After Another Blockbuster Deal, Does Media General Have Room to Run?

After spending a few years slimming down, which included offloading its community newspaper operation to Warren Buffett through his Berkshire Hathaway holding company in 2012, Media General (NYSE: MEG  ) is back in growth mode as it tries to build greater bulk in the local television broadcasting business and catch industry leader Sinclair Broadcasting Group (NASDAQ: SBGI  ) . The company acquired privately held competitor Young in late 2013 in a deal which added thirteen stations to its portfolio of properties and extended its reach to 14% of the population.

More recently, the company announced an even bigger deal with the acquisition of major competitor Lin Media (NYSE: LIN  ) and its more than 40 television stations for roughly $1.6 billion. After a big stock-price run over the past twelve months, though, does Media General have more upside for investors?

What's the value?
Media General owes a debt of gratitude to Berkshire Hathaway, which acquired the company's under-performing newspaper operation and provided a much-needed $400 million term loan that gave Media General time to restructure its operations, which were focused on the local broadcasting business. Like its competitors, Media General has also benefited from a gradual, multi-year rebound in the overall domestic economy. This trend has favorably affected its advertising revenues, especially from the automobile industry, a key customer group. The net result for the company has been a general improvement in its profitability over the past few years and a stronger financial profile from which to build shareholder value.

In its latest fiscal year, Media General reported solid financial results highlighted by an 18.3% top-line gain that primarily stemmed from the added revenue from Young Broadcasting, as well as organic growth across its non-political advertising revenue categories. While the company's operating profitability declined versus the prior-year period, predominantly due to a large drop in political advertising revenue, its profitability improved against fiscal 2011, the last comparable, non-election reporting period. More importantly, Media General's better cash flow characteristics, courtesy of a more diversified geographic mix of properties, allowed it to refinance debt at lower interest rates and this will positively impact future operating cash flow.

Strength in numbers
The deal with Lin Media should make Media General an even stronger franchise. It more than doubles the company's portfolio of television properties, leaving the combined company with 74 stations in 46 markets that reach an estimated 23% of the population. In addition, the transaction will greatly strengthen Media General's capabilities in the digital marketing segment. This has been a recent growth area for Lin Media, mostly through a myriad of acquisitions that include its recent purchase of Federated Media Publishing, a major provider of digital-content services to a wide range of industries.

Of course, the main benefit of the tie-up is on the cost side of the equation, where Media General's management initially expects annual cost savings in the neighborhood of $70 million.  Indeed, the tie-up should allow Media General to get closer to the industry's standard bearer of back-office efficiency, Sinclair Broadcasting Group. Sinclair is the industry's kingpin, with more than 150 television stations across the country that reach an estimated 40% of the population.

Sinclair enjoys an operating margin that is significantly better than that of either Media General or Lin Media. This mostly stems from its ability to create efficiencies in its back-office operations through joint-services agreements between its stations, especially in the areas of sales and news development. More importantly, the company's relatively lower-cost structure provides for greater cash yields across business cycles. This allows management to make investment decisions for the long term, which include forays into the digital-marketing area. The ultimate result for Sinclair is greater shareholder value, as its investments lay the groundwork for future profit growth.

The bottom line
Warren Buffett made a calculated bet on Media General back in 2012, loaning the company a tidy sum of money that also included a kicker, warrants to purchase 4.6 million shares of stock that, at the time, represented an almost 20% stake in the company.  He likely believed that Media General's financial difficulties were temporary and that management would be able to right the ship eventually. Not surprisingly, he was correct and the company's improved financial prospects show this, with corroboration provided by its stock price more than tripling since its May 2012 refinancing. While the company is certainly not as cheap as it was back then, Media General's tie-up with Lin Media looks like a smart move which could drive profits higher and provide the corresponding shareholder value.

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