by Erwin G. Krasnow, Doug Ferber & Bishop Cheen
Deal flow speaks volumes about the entrepreneurial appetite for broadcast properties, and with the FCC’s broadcast incentive auction drawing closer, Garvey Schubert Barer attorney Erwin G. Krasnow ([email protected]), DEFcom Advisors CEO Doug Ferber ([email protected]) and SNL Kagan Analyst/Consultant Bishop Cheen ([email protected]) have written an extensive commentary de-bunking common auction myths. Our previous installment discussed the myth that real estate brings value to a deal.
Here, the trio discuss the myth about banking on a 100% leveraged purchase.
Benjamin Franklin said that a person’s three best friends are an old wife (or old husband), an old dog, and ready money. Few buyers will be able to finance an acquisition with 100% equity. Also, buyers should not “bank” on finding 100% debt financing. Having an appropriate amount of equity on hand and sources of potential debt financing available are the elements of the “ready money” that buyers need so that they can transparently display to sellers their ability to close a transaction.
For most purchases, it is foolhardy to assume that banks or other lending institutions will supply most, much less all, of the necessary funds for an acquisition. A purchase price at eight to ten times cash flow effectively stretches this cash flow too thinly for the lender, especially when up to 80% of the acquisition price must be repaid with interest. Other than Wall Street and “seller paper,” banks and commercial finance companies are arguably the “cheapest” source of financing.
For very modest acquisitions such as a small market radio station, crowd funding might help to fund a small percentage of the deal. However, it is increasingly difficult to find conventional lenders for station acquisitions, especially a single station acquisition in a market, as it leaves the buyer vulnerable to competitive pressure from larger groups. Many lenders tend to focus on “bricks and sticks” that will rarely cover the purchase price. Some lenders, such as Bank of America, also have private equity arms that provide “mezzanine funding” or outright equity plays (at one time, Bank of America’s private equity group held 26% of the stock of Cumulus Media Inc. and served on its Audit Committee).
If you are able to work with a knowledgeable lender, consider getting the lender involved as early as possible. An experienced broadcast lender can help you to assess the marketplace, the appropriate multiples, and the risks in ways that may prove useful even if the lender does not ultimately bankroll the deal.
As of this writing, some hedge funds are loaning money to broadcast stations, making senior debt easier to secure. (Hedge funds are pools of capital that seek high returns by employing higher-risk strategies.) However, a senior secured lender typically requires a pledge of the “stock” of a licensing entity, and 100% of its physical assets as collateral. Such lenders may also require personal guarantees. Should a borrower wind up in default of a loan document’s financial covenants, the senior lender can compel a “fire sale” to recoup its investment.
In today’s marketplace, borrowing multiples used by banks and finance companies range from 3 to 5 times cash flow. Some lenders may stretch the borrowing multiple a little more if they believe there is enough upside potential, or if the buyer is a successful group owner but generally speaking, all the “moons have to line up” to attract a meaningful amount of debt financing.
Private equity greatly increases an entrepreneur’s blended “cost of capital.” While the interests of private equity investors are generally more closely aligned with those of the entrepreneur, these types of investors usually require a controlling interest in the company. In a venture-backed transaction, management often works for a carried interest which, in the nomenclature of private equity, is essentially a stock option pool representing 10-15% of the profits from the investment.
“Mezzanine financing,” sometimes referred to as “stretch senior financing,” costs somewhere between senior debt and equity. It acts more like senior debt and may have convertibility features (sometimes characterized to as “a wolf in sheep’s clothing”). Borrowers need to beware of the caveats and covenants that the mezzanine lender requests. In today’s market, the interest cost of mezzanine or bridge financing is effectively in the teens.
The amount of “personal equity capital” an entrepreneur contributes toward the purchase price will determine their ability to avoid the risks and potentially severe consequences of accepting restrictive financial covenants and overly intrusive equity investors. With lenders using five to eight-and-a-half times BCF, less equity is needed today than 10 years ago. At the same time, however, mezzanine financing may fill in the buyer’s financing holes and allow the deal to move forward. Generous lending multiples and terms are typically are reserved for group owners and veteran station buyers with proven track records of success in operations and in garnering handsome returns on invested capital.
As most veteran station investors have learned (often the hard way), leverage is a wonderful servant, but a terrible master. One of the consequences of over-leverage is that the buyer will have little or no room for error. This is particularly true in a buyer’s first year or two of ownership, but it also applies to a buyer adding a station to an existing market cluster.
Buyers will make mistakes. Some miscues might be easy to fix, such as hiring the wrong person; others will have more serious consequences, such as poor format decisions.
In all these cases, the buyer needs deep pockets to cover losses or reductions in BCF and to make the necessary adjustments. High leverage does not permit much room for mistakes, because the buyer may have no more funding available or the incremental cost may be prohibitively high.
Next time, the authors will cover the myth that anyone can be a turnaround artist.
Erwin Krasnow co-chairs the Communications Group of Garvey Schubert Barer, is Washington counsel to the Media Financial Management Association and former NAB general counsel. He has represented sellers and buyers of broadcasting, cable, tower and telecommunications properties in transactions totaling in excess of $21 billion. Reach him at: [email protected]/
Doug Ferber began his career as an entry level sales trainee for Bonneville International Corporation in 1984. After milestone assignments with Capital Cities/ABC and Interep National Radio Sales, Doug has brokered more than 50 transactions valued at over $400,000,000. He founded DEFcom Advisors, LLC, a Media Financial Consultancy Company, in 2009. Reach him at: [email protected]/
Bishop Cheen writes the “CAPITAL Letters” blog for SNL Kagan, is a consultant for Kagan Media Appraisals on valuations, expert witness and other financially focused assignments. He also teaches seminars and online courses (for the SNL Knowledge Center) on trends, economics, and valuations in the media/telecom industries. Bishop retired from Wells Fargo in 2012 as a managing director and senior analyst. Reach him at: [email protected]/
