Banks Get the Message, Court Media Business

Paul Kagan, a Carmel, Calif.-based specialist in evaluating broadcast properties, has been running seminars for industry members for several years. Lately, like the producer of a prime-time show whose lead-in becomes a big hit, he has found his audience expanding.

“Over the past two years,” he says, “the audience has been half broadcasters and half bankers.”

Indeed, major lenders such as banks and insurance companies who have not traditionally provided long-term credit to broadcasters, are plunging into radio, TV, and cable lending as if experiencing a revelation. Actually at work are a pair of revelations, for not only have bankers discovered the benefits of lending to media companies, but media companies have discovered the value of debt.

“Bankers en masse are finding media stocks a good place to lend money,” says Jeffrey E. Epstein of First Boston Corp., the investment banking firm that represented American Broadcasting Cos. in talks which resulted in its merger agreement last month with Capital Cities Communications Inc.

The combination has turned particularly potent over the last two years, which have seen leveraged buy-outs, other going-private transactions, and debt-loaded mergers occurring at a rate double that of the previous decade. Since only the very largest companies have access to the market for debt securities, most of the industry’s borrowing has come from traditional lenders such as banks and insurance companies.

Magnitude Is Growing

Not only the rate but the magnitude of such deals is growing. Eight broadcast companies were wiped from the public roles in 1984 by liquidation, sale, or leveraged buy-out worth a total of $4.2 billion, according to Kagan. Four of those deals, valued at $3 billion, were among Fortune magazine’s 50 biggest deals of 1984.

(Those four were, in order of size, the leveraged buy-outs of Metromedia Inc. and Wometco Enterprises; the purchase by Dallas-based A. H. Belo Co. of Corinthian Broadcasting, a Dun & Bradstreet subsidiary with a coveted Houston TV station; and the leveraged buy-out of Harte-Hanks Communications, a newspaper and broadcast group. The other four deals last year were the sale of Outlet Co. broadcast properties to Rockefeller family interests, liquidation of Gross Telecasting, sale of Post Corp. to a private buyer and the sale of Cowles Broadcasting to the Hobby family of Texas.)

No broadcast or cable deal had even made Fortune’s annual list since 1981, when Westinghouse Corp. acquired Teleprompter, a cable-TV operator, for $647 million. The stakes promise to grow even higher in 1985, assuming two proposed deals are completed before the end of the year: the ABC-Capital Cities merger is valued at $3.5 billion, and Taft Broadcasting’s acquisition of Gulf Broadcast Co. is priced at $755 million.

Loans Nearly Double

In the first six months of 1984, according to a Kagan survey, loans outstanding to radio and television groups by banks and insurance companies nearly doubled to $5 billion from $2.6 billion at the end of 1983.

About a quarter of the increase came from a single deal--the Belo acquisition of Corinthian. With the exception of about $80 million raised in a stock offering, Belo financed the $600-million deal with bank debt.

Kagan argues that the sharp increase has barely dented the industry’s borrowing capacity, which he places at five times its cash flow. With that figure, defined as operating earnings plus depreciation, reaching $4.5 billion last year, that means a borrowing capacity of $22.5 billion for broadcasters alone, or nearly five times their current loans outstanding.

“It’s an industry that hasn’t borrowed nearly as much money as people are willing to lend,” says Katherine C. Marien, manager of the 4-year-old communications group at Boston-based Bank of New England.

Since many investment professionals foresee a flood of mergers and buy-outs looming for the media industry (including group broadcasters, networks, cable system operators, and newspapers), this unused pool of capital bears important implications.

Target for Acquirers

In the first place, it makes any under-leveraged company a target for acquirers, who theoretically can use the target’s borrowing capacity to finance a deal, hostile or otherwise. The overly healthy balance sheet of CBS Inc., which is otherwise considered almost impregnable to takeovers, is thought to be an exposed flank. CBS’ long-term debt of $371 million at the end of 1984 was 23% of equity and about 1.1 times its cash flow.

“Someone could acquire CBS with CBS’ assets because it has (almost) no debt,” Kagan observes. That is not lost on CBS, which last week disclosed that it has lined up a bank credit line of $1.5 billion, earmarked for such defensive maneuvers as acquisitions.

Similarly, A. H. Belo, which went public in 1981, “needed some debt on the books,” says James M. Moroney Jr., its chairman and chief executive. That was partially behind its purchase of Corinthian in a leveraged deal.

“We were a public company with absolutely no debt at all and a lot of cash,” he says. “That makes you somewhat of a sitting duck.” (At the end of 1983, Belo had $400,000 in long-term debt; a year later, it had $350 million.)

Combined with this month’s change in Federal Communications Commission rules governing multiple ownership of TV and radio stations, the leveraging of broadcast companies could contribute to a rise in prices for properties placed up for sale.

Wall Street Divided

Wall Street onlookers are divided on whether the FCC change--increasing the number of television and FM and AM radio stations that may be held by a single owner to 12 each, up from seven--will place more stations on the market or fewer. (More companies can buy stations in larger markets without having to divest any existing properties, for example.) But most expect prices of any stations on the block to appreciate.

Historically, broadcasters have been virtually debt-free for several reasons. One is that their properties, particularly TV stations, have been strong cash producers. Thus, broadcasters haven’t needed banks much except to pay interest on their deposits.

“They’ve been so cash-rich that a lot of these companies have been lending to us,” says Phyllis Riggins, manager of the communications division at Republic Bank of Dallas. Thus, when industry growth remained slow, any broadcaster seeking to make acquisitions could manage to do so with internally generated cash.

Another factor is what First Boston’s Epstein calls the “generational question”: Many broadcast companies are still run by the pioneers who started the business and who as a group harbored an aversion to debt.

Under founder Leonard Goldenson, for example, ABC’s total long-term debt has declined over the last three years to $116.7 million from $152.6 million, dropping to 5% of equity from 8%--while ABC’s rising vulnerability to takeover might have made the reverse trend a prudent course.

Virtually No Debt

“ABC has virtually no debt . . . ,” says Alexander T. Mason, head of the media group at New York-based Bankers Trust Co., a long-term lender to broadcast companies. “Its only bank borrowing was a short-term buildup of working capital for the Olympics--and as soon as the advertising revenues came in they brought it down.”

These factors are changing. The cost of acquiring properties has soared as the opportunities have expanded. Many broadcasters who owned close to the old maximum of seven stations could not justify new broadcast acquisitions. The 12-station ceiling gives them an inescapable rationale for expansion, for a group of 12 stations has a geometrically expanded economy of scale over seven or fewer. Buying programming is far cheaper, and even producing programming--spreading the costs among 12 stations or joining with other groups to spread it even thinner--comes within the financial reach of more broadcasters.

“Now that one property can cost $200 million-to-$400 million,” Republic Bank’s Riggins says, “even someone with a lot of cash will need some help in buying.”

The industry’s appetite for cash has grown just as the banks’ willingness to lend has blossomed. Traditionally, bankers were loath to lend on anything but brick-and-mortar assets--the balance-sheet lending that gives them what appears to be a comfortable claim on a borrower’s hard assets.

Real Value Is License

Broadcasters, of course, have virtually no hard assets. Bricks-and-mortar assets are negligible. “The real value is an intangible asset called the license,” says Mason of Bankers Trust.

Instead, broadcasters have cash flow, an asset that bankers had to learn to love.

Some bankers say the advent of cable, which attracted a lot of bank lending, eased the way for broadcast lending, for cable companies were a hybrid of brick-and-mortar (their physical systems) and intangibles (their monopoly franchises).

“With cable getting hyped as the glamour industry of the ‘80s, a lot of bankers found that cash-flow lending was something they could tolerate,” says Bank of New England’s Marien. Furthermore, she says, “as competition among lenders for cable loans increased and the glitter came off the industry, banks began looking for other cash-flow lending.”

Now that they have become converts, some broadcasters are turning to leverage with the fervor of zealots. In its $755-million takeover of Gulf Broadcast, Taft Broadcasting may take on debt of nearly twice its net worth of $330 million. To finance the ABC merger, Capital Cities will be borrowing about $2.2 billion (presumably to be converted later to public debt)--about five times the estimated 1985 cash flow of the pre-merger companies, but a lower multiple if the merger produces the economies of scale and the hot growth Wall Street anticipates.

Crash Usually Follows

Of course, any follower of the banking industry knows that the gusto with which lenders treat any new group of creditors is almost invariably followed by a crash--witness the carnage produced by bank over-lending to such popular credits as real estate developers, oil and gas companies, developing countries, and even cable-TV systems. Some bankers warn that lenders are overlooking the importance of fundamental credit analysis here too.

“We are now in that euphoric stage in broadcasting,” says Marien, “and we’ll probably have a shakeout.”

Even Sun Belt broadcasters--by far the most popular borrowers and those whose properties are most highly valued in the market--may already be experiencing a reevaluation. A. H. Belo’s Moroney says his company got unsolicited lending offers from banks as far afield as New York, Chicago, and Philadelphia when it sought financing for the Corinthian purchase (it chose to stay with Texas lenders).

The same company last week said its operating profit for the first quarter ended March 31--the major component of cash flow--will drop to less than half the $7 million reported in the same period a year ago. The reason? An industry-wide decline in broadcast revenues striking particularly hard in the Houston market.