September 10, 2013
2013 Value Investing Challenge
Spencer Grimes, Twinleaf Management LLC
Investment Idea Submission: Crown Media, Inc. (Nasdaq: CRWN)
Financial and Valuation Metrics:
Share Price (7/31/13): $2.45
Target Price (12 months): $4.25 (+73%)
Shares Outstanding: 360M
Market Capitalization: $882M
Net Debt (3/31/13): $450M
Enterprise Value: $1,332M
2012A Adjusted EBITDA: $138M; 2012A FCF: $28M
2013E Adjusted EBITDA: $149M (+8%); 2013E FCF: $96M
2014E Adjusted EBITDA: $159M (+7%); 2014E FCF $109M
EV/2013 EBITDA: 8.9x; EV/2013 FCF: 13.9x
EV/2014 EBITDA: 8.2x; EV/2014 FCF: 12.1x
CRWN owns and operates Hallmark Channel and Hallmark Movie Channel, family-oriented domestic pay TV networks that deliver a mix of original and acquired programming to household universes of 87 million and 50 million, respectively. The business is solid but unspectacular, with forecasted mid-single digit revenue increases and modest margin expansion leading to projected EBITDA increases of 8% in 2013 and 7% in 2014. Advertising represents 75% of total revenue; subscription fees from cable and satellite operators make up the balance. There is no international business component (it was sold in 2005) nor program sales to the likes of Netflix or Hulu due to copyright issues. Capex is de minimus and, CRWN is not expected to be a federal taxpayer for the foreseeable future (more on this important recent development below).
Due to offsetting factors -- decent audience ratings but a lack of corporate leverage over distributors owing to its independent status – CRWN has wisely chosen to emphasize ad sales growth and blanket distribution over affiliate fee increases. As a result, the two Hallmark channels are among the best value in the industry as measured by ratio of affiliate fees to audience viewership, though its core audience demographic is less than ideal. One thing is clear: in a world of media conglomerates that generate significant operating efficiencies via ownership of multiple networks, CRWN’s operating performance is restrained by its independence. is the last remaining independent programmer of its size.
Privately held Hallmark Cards, Inc. (HCI) is a 90.3%-controlling shareholder of CRWN as a consequence of a controversial debt-to-equity recapitalization in 2010. Accordingly, the float is 35 million shares, average daily trading volume is ~225,000 shares (~$500,000 per day) and the bid-ask spread is tight.
A liquidity event for minority shareholders is very likely in 2014. Never say “near certainty”, but we believe that to be a more accurate description of the likelihood of a transaction that delivers an attractive premium for shareholders.
Q: Why do we believe that to be the case?
A: Several factors point to a sale of CRWN in 2014
A standstill agreement between HCI and minority shareholders - a legacy of litigation that unsuccessfully challenged the terms of the debt-to-equity recap – expires on 12/31/13. Among other provisions, the agreement restricts HCI from increasing its stake in CRWN or selling its stake without delivering a 50-cent per share premium to the minority shareholders. While a mere $17.5 million deterrent (50 cents x 35 million shares), we believe that the 2010 litigation created sufficient ill will that HCI will simply allow the 50-cent premium provision to sunset before selling CRWN.
In a display of abundant disclosure and excessive caution undoubtedly prompted by its attorneys, HCI filed an amended 13D on 6/24/13 that served nothing more than to remind investors of the standstill expiry and that all of HCI’s options with regard to its CRWN stake remain open. CRWN shares surged 25% over the next few days.
As we noted in an open letter to the CRWN board of directors in September 2012 that urged a sale of the company (the letter appears as a blog post at www.twinleafmanagement.com; the board did not respond to it), scale matters. In an industry that is more complex and competitive than ever before, there is zero industrial logic to being a midget in a land of giants. We believe that HCI and the CRWN board recognize this.
In its existing ownership structure, the Hallmark channels have muted growth potential and limited operating efficiencies remaining to capture, suggesting the business is approaching maturity. In other words, after XX years of involvement with CRWN, 2014 is an ideal time for HCI to sell, irrespective of any other considerations. Though 8% and 7% adjusted EBITDA increases are forecasted in 2013 and 2014, 2015 looks more challenging.
Valuations for television assets, especially pay TV networks, are firm and several logical buyers are present. There is even an outside chance that HCI attempts to take CRWN private but, we see this outcome as very unlikely.
Q: What is CRWN worth to a strategic buyer and who might it be?
A: $4.25 to $5 per share; CBS and Scripps are the most likely buyers
Recent comparable sales are instructive but not perfect. The Outdoor Channel was sold in a bidding war in May 2013 at an EV of $194 million, net of cash and non-core assets, or about 16x 2013 adjusted EBITDA of $12 million. In 2012, NBCUniversal sold its 15.8% stake in A&E Networks to controlling shareholder Disney/Hearst for $3.1 billion, also estimated to be a 16x multiple. Conservatively placing a 12x multiple on CRWN’s 2014 estimated EBITDA of $159 million and adjusting for estimated net debt of $380 million in early 2014, one arrives at $4.25 per CRWN share. Should M&A interest in CRWN be especially robust, CRWN shareholders could see $5 per share (13.84x 2014E EBITDA).
Strategic buyers of CRWN will salivate at the operating efficiencies available to them. We believe there is at least $50 million of redundant expenses that a buyer could take out in short order, effectively reducing the transaction multiple by perhaps three turns. There are also revenue enhancements that a strategic buyer would recognize, both in ad sales and distribution. Obvious examples on the distribution side would include restoring the Hallmark channels to AT&T’s 5 million subscribers and nudging up affiliate fees.
CBS and Scripps are the most logical buyers. Though CBS would likely capture fewer synergies in a CRWN acquisition given its limited pay TV programming portfolio, it may covet CRWN the most. Indeed, CBS has publicly stated its desire to expand in pay TV. Scripps has a complementary portfolio of pay TV networks and would be in a better position to fully exploit the cost savings and revenue enhancements. Other plausible strategic buyers for CRWN are 21st Century Fox, Discovery Networks, Time Warner and Disney/Hearst. None of these prospective buyers should have dilution concerns with paying 12x EBITDA for CRWN.
Q: What is the downside risk for CRWN if an M&A event doesn’t happen?
A: Considerable FCF and an improving balance sheet and the prospect of a return of capital suggest it is minimal.
If a sale of the company doesn’t occur, strong cash flow generation, an improving balance sheet and deployment of tax-shielding NOLs suggest that CRWN will be in a position to return capital to shareholders beginning in 2014. Management has stated a debt leverage goal of 2.5x LQA EBITDA, which should be achieved in the second half of 2013. In a value-creating move underappreciated by the market, HCI transferred a portion of its ownership stake to a German subsidiary in late 2012. The transaction reduced HCI’s direct stake in CRWN to 79.9%, allowing CRWN to become an independent tax filer and enable the use of accumulated NOLs. This new tax status should allow CRWN to preserve $70 million of cash in 2013 and 2014 that would have otherwise been passed through to HCI for CRWN’s attributable tax liability.
Given the lingering animosity surrounding the 2010 recap, some CRWN observers think that HCI’s behavior will be entirely self-serving with zero regard for the minority shareholders. We disagree. HCI could have flushed the equity entirely in the recap and we foresee no reason why HCI would behave irrationally upon expiry of the standstill agreement at the end of 2013.
An independent CRWN is clearly sub-optimal for CRWN’s operational performance and, of course, its shareholders. But should a sale of the company not occur, we see very little downside to CRWN shares. Using $169 million of 2015E adjusted EBITDA (+6%), the same 8x valuation multiple at which shares trade today and adjusting the net debt balance to $300 million at year end 2014, one arrives at a per share value for CRWN of $4.58, comparable to a projected takeout price but one year later.
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