FINANCIAL WOES ROIL TV STATION MARKET

The credit crunch has forced some players in the TV station sales game to the sidelines, but the tighter money may be a blessing in disguise for others in the station marketplace.

Private equity firms and hedge funds have been responsible for many of the high-profile station deals in the past nine months. But unless they had already pinned down financing commitments for a pending deal, they are backing off until markets roiled by the subprime mortgage meltdown calm.

The upside: With the deals on hold, there's less competition for smaller transactions in which so-called strategic buyers—that is, established station groups—seek to pick off complementary properties instead of trying to swallow a company whole.

"Your traditional buyer is going to benefit from less competition from private equity money," says John Tupper, a station broker and owner.

“Less competition may create more opportunity for a little different price structure."

For station group owners LIN and Nexstar, however, the timing of the squeeze could hardly have been worse.

In May, when company stocks were near 52-week highs and the sale frenzy was peaking, the two broadcasters announced that they were considering cashing out.

By late July, deal negotiations were reportedly well advanced, with final offers for LIN set to be presented in early August and for Nexstar in early September.

Then bidders started feeling early shocks of the credit quake and headed for cover. That left Nexstar and LIN with little choice but to mothball pending sales.

"There's a saying here in Texas that you can't push a rope and in this current credit environment, that's what we were doing," says Perry Sook, president and CEO of Nexstar. "Credit markets have literally seized up like an engine running without oil."

Some see the window staying closed for a while, probably at least until next year. But Sook is sanguine about the future.

"All I can say from my perspective is that the pendulum always swings back and forth and it always swings too far in one direction," he says. "When it swings back, we will have the advantage of additional operating months and cash flow and likely be in 2008 with political revenues coming on line."

Meanwhile, if he sees a chance to augment Nexstar's portfolio, don't be surprised to see Sook turn into a buyer.

"We are always looking opportunistically at ways to add value to the company, whether on the buy side or the sell side," he says.

"As I said in our quarterly conference call, we are financial animals and we will do whatever we can to create value for shareholders. As we go down the road, we will continue to consider all those options."

Nexstar and LIN have substantial portfolios—49 stations for Nexstar, 31 for LIN—and it's such firms seeking a full-scale sale that will be most affected by the abrupt evaporation of plentiful, cheap money, contends Damian Riordan of HT Capital Advisors.

"The headline on it for me is that it impacts very large platform companies that are somewhat ideally suited for exit to LBO firms," Riordan says. "Companies like [LIN] and Nexstar pulling themselves off the market is probably not a bad idea."

Private equity and hedge fund acquisitions have helped push up station and company valuations to as high as 16 times cash flow.

Private money firms' approach to buying such properties is similar to a homebuyer/real estate investor: put 20% of the purchase price down, finance 80% through cheap loans. They then use company cash flow to make interest payments, keep some powder dry for the next attractive deal.

Such firms have an investment window that's typically five to seven years. Along the way, they seek to cut costs, enhance cash flow and revenues with an eye towards doubling their money when it's time to cash out.

But with loan money suddenly expensive, when it's available at all, private buyers are backing off.

Rick Michaels, chairman and CEO of the investment banking firm Communications Equity Associates (CEA), was in London talking to several of the larger investment banks as the credit crisis was unfolding. One thing quickly became clear, he says.

"The availability of credit on really large transactions is extraordinarily difficult,” he says. “The big banks haven't been able to sell off paper."

That's no help for Nexstar and LIN, whose sale prices were pegged at around $1 billion and $2 billion, respectively. But for station owners such as Fox, Lincoln Financial, Acme and others that are willing to parcel out their properties in smaller deals, it could help.

"In down times, not everyone says woe is me," says Larry Patrick of Patrick Communications. "Some are saying the fat lady just sang and we're going to look very selectively at properties we think will work."

Bear, Stearns' Victor Miller, in a recently published report, acknowledges that while big deals are taking a breather, there's still plenty of action in deals involving smaller numbers.

"Deals that can be 'digested' still carry strong multiples," Miller wrote, specifically citing Fox's nine stations and three owned by Lincoln Financial.

As evidence, he cites the recent $330 million sale of Montecito's four stations by private-equity firm Blackstone to New Vision Television. The sale price reflects a blended 2006-07 cash flow multiple of 14 times.

Fox and Lincoln Financial are not the only ones seeking strategic buyers. Acme Communications is shopping its remaining six CW affiliates, recognizing that they may go piecemeal to station groups looking, perhaps, to create duopolies.

“Obviously, the marketplace is very confused ... and values are difficult to figure out right now,” said CEO Jamie Kellner said on a conference call to discuss second-quarter results.

Not coincidentally, as credit markets have eroded, so have stock prices. As of yesterday’s close, Nexstar shares were trading at $8.23 and LIN's at $13.49. Nexstar traded as high as $15.41 on July 5 and LIN as high as $20.24 on May 18.

The shutdown of credit coupled with sliding stock prices creates a vicious cycle for stock-based sales. Under pressure from senior lenders including banks, potential buyers are forced to lower their borrowing threshold from, say, 10 times cash flow to six or seven times. That, in turn, lowers projected sales multiples.

Miller had earlier pinned a mid-point valuation on LIN of $22 per share, representing a 13.5 multiple of blended 2007-08 EBITDA. He'd pegged Nexstar at $17.50 and 12.5 times.

Earlier this month, after the companies withdrew, Miller projected numbers closer to $18 per share midpoint for LIN, representing 12 times EBITDA and $15.50 midpoint for Nexstar, also a 12 multiple.

But don’t count the private money out. As financial insiders say, one guy's downside is another's upside.

"Hedge funds and private equity funds are well positioned for these kinds of volatile times," says HT Capital's Riordan. "It's an area where they tend to benefit because of their willingness to participate in any and all levels of capital structure."

Thus, private money firms awash in cash might turn into lenders, instead of borrowers, helping finance acquisitions by strategic buyers, which could include the private money firms themselves, particularly if they're looking to bolster existing station portfolios.

In past credit crunches, hedge funds have functioned as collectors, buying distressed debt from banks at something under face value, then recovering the debt at full value, plus some.

In such situations, the entity recovering the debt adds a five percent interest charge on top of the default interest rate, often somewhere around 12%.

Those entities also are permitted to obtain reimbursement for the cost of recovering the debt, a process that may take a couple years or longer, if the firm goes into bankruptcy such as Granite and Communications Corp. of America did.

And if they can't recover all or a portion of the debt, a hedge fund or private equity firm might be willing to convert the unrecoverable portion into stock, carving out a path to possible control of the company.

Often, senior lenders avoid getting into ownership because they're focused on managing money, not businesses, or because regulation prohibits it.

As a result, "I would expect to see convertible preferred instruments come back into vogue," says Sook.

If a bank senses a loan's about to go into default, it has three options, says Patrick: immediately reserve the full amount of the loan or at least the upcoming payment on the loan, foreclose if the loan goes into default or sell the loan.

"Along comes an unregulated entity, a hedge fund, for instance, and says: 'We'll give you 70-80 cents on the dollar.' Though not perfect, a lot of times, the bank says hey, we're done."

Mezzanine lenders, the firms that offer bridge loans when senior debt availability or interest rates are unattractive, also stand to benefit.

"Mezzanine or other opportunistic financial sponsors are able to react quickly in times of volatility," says Riordan.

"What comes with [such debt] is that it's expensive money but it's flexible,” he says. They can put the money to work quickly and can provide more leverage than standard terms. But you pay like twice the going rate."

While there are similarities between the current credit crunch and previous tight markets in the early and late 1990s, there's a key difference this time: No one is talking down broadcast.

With 2008 a presidential election and Olympics year, Internet revenues beginning to rev up and a retransmission fee cycle building, the sector still looks attractive.

"I would point out that the fundamentals of the TV industry still are there," says Mark Fratrik of BIA Financial. "While I'm not as bullish as I was in the level of activity, I think there will be continued interest in some acquiring stations and others selling."