Satellite radio is the wave of the future. There's no stopping it. But will traditional radio roll over and die? I doubt it. And since many have taken their eye off the traditional radio ball, perhaps there are some bargains to be found among the smaller industry players.

Let's play word association
When I say the word radio, what are the first things that come to mind? Your favorite local radio station? Satellite radio from Sirius (NASDAQ:SIRI) and XM Satellite Radio (NASDAQ:XMSR)? Perhaps you question why traditional radio still exists. I lag far behind the early adopter curve and yet my family has 20GB of digital music, an iPod from Apple (NASDAQ:AAPL), and a cool transmitter that lets us play program director in the car.

With all of those substitute technologies bearing down on traditional radio and advertising revenues creeping along with 3% to 4% growth, it's no wonder radio stocks have fallen to new lows. The signal is coming in loud and clear: Traditional radio is dead! Long live satellite radio. Right? Maybe not.

Regardless of all the choices we have for content, local radio stations are important to local economies. You get some decent music, local news and events, and you get to hear about what's going on at local businesses. That's the great thing about radio stations in small- and mid-sized markets (as defined by markets ranked below No. 30 in revenues) -- it's customizable. Although the content may not have mass appeal, local radio stations with good ratings can still attract local advertising dollars aimed at specific audiences, which is exactly why I am looking for bargains in pure-play radio.

Who are the laggards?
You may never have heard of the actors in this play. I have to admit I didn't know Cumulus Media (NASDAQ:CMLS) even existed before doing my research. But that is why Warren Buffett and many others in the First Church of Value Investing preach the importance of reading. You never know what new things you'll learn.

Cox Radio (NYSE:CXR) is not just a mid-market station owner. It serves some larger markets like Atlanta, Houston, and Miami as well. Among the companies I'm looking at, it owns the smallest number of stations, 78, but brings in the most revenue, $438 million. Unlike Citadel Broadcasting (NYSE:CDL), whose 213 stations are spread across 47 markets, Cox Radio serves 18 markets concentrated along the East Coast and in the South. And then there's Cumulus Media. It owns 310 stations and serves 61 markets across the country. That's quite a footprint!

Our actors come in different shapes and sizes and appear to be using some different competitive strategies. So let's dig a bit deeper and see what else we can learn about these companies and whether they represent value plays today.

What's the frequency, Kenneth?
In order to generate profits, radio station owner/operators have to be tuned into their station operating income margins (SOIM), a non-GAAP convention that tries to model how well stations, by themselves, are performing. SOIM does not include depreciation, amortization, licensed marketing agreements, or corporate expenses including interest payments. Think of it as the first level of cash flow that the company can use to pay its bills.

Station Operating Income Margins
Cox Radio Citadel Cumulus
2003 39.5%


2004 40.5% 42.8% 36.8%

Citadel is a very efficient operator, and Cox Radio follows close behind. Remember that Cox has bigger stations in its portfolio, so programming costs are bound to be higher. I'm glad to see it's improving margins. Cumulus rounds out the bottom of these three. Serving smaller radio markets means generating less revenue per station and having costs that don't decline as fast.

Getting bigger all the time
Over the last three years, Citadel and Cumulus have been on acquisition binges.

Acquisition Spending ($millions)
Cox Radio Citadel Cumulus
2002 $0.5 $3.4 $132.2
2003 $0.2 $179.7 $133.6
2004 $0.7 $157.5 $93.7

They've been spending lots of money to add new stations into their playlists. Cox Radio, on the other hand, has taken a different approach. It's forgone the temptation to bolt on new radio stations and instead concentrated on programming. As a result, Cox Radio stations maintain their high ratings and attract advertisers, generating good sales and margins.

So let's see how well Citadel and Cumulus have been playing the acquisition and integration game.

Citadel Same Station Op. Inc. Growth Cumulus Same Station Op. Inc. Growth Citadel Same Station Margin Cumulus Same Station Margin
2003 $151.0 $95.0 43.2% 36.2%
2004 $160.6 $104.3 44.0% 37.9%
Growth 6.4% 9.8% 0.8% 1.7%

Same-station sales and margins are growing at Citadel and Cumulus. Obviously that is a testament to their ability to operate, but I think it's also a testament to their ability to purchase assets and make them productive after integrating them. If management at both companies can continue to make good acquisitions and improve margins along the way, capital will be allocated Foolishly and value will be created.

The market's thoughts
I think the ratios below, computed using fiscal year 2004 results, support my hypothesis that the stock market does not seem to care much about traditional radio companies.

Cox Radio Citadel Cumulus
Debt/Equity 0.38 0.48 0.55
Times Interest Earned 4.73 1.62 3.81
Price/Book 1.30 1.10 0.82

Each of these stations has better debt-to-equity ratios than radio behemoth Clear Channel Communications' (NYSE:CCU) 0.87. Cox has used operating income to pay down debt, giving it the flexibility to stay the course and concentrate on programming or acquiring new stations. Citadel, which turned profitable in 2004, has a debt-to-equity ratio of 0.48, but its times interest earned (earnings before interest and taxes divided by interest) is just 1.6. It has just enough to make its interest payments, but there's not much left over for equity holders.

Cumulus has the highest debt-to-equity ratio, but it's not out of control. With times interest earned at 3.81, it has a much easier time servicing its debt while generating good returns for shareholders.

The most surprising number seems to be Cumulus' price-to-book ratio, which is less than one. The implication is that its assets are not valuable. Again, perhaps the market is looking at its smaller markets and seeing very few growth opportunities. Maybe that could give Cumulus a chance to continue buying good assets at cheap prices and making them more valuable by operating them well.

The Foolish bottom line
To me, Cumulus is the most attractive stock in this overlooked bunch. Its acquisition strategy seems to be working and its balance sheet seems to be pretty solid. Companies in unloved industries may not be your cup of tea, but I wanted to show you that you can find opportunities in places where people aren't looking. Buying hot stocks just because you think someone else will pay more later on down the road is a fool's game. Traditional radio stations may be cigar butts that have only a few puffs left, but radio has survived disruptive technologies before and can maintain pricing control as long as ratings stay high.

If you're interested in other contrary ideas, add Philip Durell's Inside Value newsletter to your reading list. He loves to troll in the murky waters of the unloved, and that's how he outperforms the market. Take a free 30-day trial to see where he's looking for bargains.

Fool contributor David Meier wrote this article listening to his favorite radio station in Greenville, S.C. He doesn't own shares in any of the companies mentioned. The Motley Fool has a disclosure policy.