Sinclair Broadcast Group: Neither Cash Nor Comcast Will Help It – Sinclair Broadcast Group, Inc. (NASDAQ:SBGI)

Everyone right now is focusing on the coronavirus, as well they should be. I don’t really see the point in trying to forecast stock movements over the next few weeks – in the short term, government bailouts and quarantines will govern this market.

Eventually, however, this madness will end, and when the market turns (assuming it hasn’t done that already), an investor’s shopping list for stocks should once again depend on long-term fundamentals. Those long-term fundamentals are what I will continue to focus on in my articles. Whenever the time comes to buy and hold stocks again, which ones should you buy and hold?

For a long time, I’ve been arguing that Sinclair Broadcast Group (SBGI) shouldn’t be on that list. In my view, its RSN bet is simply imploding, and there’s no easy way out of it now. But many have been pointing out that with Sinclair being pummeled so much harder than even the rest of the market – it was down to $13 at one point, compared to a 52-week high of $66.57 – that it was time to bet on a sharp rebound.

I am not convinced, and I will explain why.

The Argument For Sinclair

Generally speaking, arguments that Sinclair is fundamentally sound despite its monumental RSN troubles come in four separate arguments: its cash position, new revenue from legalized gambling, its distributors being eager to continue to carry Sinclair’s content – above all Comcast (CMCSA) – and its power to simply go over-the-top like everyone and their mother is doing these days if distributors won’t give it the terms it wants.

That’s kind of a lot to cover in one article, so today I am going to examine the two issues that most affect Sinclair’s position today, the cash and the Comcast deal, or lack thereof. The legalized gambling and OTT points are a little more speculative at this point but I still plan to tackle them in another article soon.

In short, I simply don’t agree that Sinclair can rely on cash or Comcast to help it. Comcast is probably indifferent at best to what happens in the RSN negotiations, that’s if it doesn’t think its interests will actually be advanced with a blackout. Nor should Sinclair’s cash position reassure investors.

Cash Is Not King Here

It has been argued by some that Sinclair’s sell-off must be overdone, since the company now has more cash on hand ($1.333 billion) than its current market cap at a $15 share price ($1.25 billion market cap.) How can Sinclair be worth less cash than it has in the bank, never mind the actual value of its ongoing business?

There are two problems with that. The first is that Sinclair does not have a net cash position at all. Along with its $1.333 billion of cash comes over $12 billion of debt, whose holders would have first call on any assets in a bankruptcy. Meaning precisely $0 of that cash is fairly attributable to shareholders.

The second is that the figure of $1.333 billion reflects a consolidated amount. As per Sinclair’s Q4 earnings call with management, only $384 million of it is in the legacy, profitable broadcast business. The other $949 million of cash is in the sports subsidiary. If the sports segment dips into the red, it will burn that cash to fulfill contractual obligations to teams.

Who Owns The Money?

The cash also might go faster than you think. Sinclair disclosed in its 2019 annual report that in January 2020, it burned $376 million in a single transaction when a “minority owner” of one of its stations – presumably a sports team – exercised its right to put their stake back to Sinclair. That number isn’t reflected in these figures, so a lot of cash burn will presumably already be reflected in the first quarter numbers alone.

And that’s before whatever cash burn comes from the subscriber declines on the RSNs. It’s a little unclear how that cash will burn this year, considering the Next Three’s suspensions of their seasons due to coronavirus. Generally, the expectation is that the standard playbook for sports work stoppages will be followed: the RSNs continue to pay as normal, and the sports leagues “make good” the losses down the road. But that is not certain, and this is uncharted territory for everyone. (It might be especially difficult to justify such an arrangement if MLB, the largest of the Next Three, refuses to pay its players during the suspension, an idea which has been mooted but not settled.)

Sinclair would almost be better off with a partial refund, given the disparity between the cost of the rights and the revenues they’re generating. But even if they got it that wouldn’t change the long-term trend line. The cash would not stop burning, just burn a bit more slowly.

And while there are provisions in US bankruptcy law allowing for the termination of executory contracts (i.e., Sinclair in bankruptcy would probably be allowed to walk away from its overpriced sports contracts with clubs) those provisions usually still allow the executory holders to become general unsecured creditors, which are higher priority than common shareholders.

In short, there is simply no way that Sinclair’s cash can represent a substantial asset if its RSNs remain underwater in their operations. The sports segment must burn its cash covering losses on the RSN deals before it can file for bankruptcy, and it must file for bankruptcy to get out of the rights deals it has cut with clubs.

So the only real question is, what is the future of the RSN segment?

Sinclair’s Leverage

That question, at this point, depends largely on Sinclair’s negotiations with Comcast, which represents somewhere around 30% of Sinclair’s total subscriber base. As I calculated in my last Sinclair article, Comcast’s revenues represent more than 100% of the operating income of Sinclair’s RSNs. In other words, with such low variable costs in the RSNs and almost any change in revenues flowing straight to the bottom line, losing Comcast will put the RSNs into the red, and leave them there so long as there is no deal.

Comcast’s path to a Sinclair deal – or break-up – will be both easier and harder than DISH’s (DISH) was. On the one hand, Comcast is, in addition to a major wireline operator, a fellow RSN owner just like Sinclair. In fact, it is the second-largest RSN operator in the country. So marking down RSN values with a pay cut or a blackout will cause mixed feelings at best at Comcast headquarters. What’s more, in some cities, Comcast and Sinclair RSNs compete for sports rights, and a Comcast move to undermine Sinclair could be seen by the DoJ as an anti-competitive move designed to entrench Comcast’s own sports monopoly in some cities.

On top of that, Comcast’s footprint is almost exclusively urban and suburban, unlike DISH’s heavy rural bent. So its customers are far more likely to be attached to the local sports teams that RSNs cover – and far more likely to get mad when they notice they’re gone. These are all reasons for Comcast to play nice with Sinclair.

Comcast’s Leverage

On the other hand, Comcast knows it has Sinclair over a barrel. Unlike DISH, which was both taking a gamble on a non-sports strategy that had never been tried before and couldn’t threaten Sinclair’s profitability on its own, Comcast is in precisely the opposite position – it knows an RSN-free approach can work, and it knows that Sinclair’s entire remaining profit stream depends on a deal. In other words, Sinclair needs Comcast even more than Comcast needs Sinclair.

My own take? Comcast will drive a hard bargain, and is not completely averse to walking away, despite the potential complications. The DoJ even gave approval to the Sprint (NYSE:S) merger, so the chances it would actually hit Comcast over Sinclair probably don’t bother it too much. As for its own RSNs, well, just because the DoJ won’t come after them doesn’t mean there wouldn’t be some benefits to kneecapping their prime competitor for sports rights.

And even setting that aside, there is little doubt that in the long run, all RSNs are living on borrowed time. Streaming is now advancing rapidly, with almost every major content creator developing their own service, and the sports leagues are expected to be little different. As such, Comcast probably doesn’t see long-term value in its own networks anyway. Their primary purpose was to make sure Comcast did not get shut out of sports content, which with sports about to go OTT will soon no longer be a concern anyway.

It Will Happen Something Like This

While Comcast is, I think, willing to walk away if the terms Sinclair asks are simply out of bounds, their first preference is doubtless to simply maintain the relationship – but at a lower price. Sinclair can’t really afford that, but with DISH proving they are not indispensable they may not have the leverage to avoid it, either.

Assuming, then, that Comcast either walks or obtains sufficient concessions such that Sinclair’s RSN division is put into the red another way, it should go something like this:

As a now money-losing enterprise, Sinclair’s RSNs fulfill their contractual obligations to the clubs as long as they are able to do so, burning the remaining cash on their balance sheet to do so. When the cash finally runs out and Sinclair management either can’t or won’t put any more cash in out of the legacy broadcast business to prop up the RSNs, they default on their payments to the clubs and seek to void the remaining years of the spots deals to end the cash burn. This, the bankruptcy court will probably agree to, but only after wiping out Sinclair’s common shareholder rights in the Diamond Sports Group (the RSN division.)

At that point, the voiding of the deals ends the cash burn, but also returns all TV rights to the clubs immediately. The clubs, in turn, probably pool those rights in the online operation, leaving the RSNs with no real content and frankly, no real reason for being. Or maybe the Diamond Group itself is put back to the clubs and they take over ownership of the RSNs. Either way, Sinclair’s stake is gone and what happens after that is kind of irrelevant as far as they’re concerned.

Investment Summary

Sinclair is on course, in my view, to seeing its Diamond Sports Group investment wiped out. Whether that comes by Comcast walking away like DISH did or simply securing substantially lower pricing isn’t really all that important, though my bet is on the latter. What matters is that it is hard to see Diamond turning a profit under the current market circumstances.

Sinclair will not be on my shopping list when the market finally starts to turn. A short is probably a little too bold, considering how far Sinclair has already fallen, so I’ll just be staying away.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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