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New Coverage of TV Station Owners

Sinclair and Nexstar are the two biggest U.S. operators.

We are launching coverage of Sinclair Broadcast Group SBGI and Nexstar Media Group NXST with no-moat and stable moat trend ratings for both companies. Our $46 fair value estimate for Sinclair implies 2019 adjusted price/earnings of 22 times, and our $128 fair value estimate for Nexstar implies 2019 adjusted price/earnings of 24 times. These companies are the two largest local broadcast station owners in the United States.

Nexstar is the largest television station owner/operator in the U.S., with 197 stations in 115 markets. Of its 197 full-power stations, 158 are affiliated with the four national broadcasters: CBS (50), Fox (43), NBC (35), and ABC (30). The 2019 merger with Tribune made Nexstar the top broadcast affiliate for Fox and CBS as well as the number-two partner for NBC and number three for ABC. Nexstar now has networks in 15 of the top 20 television markets and reaches 69 million television households. Nexstar also owns WGN, a nationwide pay-television network, and a 31% stake in Food Network and Cooking Channel.

Sinclair is the second-largest television station operator in the U.S. with 191 stations in 89 markets. Of its 607 channels, 154 are affiliated with the four national broadcasters--Fox (59), ABC (41), CBS (30), and NBC (24)--with another 86 channels on networks aligned with CBS (47 CW channels) and Fox (39 MyNetworkTV channels). Via the 2019 purchase of Fox Sports Networks from Disney, Sinclair is now the largest owner or operator of regional sports networks with 14 Fox-branded RSNs covering 42 NBA, MLB, and NHL teams along with Marquee Sports Network, the new home of the Chicago Cubs. The company also owns the Tennis Channel, four multicast networks, and professional wresting promotion Ring of Honor.

Broadcast or local advertising is an important source of revenue for both companies. The majority of this revenue is generated at the local level by selling ad time to area businesses including restaurants, auto dealerships, and retailers. Because of their size and geographic reach, Sinclair and Nexstar also sell advertising on a national basis to auto manufacturers, telecom firms, fast food restaurants, and retailers via their ad agencies. The growth in political ad spending has increased the importance of elections, particularly in even years with either presidential or midterm congressional elections. We expect that both companies will continue to benefit from political ad spending growth offsetting slower broadcast ad growth.

Over the last decade, retransmission revenue has grown rapidly as a source of revenue for local television stations. If a pay-television distributor like Comcast or Dish Network wants to carry one of the four broadcast networks in a specific market, the distributor must retransmit the local station feed for that market. While the growth in retransmission revenue will continue to be a growth driver, we project that national networks will continue to raise their fees, decreasing the bottom-line benefit to local station owners.

Sinclair now operates 15 RSNs covering 43 professional teams. The majority of revenue for the RSNs comes from affiliate fees, which are among the highest in the pay-TV bundle. However, these high affiliate fees, along with the relatively low viewership of RSNs in comparison with other channels, have led some distributors to question the price and placement of RSNs on the standard tier. We project that the pay-TV platforms will continue to push back on fees and tiering for RSN, but Sinclair may be able to deflect some of the pressure by packaging its local broadcast networks with the RSNs.

Challenges Ahead, but Not Enough to Change Competitive Position The U.S. broadcast or over-the-air television marketplace is dominated by the four national networks, but the actual OTA signals are broadcast by local television stations within a specific designated market. While many of the local stations in major markets are owned and operated by the broadcast networks, the vast majority of stations are owned by other businesses. As an example, ABC has over 240 local stations in the U.S. with only eight O&O stations. Many of the non-O&O stations were historically owned by local businesses that owned fewer than 10 stations.

The 1990s saw a wave of consolidation in the local station marketplace that has continued to this day as the Federal Communications Commission has weakened its stance on media ownership concentration. Sinclair has been one of the most aggressive consolidators of local television stations over the last 30 years as it only owned three television stations in 1991. While the company had expanded to 61 stations by the turn of the century, the buildup to 191 stations largely occurred over the last decade. Nexstar has also transformed itself over the past 20 years via consolidation, as it owned only 20 television stations in 2002. It added 65 stations via the Media General merger in 2017 and 31 from the Tribune merger in 2019, almost doubling the number of stations in two years.

Local affiliated broadcast stations historically generated the vast majority of their revenue from advertising sales to local businesses. With the consolidation of local station ownership, companies like Sinclair and Nexstar began to sell national advertising as station coverage could allow advertisers to reach a larger daytime audience. Another boost to advertising revenue for local stations was the 2010 Supreme Court decision in Citizens United v. Federal Election Commission, which struck down spending restrictions on political communications by corporations, unions, and other groups. As a result of the ruling and the increased politicization of American society, ad revenue has begun to spike in even-numbered years with larger growth in presidential election years.

Local station revenue has also been lifted by the growth of retransmission revenue over the last 15 years. If a pay-TV distributor like Comcast or Dish Network wants to carry one of the four broadcast networks in a specific market, it must retransmit the local station feed for that market. Due to FCC regulations, a distributor cannot offer an out-market equivalent to replace a local channel. In other words, Comcast could not replace the feed from the local CBS station in Baltimore with the feed from the Washington, D.C., CBS station. Similarly, YouTube TV could not select a single local broadcast (say, Baltimore) and distribute it nationwide so that all customers can view the nonlocal content (say, The Big Bang Theory or the NFL Super Bowl). This means that any pay-TV distributor (traditional or over the top) must negotiate on a market-by-market and station-owner-by-station-owner basis in order to offer local broadcast channels.

Local OTA stations can either choose “must carry” status (forcing carriage in a local market) or “retransmission consent” on a triennial basis. Most if not all affiliates of the four national broadcasters have migrated to retransmission consent over the past 20 years and thus receive a retransmission fee for each subscriber on a monthly basis from pay-TV operators. These fees have increased rapidly over the last decade as the O&O stations have aggressively negotiated for higher fees by leveraging their must-have content and sport rights. The broadcast networks, particularly CBS, have been pushing affiliate stations to follow suit in holding out for higher retrans fees.

These boosts to station revenue and margins have been offset by a number of secular trends. On the advertising side, new money is increasingly flowing to digital advertising, including online video. Local stations are now fighting over an ad revenue pie that is at best stagnant to declining slowly. Additionally, the ongoing fragmentation of media means that viewers are watching less broadcast television. The shift of news online has also hurt viewership of local news, an important local ad revenue generator.

These changes in viewer behavior are crimping the growth of ad revenue for local stations. Both ad and retransmission revenue are being hurt by the cord-cutting trend and the viewer shift to on-demand viewing options like Netflix or Hulu. The national networks have been able to offset some of this loss by either selling content to the streaming platforms or creating their own direct-to-consumer offerings, an avenue largely denied to local station owners due to the lack of a content library. Critically, the growth in retrans revenue is increasingly being diverted to national network owners, which have begun to raise network affiliation fees and “reverse compensation” fees. Reverse comp is generally set at a percentage of retrans revenue with some networks like CBS setting an expected retrans amount and threatening to pull affiliation if not met. We believe that the national networks increasingly hold the upper hand in part because of the relatively higher viewing of national content versus local content and their DTC offerings.

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