In an effort to find companies that may actually benefit from the current multi-country quarantine, I decided to look at Meredith Corporation (MDP) (OTCPK:MDPEB). The fact that Meredith’s National Media Group delivers news and entertainment to ~185 million Americans monthly is a good sign in my estimation. Additionally, I think the company should benefit from the fact that they are the number one magazine operator in the United States. This is a terrible time for many reasons, but I think people who are forced to remain indoors will continue to rely on media companies like Meredith for their news and entertainment. In addition to the potential tailwinds for the company’s business, the shares have lost about 65% of their value over the past three months, and that has me intrigued. Finally, the current dividend yield seems compelling, so I want to try to understand how sustainable it is. For those who just can’t wait to get to the exciting conclusions derived in this article, I’ll come to the point. I think there’s a better than average chance that the dividend will be cut. I also think the shares are ridiculously cheap in light of the fact that this is a going concern. Finally, for those who remain nervous about buying, the options market provides an opportunity to collect significant premia.
The past several years have been interesting at Meredith in a number of key ways. While revenue has grown dramatically (up at a CAGR of about 14.8% over the past five years), net earnings have been quite volatile. Debt and resulting interest payments have also been on the rise over the past few years. I won’t say that management treats shareholders well, given the share structure (more on that below), but I will suggest that common shareholders benefit from the fact that they receive the same dividend as class B shares.
When reviewing the state of the financial world at Meredith, the most relevant question in my mind is how likely is this company to cut its dividend. If the dividend is safe, the investor will enjoy spectacular cash flow during the recession, and will likely see a huge capital gain when this crisis passes. At the same time, if the dividend is cut, shares will likely drop further in price, and the investor will enjoy a much less pleasant ride through the current crisis. Unfortunately, before getting into the question of dividend sustainability, we must start to understand the relationship between the various classes of shares at Meredith. At the moment, there are three classes: common, class B, and Series A preferred shares.
Is the Dividend Sustainable: Prelude
Before answering this question directly, I need to spend some time writing about the share structure here. With apologies to Orwell, all shareholders are equal, but some are more equal than others. This is certainly the case at Meredith, where class B shareholders are entitled to the same dividends as common shareholders, but get 10 votes per share. Thus, these class B shareholders exert effective control over the company as they control about 56% of the votes. Class B shares are non-trading and were given to family members of the founder.
In addition, both common and class B shares are subordinate to Series A preferred stock. On January 31, 2018, in exchange for an equity investment of $650 million, the company issued 650,000 perpetual convertible redeemable, non-voting Series A preferred stock, as well as detachable warrants to purchase up to 1,625,000 shares of common stock with a strike of $1. The dividends on Series A perpetuals must be paid before common shareholders can receive any dividends, and the Series A are non-callable for the first three years after issuance.
The following table outlines future cash commitments, and I’ve highlighted the required payments of Series A dividends for your enjoyment and edification.
Source: latest 10-K
To put these figures in context, the company spent a total of $161.9 million in dividends in 2019 and $121.5 million in 2018. The Series A preferred shares received $55.9 million of that in 2019, and $22.9 million of the $121.5 spent in 2018. I would recommend that interested shareholders read note 14 of the latest 10-K for further details on the Series A preferred shares. I think the following excerpt from the latest 10-Q describes the relative benefit to various classes of shares.
Source: latest 10-Q
I don’t consider the issuance of the Series A to have been good for then current owners. My hope is that the wealth destroying consequences of this decision have been largely priced into the shares.
Is the Dividend Sustainable: Question (finally) Answered
I think net income is a relevant measure because things like depreciation, share-based compensation, and asset write-downs are real things with real economic consequences. That said, I think dividend sustainability is all about cash, and so I think it’s best to look at the cash-generating capacity of the firm. Per the contractual obligations table above, I estimate that the company will be spending about $290 million over the next six months, and a further $916 million over the period June 2020-June 2023. So, the company will be spending ~$1.2 billion over the next 3 ½ years. This compares to cash on hand of about $21 million, and $291 million available under the revolving credit facility, for a shortfall of ~$880 million that must be covered by cash flow. Over the past 3 ½ years, the firm generated cash from operations of ~$685.9 million. Assuming the next three years resembles the past (a big assumption, I know), my back-of-the- envelope calculation then suggests that the company will need to find another $202 million somewhere. Here’s my arithmetic: $1.2 billion outflow – $312 available immediately-$685.9 million assumed CFO = ~$202 million. If the company can’t raise this cash in the credit markets, there’s a high degree of probability that the company will need to suspend the dividend.
Source: Company filings
I think the company is in danger of cutting its dividend, and I think investors have been devastated in a very short time. That said, I think the way investors make money is by exploiting the disconnect between current assumptions about a company as expressed by that company’s stock, and the reality of the business. For that reason, I want to look at the stock as a thing distinct from the actual business, to see if the market has “gotten ahead of itself” on the downside. I judge the soundness of the market’s current view in a host of ways, ranging from the more simple to the more complex. On the simple side, I look at the relationship between price and some measure of economic value, like earnings, free cash flow and the like. In this case, given that earnings have been so volatile, I decided to look at price to book value. On that measure, the shares have fallen back down to great financial crisis levels, per the following:
In addition to the above, I also want to try to understand what the market is forecasting about the future. In order to do that, I use the methodology outlined by Professor Stephen Penman in his book “Accounting for Value.” In this book, Penman walks investors through how they can, using the magic of high school algebra, isolate the “g” (growth) function in a standard finance formula. This allows them to understand what the market must be assuming about the future of a given company, given its current price. Taking all of this into account in this case suggests that the company will grow at ~.3% in perpetuity. I consider this to be an extraordinarily pessimistic forecast.
Options As Alternative
I can fully understand why someone would be nervous about buying these shares at current levels. The share structure is not particularly shareholder-friendly in my estimation, and there’s a significant chance that the dividend will be cut. Were it not for the current valuation, I wouldn’t consider this company at all. That said, even the most skeptical among us must acknowledge that there’s some value here. For such people I recommend selling put options on Meredith. If, as I suspect, the shares rally from these levels, the investor simply pockets the premium. If the shares continue to drop in price, the investor will be obliged to buy, but will do so at levels well below those seen during the great financial crisis.
At the moment, my favorite options to sell are the September puts with a strike of $10. These are currently bid-asked at $1.30-1.85. If the investor simply takes the bid, and is subsequently exercised, they’ll be buying at a net price of $8.70. This is about 8% below the lowest price seen during the 2008 financial crisis, and I think that’s a great entry point. Of course, if the shares remain above $10, the investor will pocket $1.30 for taking on what I consider to be a very reasonable six-month obligation.
In fairness, I should point out the risks associated with this strategy. Every investment comes with risks, and short put options are no different. I think the risks of put options are very similar to the risks associated with a long stock position. If the shares drop in price, the stockholder loses money, and the short put writer will be obliged to buy the stock. Thus, both long stock and short put investors want to see higher stock prices. Also, some (though certainly not all) short put writers don’t want to actually buy the stock, they simply want to collect premia and move on. For these people, actually owning the stock is a problem. I should say that I’m not such a person. I’m happy owning stocks, but at a price that I deem acceptable.
In my view, put writers take on risk, but they take on less risk (sometimes significantly less risk) than stock buyers in the following way. Short put writers generate income simply for taking on the obligation to buy a business that they like at a price that they find attractive. This is an objectively better circumstance than the person who takes the prevailing market price for the shares. This is why I consider the risks of selling puts on a given day to be far lower than the risks associated with simply buying the stock on that day. Selling puts is analogous to receiving money for taking on the obligation to buy the stuff you were going to buy anyway, at a lower price than is currently on offer. There’s risk there, but it’s far less than simply buying in my estimation.
It’s fair to say that most small investors can’t exert strong control at a given company, and that’s certainly the case with small shareholders in this case. The difference with Meredith, though, is the fact that the 470 holders of record of Class B stock exert full control over this company. That may be troublesome for some investors. Also troublesome is the idea that the dividend is at risk in my estimation. Comparing previous cash from operations and available cash and credit facilities on the one hand to immediate financial obligations creates a fairly significant shortfall. This presents the very real chance that the dividend will be suspended here, at least temporarily. If that happens, the market will likely react negatively to the news.
That said, this is a media company at a time when demand for information and entertainment is relatively high. Also, the shares are priced at 2008 financial crisis levels, and the market seems to be pricing in a great deal of bad news here, including the probability of a dividend cut. If an investor assumes, as I do, that the company will survive the current crisis, they must buy the shares. I think the market is pricing in too much bad news here, and I think investors with a reasonably long time horizon are in a position to exploit that mispricing. Failing that, the short puts recommended offer what I consider to be a win-win trade.
Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in MDP over 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.
Additional disclosure: In addition to buying shares, I’ll be selling 10 of the puts mentioned in this article.