ETM : Quarterly report update

May 14, 2011

ETM stock dived recently after the release of their 10Q. I gave the report a quick read to see what precipitated the decline.

Although revenue is up in an odd–numbered year (unusual because revenue tends to be down in odd-numbered years due to an absence of election advertising), net income declined precipitously. Reasons given by management are as follows :

  • There is a $1.5M merger/legal cost due to an abandoned acquisition of another radio group.
  • Management rolled out the PPM system, resulting in higher expenses. PPM stands for Portable People Meter, a new technology by Arbitron that measures radio listening through detection of inaudible codes embedded in radio broadcasts. This is more accurate than the old diary-based measurement. Radio stations incur costs when installing the encoders in their broadcast towers, but typically report a doubling of audience due to less forgetting of programs by listeners.
  • And of course, management gave themselves more options at these low prices, resulting in higher non-cash compensation expense.

The $9M acquisition of KUFX-FM resulted in higher revenues, but there new stations also probably have higher operating costs than the rest of ETM’s stations. Management may be anticipating that the drag of the new stations may continue for at least one year, and expects that operating expenses will remain increased through the balance of the year. This, I believe, is the main reason why the stock fell.

It seems that the rise in expenses is due mainly to management’s efforts to grow the company and perform infrastructure upgrades. This begs the question : should management divert cash to growing the company now rather than paying down debt?

I am inclined to give management the benefit of doubt for the moment. Even if management uses all of the cash flow to pay down debt, it would take a minimum of 10 years to completely pay off the debt, and the reduction in principal in the meantime will have minimal effect on interest expense given the low interest rate. Hence, it may be a better idea to try and grow the company to achieve a larger cash flow in the future, at the cost of increased operating leverage and fragility to economic conditions. That said, being saddled with lower cash flow for the rest of 2011 due to the acquisition is hardly a confidence builder. I shall be keeping a close eye on whether management manages to bring down operating costs in those new stations so that they approach previous operating margins, and of course, any actions taken to refinance the huge debt.

Frankly, unless the acquisition turns out to be some incredible hidden gem (and from the revenue reported, I don’t think so), the most important factor determining cash flow is the interest rate at which the debt is refinanced. This is a factor largely outside management’s control. Even if they divert all of cash flow to pay down debt, this is unlikely to impact coverage ratio much given the rapidly approaching refinance date in 2012. My take is that management is either confident that refinance is possible at some reasonable interest rate, or has essentially stopped worrying about the debt issue as something outside their sphere of control, and decided simply to concentrate on the business. Whatever the situation, it appears that management is going to refinance the debt at the last possible moment, and we’re headed for a showdown in 2012. Given the recent decline in the stock price, I have a market loss in my ETM position, but have decided to hang on to it for now, and will strong consider averaging down if the price ever hits the $6-7 range.

Disclosure : I have a long position in ETM

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