverage position.  If you get to five years rarely will you have a distress situation.

BL: If you look at the go-go days of radio, we used to call them for asset buyers get out of jail free cards.  If you ever had a downturn you could sell an individual asset and be de-levered quit significantly.  If you look at the most recent radio auction, the Lincoln Financial auction, only one asset was sold and that was Charlotte, which is a pretty good growth market we hope will continue.  The other assets did not get sold because there was no buyers for them or the buyers that wanted to buy them didn't have the access to capital to close on them or the seller just was unwilling to sell them at the price that the market bore.  That market was somewhere ten times or below.  You can't count on a buyer to sell that collateral efficiently at a high price today to back up that incremental half a turn of leverage.  I think the result of that is just less leverage today, with the hope that the market kind of gets back to a growth scenario where there's much more strategic interest and much more capital going to chase that transaction.

JD: The ability to exit a credit on a sale is of paramount importance to us.  We just don't go down one-way streets.  Aside from the sale of assets, partial liquidation, there's always for us, because we typically go in at higher leverage than standard lenders, if the customer just gets down to five or six times they could refinance elsewhere rather than a sale.  We often have in the back of our minds we're not a "loan to own" shop, and there are loan to own hedge funds out there, but we do often in the back of our minds have an alternate exit strategy just based on other operators we know beyond what the borrower may have had in mind when they come to us.

MF: Jim made some reference earlier about the writer's strike and whether or not people are going to flock back to over the air television stations. What's your opinion in terms of any long-term impact of not having Grey's Anatomy every Thursday night?

BL: That's a hard question to answer.  I think any time that they strike and it lasts any period of time, it has an impact on people and they do other things. They start kind of moving on with life.  So you know...

MF: Like reading books and things like that, huh?

BL: Maybe not like reading books, but certainly playing video games or watching You Tube.  In the target demo, the younger demographic, people move on very quickly.  Fortunately, I think a lot of the programming that have come out of the network in recent years has been very high quality programming, so hopefully it's got some stickiness and people come back.  I suspect we're going to see some of that come back.  Only time will tell whether people kind of moved on from TV.  It's certainly going to have an impact in the short-run, as it has had an impact at the network level.  I'm hopeful that people will come back to these programs because they are very high quality and we'll get back to business as usual.

JK: I concur with what Bruce just said.  When people move on from something there's always the risk that a certain percentage of those that have left aren't just going to come back because they've found something else to do with their Thursday nights.  We're taking a wait and see approach, but I think at the end of the day there probably will be some modest deterioration of viewership that results from the strike.

JD: I think a portion of that will become permanent.  The question is how much?  People have reprogrammed their TiVos.  They've figured out finally how to download episodes onto their iPods and play it on their television set and/or stream that straight to their PC.  Once people have been sort of forced to find those alternatives they probably won't give them up quickly.

MF: Jack that's all the questions.  These guys answered them so completely I don't even have any follow-ups.

JM: Well let's ask our panelists if there are any issues that they wanted to bring up that we haven't touched on.  Bruce?

BL: Well just in summary, we made a market and are very committed to the radio and television industries.  It's a difficult time right now. We're going to work with our clients to get them through it and get them to the other side.  It's an industry that we continue to support.  We have equity research as well as high yield research in these industries, so we are committed to this business.  It's just a difficult time we're going to have to work through.

MF: One of the few remaining equity research people, huh?

BL: Yeah, there's about three of them.

JD: I wish the radio industry would come up with something like a $50 mail-in rebate for everybody who buys an HD radio set for their new car.  You know, two or three years of that, mirroring what the satellite industry did, I think we could get the radio industry to a fresh tier, a fresh level.

JK: We, like Bruce and Jim, we continue to be committed to both industries and it is a very challenging time.  This is the time that you endear yourselves to the private equity community and to your clients.  We fully plan on doing that for 2008 and beyond and we'll do what we can to help spur growth in the sector.

JM: Well this is our Third Annual Financial Roundtable for RBR & TVBR so hopefully the Fourth Annual will be a little bit more upbeat and we'll be out of this by then.