Here's a puzzler. How can a listed entity with cash backing of $1.49 per unit, an entity which throws off cash earnings of 40c per unit from its operating businesses, be valued by the market at just 65c?
This is the question which has bedevilled Macquarie Media Group and its security holders who have looked on despondently this year as the stock shed more than 80% of its value. True, anything with debt has been rough-handled, media stocks generally are on the nose, and MMG is beset with "Macquarie fatigue" along with the rest of the stapled stable.
Still, it would appear to be a pretty compelling value proposition. So management hands down the results of its "capital management review" tomorrow hoping to restore a bit of confidence. A big cut in distributions to pay down debt is on the cards.
What went wrong? MMG was floated at $4.75 per unit in 2005 at a time when the mother was spreading its wings away from its traditional infrastructure funds into any asset class which could loosely be defined as "infrastructure-like", that is assets with steady cash-flows over a long term.
Some media businesses apparently showed these characteristics and the seed asset for MMG became Australia's leading regional radio businesses, previously known as RG Capital Radio and DMG Regional Radio. These radio businesses, slotted into the requisitely complex stapled structure in 2004, were capably run by Rhys Holleran, and still are.
They have been among the standout performers of the media sector in Australia, consistently growing earnings in good times and bad.
After the float, MMG did a few good deals - such as the acquisition and subsequent disposal of a Taiwanese pay-TV operation - .and some not so good, such as the acquisition of regional newspapers in the USA and the purchase of the regional TV business of Southern Cross Broadcasting at the top of the cycle.
The upshot? MMG now holds a smallish US newspaper business (2009 EBITDA before around $26 million) and a large Australian regional radio and TV business (2008 EBITDA around $140 million).
As has been its wont, the Macquarie mothership loaded these operating assets up with as much debt as the banks were prepared to lend.
The US newspapers are carrying debt of $US143 million and the Australian media business is geared to around 6x EBITDA with total debt of $849 million. All of this debt is held at an asset level with no recourse to other entities within the group.
On the face of it, this means that the $320 million in cash that is held at a group level is out of reach of the banks.
So why the 65c stock price?
It is only since September 2008 that the MMG share price has started to look particularly ill. Until then, the price had been tracking above $3.50 as investors believed that regional media assets should be valued at close to 10x EBITDA, while the strong cash-flow from the business was expected to support a dividend north of 40c per security.
In three months this has all changed. With the likes of News Corp shares having traded at as low as 4x EBITDA in the last couple of months it is not clear how MMG's assets, which are geared to well in excess of this multiple, have any equity value at all in the current market.
Moreover, although the operating businesses would still be generating strong cash-flow there have been hints that MMG might change its distribution policy. If so, the dividend alone would not prop up the share price.
Attention has consequently turned to the cash balance held at an MMG group level and whether or not this represented the best guide to the value of the stock.
For the cash balance to put a floor under the MMG share price, the market would have to be convinced that the cash was either going to be returned to investors, or deployed in a fashion which unambiguously created value.
The key risks to the cash balance were that MMG would splash it on further acquisitions, or that the cash would be applied to reducing the debt burden on operating assets - presumably to support a refinancing of the over-geared businesses.
Unfortunately, the MMG Board does not have a track record that inspires confidence. Let's look at the decisions.
First to the over-priced acquisitions: Southern Cross Broadcasting was bought at 13x EBITDA, and the benefits fell - as is so often the case - not to MMG investors but into the Macquarie Group's bonus pool via lush advisory fees.
Secondly, and as recently as October 2008, the board demonstrated a lack of understanding of the current macro environment. In announcing its review of capital management, MMG was at pains to highlight that this review would focus on evaluating "the potential benefits to security holders of the partial pre-payment of business-level debt".
To even consider this approach overlooks the obvious; that in the current market cash is king. Even if the entire cash balance were applied to reducing the debt on the Australian business it would still be geared to close to 4x EBITDA.
Thanks to the uncertain earnings outlook, and the multiple on which a refinancing could be achieved in due course, there is too great a risk that prepayment of debt would be to throw good money after bad. Remember, the debt is in the assets, not the company.
A further issue with debt repayment is the alignment, or otherwise, or MMG management's interests with those of shareholders.
Curiously, if the current share price and cash balances were to be maintained, Macquarie would never again be entitled to even a base management fee from MMG as the group-level cash balance is netted off the market capitalisation before calculating Macquarie's 1.5% base fee. The cash balance is currently greater than the market capitalisation. Applying the cash to debt reduction at an operating company level would be in the interest of Macquarie fees, rather than MMG unit-holders.
Surely the independent directors of MMG would always put investor interests in front of Macquarie?
At the inception of MMG, the MMG prospectus made clear that, in most circumstances, the management company (wholly owned by Macquarie) would be entitled to an annual base fee of 1.5% of the MMG market capitalisation.
Presumably in order to justify this fee - which at the time was expected to be more than $15 million a year - the prospectus also said the management company was to employ the 10 most senior managers in the radio business. These executives were seconded from the bank into the operating businesses but their employment costs were to have been met by the manager (the bank - now the group).
Somewhere along the way though this changed. The fine print of the Asset Advisory Agreement, as it now appears on the MMG website, reveals that just two employees of the Australian media business, that is the CEO and CFO, are employed by the manager and seconded to the business.
The other eight managers have been transferred back into the operating businesses. Assuming a salary of $250,000 per head, this represents a transfer of expenses of around $2 million annually away from the manager. There has been a transfer of value out of MMG back into the mothership - and nobody seems to have picked up on it.
mwest@fairfax.com.au
BusinessDay
