TEGNA Inventory: Fading Deal Prospects May Hit TGNA (NYSE:TGNA)

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Almost two years after my last article on the subject, I’m returning to the subject of TEGNA (TGNA) as a new round of buyout rumors make their way through the rounds.

A Quick Primer

To avoid all confusion, I will just briefly define some of my terms. Those already very familiar with the industry can skip this section.

Broadcasting, unlike cable, actually consists of two separate groups of companies: the major media companies we traditionally associate with “broadcast” like Fox Corporation (FOX) often license their feeds to independent local TV stations in each city, although they sometimes buy such stations themselves (these are called “owned and operated” stations.) I refer to the major media companies as “studio broadcasters” because they own the studios where all the primetime shows are actually created and sports commentators are based, and the lesser known companies who own the independent stations in each city I call “affiliate broadcasters.”

TEGNA is one of the largest such groups in the country, and following their renewal of their affiliation agreement with Comcast’s (CMCSA) NBCUniversal they are the largest affiliate group for that station. They are also the second largest affiliate group for Viacom’s (VIAC) CBS. They have lower but still substantial ties with Fox and Disney’s (DIS) ABC.

Industry-Wide Thesis

For a long while now, I’ve been skeptical about pretty much the entire affiliate broadcasting industry. It just seems to me that as streaming continues to become more prevalent and studios can more and more easily reach all their customers nationwide directly, they just don’t really need the affiliates anymore. Over the years I’ve developed a couple of different theories about how that might play out, and they haven’t exactly gone according to plan. My article on Gray Television (GTN) which pinpointed nonprofit streamer Locast as potentially a fatal blow, didn’t exactly see my prediction pan out since Locast just went out of business.

And yet, if we look strictly at my investment recommendations, not my event predictions, someone who followed my advice would not have done too bad. Since my article on Gray Television went live in 2019, it has underperformed the S&P, and continues to even with the recent shutdown of Locast – a very surprising judicial decision that seems to rest on an incredibly cramped reading of the rebroadcast exception. But I’m not a lawyer and this is not a legal article, so never mind. Sinclair Broadcast Group (SBGI) has given back all of its post-RSN gains and then some. So most investors would have been well served to take my advice about avoiding major affiliate broadcasting stocks.

The only time I got into trouble making a recommendation about broadcast nets was actually when I broke with my usual practice and said that one particular broadcaster, TEGNA, might actually be able to break the mold and generate a decent return. If you’ve followed the stock at all since then you know that hasn’t happened – TEGNA is up 29% since I wrote that article near the height of the COVID market meltdown, but the S&P is up 84% over the same time frame.

In my defense, I didn’t just forget about all the points I’d made against broadcast nets when I wrote that article – the article’s thesis was that TEGNA had gotten a rare chance to sell out of the broadcast business and it looked like management was going to take it. The extent of the COVID carnage collapsed talks and prevented any deal from materializing, so I consider it a COVID surprise more than a miss that TEGNA has so underperformed my expectations.

Round Number… Well, I’ve Lost Count

Well, here we go again. Roughly eighteen months after COVID collapsed talks, the same dance partners are at it again, with Standard General and Apollo Global Management (APO) teaming up to submit a bid and Byron Allen trying to derail it with an almost-offer of his own that is somewhat shrouded in mystery, and always seems to be almost ready to go. The only thing missing from the last round of craziness is Gray Television, which apparently wasn’t up for a round three or four or whatever round we’re on by now. Just like last time, Standard and Apollo seem to have the better bid but there are antitrust concerns, and Allen would be much more likely to get through DOJ and the FCC if he could actually put a bid together. It’s still possible there’s no deal at all and this whole thing was supposed to be wrapped by New Year’s one way or the other, but obviously that deadline has slipped.

TEGNA’s Fundamental Problem

So one overhang for TEGNA stock is simply that it’s not clear there will be a deal. But given the underperformance of affiliate broadcasting over the last few years, and the probability that it will continue, it’s fair for investors to ask why anyone wants to buy TEGNA or any of the others at all. When asked, Byron Allen said he saw two major strengths for affiliate broadcasters, exclusive sports rights and extensive local news operations.

In my view, neither of these holds up. And the weakness of the affiliate broadcasting business model makes it both harder to make money and harder to sell to someone else.

Blackouts Blackening Prospects

Start with sports. It’s long been taken as an article of faith that the extensive sports contracts the Big Four broadcasters (NBC, CBS, ABC, FOX) have makes them and their affiliate partners impossible to drop. But we already know this is no longer completely true. Not only can they be dropped, they have been dropped already. And TEGNA, if anything, is getting dropped faster than some of the others.

Blackout disputes are getting depressingly common these days, but even by modern standards TEGNA has been racking up quite a few. For one thing, Mediacom and Tegna are currently in a dispute, but that’s relatively small potatoes.

More significant is TEGNA’s recent disputes with two of the larger players in the pay-TV space, DISH Network (NASDAQ:DISH) and Verizon FiOS (NYSE:VZ). What’s somewhat confusing about this is that they’ve yielded different results, thus far. Verizon’s dispute followed what has become the typical playbook: they blacked out TEGNA’s stations for a few days, people complained about both sides, then it was announced that a new deal had been reached. Everyone was happy again, or at least happier.

But as usual, DISH Network is leading the way. Two years after becoming the first major pay-TV player to drop Regional Sports Networks – a decision that fundamentally altered the nature of the pay-TV bundle for the first time in probably decades – DISH is now leading the most prolonged blackout of a major broadcast affiliate I can remember. There is talk that perhaps Tegna simply won’t ever come back to DISH, and people no longer assume it’s just talk. Charlie Ergen has proven before he’s not afraid to be a maverick.

DISH dropped TEGNA stations all the way back in the first week of October, which means it went through most of the NFL season without them. In the past, the thought of losing CBS, NBC and FOX affiliates in the middle of football season was always enough to bring any distributor back to the table, even the wily and unpredictable DISH. This time, DISH toughed it out – by which I mean they refused to grant TEGNA the rates it sought, though DISH tried a couple of other maverick things to get TEGNA stations back. Now, they’ve made it through football season without caving in; which means that this might actually be a permanent blackout, with DISH dropping TEGNA’s affiliates the way it dropped Sinclair’s RSNs a few years ago.

Streaming Is Still The Problem

Why is this happening now when it wasn’t before, and why do I think TEGNA may be uniquely vulnerable to it?

The reason is that different studio broadcasters are moving at different speeds to acclimate to the new streaming reality. And suddenly, a CBS or NBC affiliation is, when it comes to sports, just about the worst affiliation an affiliate broadcaster could have. FOX is guarding NFL rights for its broadcast division and says its streaming service, Tubi, will only have access to condensed replays after the game.

CBS and NBC, however, are all in on streaming. Their Paramount+ and Peacock Premium streaming services now offer full access to all NFL games, without a pay-TV subscription requirement. And TEGNA has a lot of its eggs in the CBS and NBC baskets. This might account for why DISH was more willing to go to the mat with TEGNA than it was with Sinclair, a more well-rounded affiliate broadcaster with whom it avoided a blackout via several extensions and, finally, a new deal. Of course, it may also simply be that Sinclair’s demands were more reasonable.

But it seems there’s no denying that football remains the pre-eminent draw for pay-TV consumers. The NFL accounted for 75 of the top 100 TV programs last year – as the Commissioner never tires of reminding us – and the decision by Peacock and Paramount+ to offer full football access for $5 per month means that an affiliate broadcaster has substantially less leverage to extract higher retransmission fees by withholding their channels, when the most popular content on that channel is now available elsewhere.

Nor is this a problem that’s likely to change soon. The latest round of NFL TV contracts included full streaming rights concurrent with linear rights, which means that NBC and CBS can continue to offer streaming in their own, affiliate-free streaming services indefinitely. Of course, such a pivotal loss of exclusivity will only increase pressure on the pay-TV bundle, which offers those same channels substantial profit. But the long-term future of TV is in streaming, and the studio broadcasters seem determined to get a move on it after Netflix basically stole a march on them for the past decade. When questioned whether NBC would be willing to pull football off Peacock if the pay-TV carnage grew too great, NBCUniversal CEO Jeff Shell stopped just short of explicitly saying no, but his view on the matter seemed very clear. Football, it seems, is on streaming to stay.

Local News Is Not The Answer

Local news matters, you’re not going to replace that any time soon

-Byron Allen, Milken Global Conference

In terms of what affiliate broadcasters bring to the table, the loss of sports exclusivity means that local news is just about the only card left to play.

Here, I think Mr. Allen is on somewhat firmer footing. Local news is indeed important to many viewers, and unlike the sports contracts it’s something truly under the control of the affiliates themselves. The way this part of the business usually works is that the studio broadcasters run the primetime schedule, and then the affiliates employ the local journalists and produce the local news telecasts.

The difficulty here, however, is that while local news is important, it is not a natural monopoly the way sports leagues are. There is only one NFL, and also only one NBA, MLB, etc. But in every city most of the major broadcasters have a local news operation. So ABC, CBS, FOX, and NBC all have their own outfits, and while local news as a whole is important to many viewers, it’s less clear how much they distinguish between NBC local news vs. FOX local news, for example.

This fact, combined with the FCC’s single-market ownership cap, means that even large affiliate broadcasters like TEGNA and Sinclair rarely own more than one of the major news outfits in a given city. This reduces the leverage that local news provides in contract negotiations, even though local news itself remains very important to many viewers. DISH, or anyone can safely drop TEGNA’s NBC feed in Phoenix and CBS feed in San Diego, for example, and trust that the CBS feed in Phoenix in and the NBC feed in San Diego, which are owned by other companies, will still satisfy their customers need for local news and minimize churn – to say nothing of ABC and FOX as well.

Quantifying The Impact

Because DISH dropped TEGNA just as the third quarter was ending, we have not yet seen any earnings report with the DISH hit factored into them to guide us as to how badly it hurts the bottom line. At most recent reports, DISH represented approximately one in seven of pay-TV subscriptions (including vMVPD) and TEGNA has been reporting about a 15% profit margin in recent quarters. The dangerous thing here is that when a distributor drops a channel, the costs don’t drop nearly as much as revenues do for TEGNA because all of that channel’s production costs, technology costs, et al are more or less fixed. If TEGNA’s costs didn’t drop at all, then, losing DISH alone could wipe out almost its entire profit margin.

However, as I noted in my Gray Television article, there usually are some pass throughs of retransmission revenue from the affiliate back to the studio, so it’s quite possible NBC and CBS are sharing in the DISH hit at least to some extent. In the most recent quarter, subscription revenue (retransmission) represented almost exactly half of the total revenue pie: $369 million of $756 million. Assuming that the studios absorb one-half of that, losing one in seven of their revenue dollars (from losing DISH) would be $108 million in lost revenue, with 25% of that, $27 million, also falling off the cost side. That would be enough to cut TEGNA’s $128 million profit last quarter down to $47 million – a nearly two-thirds reduction.

And there’s the risk that another major distributor pulls a DISH, too.

Uncharted Territory

It’s important to emphasize that we are all somewhat flying into uncharted terrain here; while dropping RSNs and other cable channels has become quite common over the past few years, dropping affiliates of the Big Four broadcasters like TEGNA has almost never happened before, and certainly has never been done permanently. But so far, DISH appears to have every intention of sticking with its new TEGNA-free content lineup, and doesn’t appear to be suffering too much for having done so. The last time DISH dropped a major channel block and it worked, it wasn’t long before other distributors began to copy their strategy. That can’t make TEGNA investors feel good.

For the moment, then, at least, it certainly seems that it is possible to maintain a major pay-TV service without including TEGNA’s affiliates or paying TEGNA’s rates. And given the new dynamics we are seeing in regards to content exclusivity, it makes conceptual sense why that might be so.

Options Are The Best Trading Option

Under these circumstances, I see little reason to invest in TEGNA, though going short is also risky if, against the odds, a deal in the low-to-mid $20s does indeed come through. While I think it best to simply avoid the stock at this time, if you must invest in it I recommend using options for this particular stock instead of a straight up purchase or short. TEGNA either is or is not going to close a deal, and when it does the stock should either shoot up or crash down, since without DISH its earnings are probably poised for a major hit.

This means that an investor can buy two options, a put option and a call option, with expiration dates set however late the investor feels they need to be for the merger situation to be definitively resolved one way or the other. While one will certainly expire worthless, at relatively short expiration dates profit on the other should be more than enough to make up for it.

The risk in such a strategy, of course, is if the merger saga drags on longer than expected and the stock treads water while awaiting more clarity, in which case both options could expire worthless. Which brings me back to why I’m just not sure I want to have any money bet on TEGNA at all right now.

Investment Summary

Things haven’t played out exactly the way I anticipated in the broadcast affiliate space, not least because I truly did not expect courts to be quite so hostile to nonprofits like Locast. But I do think the last few years have vindicated my view that as streaming grew, affiliate broadcasters would become less and less central to studio broadcasters business, and therefore by extension to pay-TV itself.

The movement of more or less the entire studio broadcasting content catalog to streaming services – either their own or someone else’s – leaves affiliates more or less controlling their local news operations and not much else. Given the competitive dynamics at play, I highly doubt that those will be enough to give them the leverage they’ve grown accustomed to as partners to studios the past few decades.

TEGNA’s close affiliation to NBC and CBS, once a strength that let them escape the worst of the damage, is now if anything an affirmative weakness. With DISH already dropping them and a lot of other distributors seeing how well that seems to be working for them, I’m even more skeptical of TEGNA’s prospects than other affiliate broadcasters, and recommend simply avoiding them for now, unless you truly believe a buyout deal is just around the corner.

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