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Media General - This Pig Might Fly

 September 28, 2011 07:19 PM

As a deep value investor, you often spend time looking at pretty awful businesses.  My fund does invest in some pretty solid businesses at cheap valuations but some of the best winners from my experience have been buying some pretty crappy businesses when valuation was at historical lows, near term prospects were relatively stronger than what the market was impounding, and credit risk was also lower than market expectations.  One of the bigger challenges is acknowledging that the business sucks for the long-term so in some cases, particularly during heavy periods of market volatility, you can see the value of these positions fluctuate considerably whereby you want to chastise yourself for owning an obvious turd.  Nonetheless, if the analysis is correct and you can avoid being your own enemy, and weight the position appropriately within your portfolio, the risk/reward of a busted but deeply undervalued holding can make a significant positive contribution to your portfolio.

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Whenever I consider a potential investment, the first thing I do is weigh the bear case (or bull case for shorting).  I want to familiarize myself with what the key risks of a potential investment are and what the skeptics see and then try to put some holes in the bear case when developing the bull case for the company.  After that, I try to reconcile the bad and good of the potential investment to its current valuation and if it looks like there's a chance to make meaningful gains (100+%) from current levels, I'll build a position slowly.

That brings me to Media General (MEG), which I think may offer one of the best risk/reward opportunities for the next year.  MEG is a newspaper and broadcast television company, offering 3 metropolitan newspapers, 20 community paper, and 18 broadcast television stations, operating primarily in Virginia, Tennessee, Florida, North Carolina, Ohio, and Rhode Island.  Aside from the newspaper and television segments, MEG owns Dealtaker, a web-based coupon site, as well as roughly 200 specialty publications in specific smaller communities.  Those wanting further detail on MEG's operations and financials can review the company's SEC filings.  Upon reviewing those filings, the following points will likely resonate as the key points for MEG bears:

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1) Levered Pig: MEG has a horrific balance sheet.  Based on MEG's Q2 2011 balance sheet, the company carries about $650MM in net debt excluding its $163MM pension liability.  On a net debt/LTM EBITDA basis, MEG is levered at about 6.5x LTM EBITDA.  However, 2010 benefited from ad spending related to the nationwide political races, resulting in much higher operating results than in off-election years such as 2011.  As a result, MEG's net debt/EBITDA ratio could be much higher as the year progresses, indicating less breathing room for the company.

MEG also has little in the way of undervalued assets on its balance sheet.  MEG management squandered cash in prior years, overpaying for acquisitions leading to $355MM of goodwill.  MEG has about $388MM in PPE and does in fact own a considerable amount of land.  In fact most of MEG's television stations are located on land owned by MEG.  MEG also owns a number of its buildings and all of its newspaper production equipment and facilities.  Nonetheless, all of these assets have been pledged as collateral.  While the value of MEG's FCC licenses may have some value beyond the $211MM recognized on the balance sheet, overall MEG's assets providing little breathing room in the event of a company credit crunch.

For example, refineries in recent years traded for cheap valuations due to high debt to cash flow metrics but the liquidation value of their key assets - the refineries - were in a number cases much higher than the depreciated book value.  This provided some margin of safety in the event of a credit issue.  MEG does not have that asset backstop. 2) Horrific management and governance: MEG's management team is awful.  CEO Marshall Morton has led MEG's overpaying acquisition spree in digital media, acquiring Blackdot and DealTaker in recent years.  DealTaker recently suffered a big set back in February 2011 when Google altered its search algorithm.  Since then, MEG is blowing money on consultants to help fix this issue but as of Q2 2011 has nothing to show for it except continuing declining sales and negative cash flow for this segment.

In addition, management owns few overall shares with CEO Morton owning shares solely through exercisable options and stock awards.  Despite the poor historical business performance of MEG under Morton and his team's leadership, MEG investors pay MEG's management team over $6MM per its latest proxy.  This total compensation represents over 10% of MEG's current equity value.  What is particularly unfortunate is that in 2011, MEG has instituted aggressive firmwide layoffs yet there appears to be little to no indication that MEG management is willing to take one for the team and scale back its pay.  This can be problematic as those responsible for the content generation are let go and what's left is an overpaid, incompetent, uninspiring management team.

MEG shares are also split in the typical Class A and Class B structures, whereby most investors have little control.  The majority of control - via Class B shares - is held by MEG's Chairman, J. Stewart Bryan III, a direct descendant of MEG's founder.  Despite MEG management destroying the company, the Chairman has shown little interest in replacing this management team.  The Board is also feckless, content to pocket in aggregate $1.2MM in fees in 2010...who knows for what other than to loot shareholders.

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