SBGI

Publicly traded companies mentioned herein: AT&T Inc (T), Comcast Corp (CMCSA), Discovery Inc (DISCA), Dish Network Corp (DISH), Gray Television Inc (GTN), Madison Square Garden Entertainment Corp (MSGE), Netflix Inc (NFLX), Nexstar Media Group Inc (NXST), Sinclair Broadcast Group Inc (SBGI), Walt Disney Co/The (DIS)

Highlights

The idea is regarding both the equity and distressed debt of Sinclair Broadcast Group Inc (SBGI). The presenter is bullish on Diamond Sports regional sports networks (RSNs), which are owned by Sinclair, based on what the presenter believes is a widely missed or understood opportunity in direct-to-consumer (DTC) digital targeted advertising.

First, some background on this deal: Disney (DIS) officially acquired Fox Sports in March 2019 and had to divest its RSNs given Disney’s ownership of ESPN. Sinclair acquired these RSNs in August 2019 for $9.6B and placed the networks in a subsidiary, Diamond Sports, which took on $8B of debt from the deal. The cover bid for those assets was a joint bid from Major League Baseball and Liberty Media.

Diamond Sports has RSNs on 43 of the 91 teams across MLB, NBA, and NHL. Since the acquisition closed in mid-2019, it has been an over-levered disaster. Investors are viewing Diamond Sports as a melting ice cube. They see linear TV in long-term decline, and competition for consumer attention on screens is higher than ever. Topline is declining while sports-rights payments are inflating. If you were building this ecosystem from scratch, you might not even have RSNs in the first place.

EBITDA is down roughly 75% from $1.6B annualized at the time of the deal to a run rate of around $400MM today. Earnings have cratered on two issues—one transitory, one secular. 

COVID is the transitory reason with virtually no professional sports for 6 months and limited engagement when games did come back online. Engagement now seems to be improving, so that issue may be behind them. 

The second issue is more pernicious. Customer stickiness to the RSN ecosystem seems to be lower than assumptions at the time of the deal. Dish Network (DISH) dropped the Sinclair RSNs in 2019 right around the time of the deal with Disney. A new programming deal with DISH has not come to fruition. Similarly, Comcast is drawing a hard line by not yet renewing with MSG Network (MSGE) for their programming. This type of sports programming seems to be less of a must-have for cable viewers compared to assumptions 2 years ago when this deal struck.

The presenter, however, is bullish based on a big pivot opportunity to a digital ad platform. The future of sports TV is in DTC. There needs to be a market for ‘cord-cutters’ and ‘cord-nevers’ and that requires a true digital product that allows interactivity, gamification, personalization, and the introduction of social into game programming.

Bears would say that it doesn’t really matter if Diamond Sports invests heavily in DTC. The cable companies have been overpaying RSNs for years and are now drawing a hard line. Bears would say that a DTC monthly subscription price of $20 would be viewed as poor value given how much content viewers get from Netflix (NFLX) or Disney for a much lower monthly fee.

The presenter says that this bear argument completely ignores the real DTC opportunity. That opportunity is in digital targeted ads. The CPMs on these ads are typically 3x the equivalent metrics for linear TV ads. Hulu, Discovery (DISCA) and HBO (T) on their ad-supported platforms generate $5 - $6 per month in ad-related RPUs with only 4 - 5 minutes of advertising per hour vs. cable sports games with 18 minutes of ads per hour. The RPU opportunity for a true DTC digital offering isn’t even comparable to the current linear TV regime. It’s 50% - 100% higher. 

Diamond Sports should also be a big beneficiary of sports gaming, which, at total market net revenue of $3B last year, has been growing at a triple-digit CAGR. He estimates that market will grow to $8B of net revenue by 2022 and $15B - $20B by 2025, and much of that revenue will be in the form of advertising.

Diamond Sports represents half of all RSNs, and RSNs presumably broadcast games to more engaged, active sports viewers. Those fans are bettors. If RSNs take 20% of that $15B - $20B sports gaming market, that would be $500MM per year to Diamond Sports in new ad revenue opportunity off a current base of $400MM in EBITDA. 

There’s also a licensing opportunity. Gaming apps – instead of comping rooms or drinks at a casino/hotel—offer different perks like free broadcasts of the games to your phone or home or even the ability to stream the games live through the sports-betting app so that the app owner can give their customers a more immersive, in-game betting experience. That is a logical next step here in the US. In Europe, 70% - 80% of sports gaming is now done in-game. 

It should be noted that a few weeks ago, MLB threw a wrinkle into this opportunity. They said that they will not allow Sinclair/Diamond to control the DTC platform for baseball. MLB wants to control it. The idea is that MLB would pay Diamond fair value for the local broadcasting rights and then maybe throw in an equity kicker on their own DTC platform. The presenter’s view is that whether DTC is Diamond-led or MLB-led, the ecosystem is transitioning no matter what to DTC with a big, accretive targeted ad opportunity for Diamond to seize upon. Advertising in DTC should grow alongside the growth in sports gaming.

Diamond does have leverage in what happens as they control the broadcast of half the MLB teams in their local markets. No league can launch a DTC product without being able to broadcast every team. Diamond Sports has real defensible rights and the leagues don’t look at these RSNs as a terminal business.

There are three securities involved here, all of which are attractive. Secured debt on Diamond Sports (DSPORT 5 ⅜ 08/15/26) trades in the high 50s. At that level, you’re creating the company at a sub-$4B cap. Forbes values Diamond Sports’s 43 team franchises at $58B with $4B in exclusive local broadcasting rights for those teams.

The presenter believes that Diamond should still have a long tail with the linear TV side of the business. It will play an important role in the ultimate transition to digital. RSNs serve as a lifeblood of revenue for sports teams given their increasingly high payrolls. In many mid-markets (where Diamond is heavily concentrated), the franchises rely on RSNs for over half of their revenues.

The presenter sees a path to EBITDA growth of $700MM to $1B, which makes the capital structure reasonably healthy with equity and a DTC platform.

The unsecured debt (DSPORT 6 ⅝ 08/15/27) trades in the low-30s and is trading below their IO value. The presenter does not believe liquidity is a problem. The notes mature in 2027. The presenter sees about 40 cents of coupon growth through then if there’s no liquidity issue ahead of maturity. At that level, you’re creating the company at roughly $7B in cap. 

The presenter thinks the linear business should be covered at close to or through par value, but with upside exposure to tens of billions of potential DTC ad revenue.

Sinclair equity, meanwhile, trades at 6.2x and is trading on just the value of the core broadcast TV business. Nexstar (NXST) and Gray Television (GTN), which are essentially the same businesses, trade at a high-6x multiple. Sinclair over-indexes to FOX stations, which are sometimes perceived as lower quality. So, it is likely that that business is either at fair value or perhaps slightly undervalued. Either way, you’re getting the Diamond Sports optionality for free.