Wednesday, June 16, 2010

Black, White or Gray TV?

Cyclical companies make for great value investing candidates. When revenue shortfalls hit cyclical companies, investors have been known to overreact to the downside, providing bargain opportunities for the value investor. When a recession hits, one of the easiest cuts for companies to make is to their advertising budgets. As such, firms reliant on advertising spending can see revenue shortfalls resulting in large earnings reductions or even losses.

Consider Gray TV (GTN), owner of several television stations, including many affiliates of CBS, ABC and NBC. As advertising budgets of America's corporations have been slashed, so too has Gray TV's revenue. But while revenue is down in the 10-20% range, the stock price is down some 75% from its 2007 level.

However, what's required for a cyclical company to qualify as a potential value play is its staying power. Unfortunately, whether Gray TV has the ability to stick around through this downturn is hard to say.

First of all, tv stations are not the oligopolies they once were. The big networks do not have the market power they had back when a "young" 49-year old Warren Buffett was scooping up ABC for its monopolistic characteristics. Today's advertisers have a variety of choice, as specialty channels have grown to steal share from the incumbents, and advertisers seek mediums which allow them to better target their customers (i.e. the internet). Therefore, even when marketing budgets return to normal, advertisers are not assured to return in droves to these particular channels.

Secondly, and perhaps more importantly, Gray TV has managed to cut costs to generate operating income, but it is still not profitable due to its high debt load. The company's debt to equity ratio is around 80%, which is generally a ratio only the most monopolistic of companies can maintain.

A monopolistic debt/equity ratio combined with a competitive (i.e. non-monopolistic) market for this company results in an investment opportunity with high downside risk. If things go well, the company may very well recover and pay off its debts. But who wants to make an even bet like that? Value investors want the upside potential without the downside risks.

Disclosure: None


Ryan said... least I got in for pennies.

I'll try to do bettr in the future. Thanks for looking at it.

Saj Karsan said...

Nonsense, Ryan, that's just my opinion! I could easily be wrong.