2023-08-08 19:26:58 ET
Summary
- Saga Communications reported increased quarterly expenses related to programming, which may lead to long-term FCF growth.
- The company has a clean balance sheet with no financial debt, which facilitates promised inorganic growth.
- The market fails to recognize the know-how of Saga Communications.
Saga Communications ( SGA ) recently reported better-than-expected quarterly revenue, and a further increase in the amount of expenses related to programming, which may, in the long term, bring FCF growth. Besides, management reported a very clean balance sheet with no financial debt, which would facilitate promised inorganic growth in the coming years. I do see a lot of risks from the growth of social media and how it affects Saga's business model. With that, I believe that the market fails to recognize the know-how of SGA, which also trades undervalued.
Saga Communications
Saga Communications is a company dedicated to the acquisition, development, and operation of radio properties within the United States. By the year 2022, the company had 79 FM transmitters, 34 AM stations, and 80 metro signals operating in 27 markets nationwide. Most of the company's income comes from the sale of advertising space within its radio broadcasts, representing close to 89% of the company's revenue for 2021 and 2022.
Despite the large number of stations that Saga Communications operates, all of these operations are brought together in a single business segment. In addition to advertising space revenues that make up the bulk of annual revenue, the company has relationships with sales representatives of national advertising, through which it receives advertising to broadcast on its stations. Representatives earn a commission based on the total revenue earned from nationally broadcasted advertisement.
The business model is ideal as contracts can be made in the short term, allowing a permanent analysis of the results for the clients and the change of content if necessary. Revenue rates for Saga are determined by the amount of audience at the time of broadcast, the classification of the market the station serves, and the number of competitors present regionally for each radio station.
Recent Quarterly Report
Saga reported better-than-expected quarterly revenue and Q2 GAAP EPS close to $0.55 in the last quarterly report. The market celebrated the quarterly earnings report with an increase in the stock price.
Source: SA
In the three months ended June 30, 2023, Saga reported net operating revenue of $29 million, with operating income of $4.2 million, and quarterly net income close to $3.3 million. The numbers were worse than those reported in the June 30, 2022, quarter.
Source: Q2 Press Release
In the first part of 2023, Saga Communications reported a decline in total assets with declines in cash in hand, intangibles, and broadcasting licenses. The liabilities also decreased, however, most investors may not appreciate that the balance sheet is not expanding.
As of June 30, 2023, Saga reported working capital worth $40 million, and net fixed assets worth $53 million. Total current assets are significantly larger than total current liabilities. I am not really concerned about a liquidity issue. Total assets were equal to $229 million. The ratio of total assets/total liabilities is close to 4x, so I believe that the balance sheet is quite clean.
Source: Q2 Press Release
DCF Model
Saga Communications' current objective is to operate the highest billing radios in mid-size markets, which are those defined by being ranked between 20 and 200 according to the US Radio Investment Report. The company was founded in 1986, so I believe that Saga has accumulated a lot of expertise in the industry, and knows how to select the best locations to generate future sales.
Programming and marketing are the two key factors for Saga while obtaining audiences in each market. Due to the nature of radio markets, audience concentration is highly disproportionate to the three or four stations with the greatest reach and capture.
Saga noted increases in operating expenses, which included increases in programming rights expenses, promotion expenses, and sales training expenses. I firmly believe that in the long term, the increase in programming rights expenses, promotion, and related costs will most likely lead to more connections with advertisers and more revenue growth.
Source: YCharts
Saga concentrates its programming on the development of decentralized local audiences, with the aim of achieving large market shares at the regional level and positioning itself as one of the largest operators in each of these. These strategic frameworks are conditioned by regulations in relation to radio operators, such as the property limit on eight stations within the same market. I believe that this strategy will continue to be successful in the coming years as it has been successful for many decades.
Taking into account the balance sheet, the total amount of financial debt, and the FCF margin, I believe that Saga could undertake new acquisitions. Management noted that the company continues to look for new acquisitions, and made several comments about how it may finance new dividend payments and M&A transactions. Under this financial model, I assumed that M&A will most likely be successful and most likely enhance future FCF margins.
Investors will appreciate management's intention about future dividend payments and stock buybacks. We may expect further stock demand after the words delivered in Q2 concerning variable dividends and stock buybacks.
To date Saga has paid over $109 million in dividends to shareholders since the first special dividend was paid in 2012. The Company intends to pay regular quarterly cash dividends in the future. Consistent with its strategic objectives of maintaining a strong balance sheet and with returning value to our shareholders, the Board of Directors of Saga will also continue to consider declaring special cash dividends, variable dividends and stock buybacks in the future. Source: Q2 Press Release
My financial model includes 2034 net income close to $17 million, with net income growth of 3.52%, depreciation and amortization worth -$3 million, and deferred income tax expense close to $9 million. Also, with compensation expense of about $1 million, deferred and other compensation of $9 million, and decrease in receivables and prepaid expenses of -$2 million, I assumed changes in accounts payable close to $6 million, which implied 2034 CFO of $38 million. If we also subtract capex worth -$29 million, the implied FCFF would be $9 million.
Now, I also included an EV/FCF of about 11x, which is close to the EV/FCF reported from 2018 to 2023. Note that the EV/5 Years Median FCF stands at about 8.01x, but the EV/FCF stood at more than 20x before 2018.
Source: YCharts
Assuming a WACC of 7.2%, the implied firm value would be $127 million. But, if assume $34.4 million in cash and short-term investments, and financial debt close to $0 million, the equity value would be $164 million.
The Company's balance sheet reflects $34.4 million in cash and short-term investments as of June 30, 2023, and $38.3 million as of August 7, 2023. Source: Q2 Press Release
Finally, the implied stock price would be close to $27 per share, and the internal rate of return would be about 2.56%.
Competition
Competition in the radio market is logically high, and is given directly by other radio stations as well as indirectly by other entertainment services. The punctual factor of competition goes through the capture of audiences. In the case of Saga, its operators compete for audiences through the content in the transmission and the presentation of talents to conduct the programs. Building a consistent audience base allows you to attract advertisers and generate more revenue from that channel. Additionally, competition in relation to the content of advertising spaces is also driven by television signals, the internet, newspapers, magazines, and new digital outreach options such as online streaming, digital platforms, and social networks.
Risks
Saga announced the death of the CEO, who owed close to 65% of the total amount of purchasing power. Sadly, I believe that Saga Communications will most likely lose a significant amount of know-how and expertise accumulated by this business executive.
In addition to Saga's near-total reliance on ad revenue, the company concentrates much of its revenue in the top five markets it serves. The sum of the revenue from these markets represented 38%, 39% and 40% of the total revenue during the last three years respectively. With some concentration risk, I believe that the lower demand for advertising in those markets would most likely drive Saga's net sales down.
As regards its acquisition strategy, the correct reading of market trends plays a fundamental role while evaluating risks. In the same sense, the ability to obtain new stations and market shares are essential in the company's current strategy. I believe that failed M&A integration or lack of new acquisition targets would most likely drive inorganic growth down, which may lead to even lower EV/FCF valuations.
In a broader sense, the radio environment is currently at risk due to the appearance of new forms of entertainment. In the same way, within the radio market, public regulators are looking to introduce new satellite technologies and digital transmission that could affect the business and Saga's operating results. Along with this, I add that the company's business framework is limited by a large series of laws regarding the use of frequency channels and future decisions in relation to the radio market that could influence the current business structure.
Conclusion
With no debt, FCF generation, and many years in the industry, I believe that Saga Communications could trade at higher price marks. I believe that the recent increase in operating expenses, including programming costs, could have a beneficial revenue effect in the coming years. Additionally, taking into account the clean balance sheet and the lack of financial debt, we could see new acquisitions to enhance net sales and inorganic growth. Online streaming, digital platforms, and social networks represent the largest risks for Saga, however even taking into account these risks, I think that Saga is undervalued.
For further details see:
Saga: Better-Than-Expected Sales, Programming Growth May Lead To FCF Growth