Gray Television Stock: Sell-Off An Overreaction? (NYSE:GTN)

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It is probably not often on Seeking Alpha that authors tell their readers that they swung and missed, but that is exactly what happened with our call on Gray Television (NYSE:GTN) back on August 26th of this year. That article highlighted our belief that Gray was a ‘Strong Buy’ for numerous reasons, but that we particularly liked the company’s positioning to grab a large chunk of political advertising dollars due to its ownership of stations in battleground states that had some very competitive races. All of the data appeared to point to strong spending from the campaigns, plus Gray and many of its peers were pointing to strong spending in primaries and early buys for the general election. Our bullishness did not seem misplaced, but to everyone’s surprise political ad dollars shifted to areas where traditionally they were not spent.

In what should have been areas soaking up political ad dollars – namely Arizona, Georgia, North Carolina, and Ohio – there was a big shift, and sometimes by both parties, to deploy funds elsewhere to prop up candidates in unusually tight races or to try and flip what was previously perceived as a “safe” seat. California, New York, and Oregon saw large increases in spending as some candidates underperformed which caused spending in key Gray Television markets to fall in the latest quarter.

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Data by YCharts

The drop-off in political spending is odd, and it hit other media names, with Townsquare Media (TSQ) also coming to mind as a name which saw a big miss on political advertising revenues. For Gray, how odd is this? Take a look at this quote from Bob Smith, Gray’s Chief Operating Officer, on the latest quarterly conference call:

“Interestingly, 2022 now appears to be the first election cycle in at least 20 years, in which the fourth quarter of the year does not produce more than half of our political advertising revenue for the full year. In July and early August, we expected that the year would rival 2020 to $652 million of political revenue on a combined historical basis.”

So Where Does This Leave Us?

Well even with the surprise miss on political advertising, which impacted top line revenues and EPS – both misses this past quarter, we have been buyers of Gray Television shares. The company continues to produce ample free cash flow, or FCF, and while the EBITDA portion of the net leverage calculation may not be growing in the current year, management is addressing the debt via debt retirement. In the third quarter management retired $100 million of their debt. Another $100 million was retired on November 1st, which means for FY 2022 the company has retired $250 million in debt prior to maturity (there is also $11 million retired due to amortization, which brings the total to $261 million). So overall debt is decreasing, which has the added benefit of lowering the company’s overall annual interest expense. Granted, a few million in interest expense savings seems trivial, but the majority of that does flow directly down to net income so it is a net positive for the company.

We also noticed in management’s comments from the conference call that their political advertising guidance is based off of none of the races going into run-offs, however in Gray’s home market of Georgia, the Senate race has in fact gone into a run-off and should see heavy spending – although not all of it on ads. Run-offs usually see additional spending on “ground game” initiatives and get-out-the-vote campaigns, but with many predicting $100 million to $125 million in additional spending, Gray should be able to grab some additional revenues in Q4 – which would be a big plus and could help them come in above the $505 million total political ad revenues they discussed on the call.

Another potential bright spot is auto, which appears to be returning to advertising. We have personally seen more ads on television over the last few months, and management indicated that auto saw positive spending year-over-year. This has not been confirmed by other types of media (for instance, radio companies have not seen across the board auto uptick) but it appears that broadcast television is seeing the return of both auto dealerships and the manufacturers themselves.

Lastly, Gray has retransmission contracts coming up for renegotiation. Management believes that they will get all of them taken care of without any issues. It has been a while since they had a renegotiated contract, but depending on how the negotiations go, Gray should be able to secure high enough rates to blunt the loss of subscribers.

Also, Gray announced today that it reached a new deal with The Walt Disney Company (DIS) to extend and renew the affiliations for all 25 markets of Gray’s current ABC affiliated stations.

Potential Issues And Risks

While we believe that Gray will see additional political money come in for the 2024 Presidential Cycle, we have to point out that there is about an 18-month period coming up where Gray will face the realities of the current macro-economic environment. Over that period, the company will have to manage EBITDA, debt reduction, leverage and floating rate debt. It might look ugly for a quarter or two… maybe more… but the company does have the 2024 political cycle to look forward to as well as retransmission negotiations and revenues from their Assembly Atlanta project beginning. With Comcast’s (CMCSA) NBCUniversal being the anchor tenant on launch, this is a de-risked real estate venture and should provide for healthy cash flows on day one.

Final Thoughts

With the stock being down over 40% since our last article, this has been a true loser. Our portfolios took a healthy hit on the position and we have looked at the reality of the situation. Leverage is going to remain at 5.4x for the near-term – even with some decently sized debt paydowns. While that might be troubling for some, we do see multiple avenues for the company to navigate through this period which could see core ad spending slump and further subscriber migration to lower margin OTT providers. The 2024 political ad dollars will start showing up in the second half of 2023 (maybe a bit earlier) but a lot will hinge on whether challengers emerge against an already declared Trump and whether Biden truly runs again. We suspect that only the Republicans will be running competitive primaries and that the spending will be front-loaded as it appears only big-name, well-funded candidates will be able to compete against Trump. With only one party running competitive primaries, we suspect that spending on the presidential level might be down but that Senate spending would increase with the GOP looking at a favorable map to reclaim a majority and the Democrats looking to defend some vulnerable seats.

Even considering all of that, we think that Gray will be able to continue to work on lowering its debt load and has ample cash flow to address its needs through 2024. We think that the sell-off has de-risked the shares, even with a potential economic pullback, and are still buyers (we even purchased some shares yesterday for client accounts). This is a great franchise, with attractive assets and a management team that is working through a balance sheet bloated with M&A debt. Long-term we think that this will once again be a winner and think that investors can sleep at night being buyers below the $12.50/share level.

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