Following the removal of national radio ownership limits in 1996 (that was the first term of the Bill Clinton Administration for those keeping score at home – after the Republicans gained control of the House in 1994), an orgy of buying radio station licenses and mergers occurred – funded by huge amounts of borrowed money.
This was the height of the Internet bubble, Enron, Worldcom, Adelphia, Tyco and the explosion of “wealth” during the “prosperity” of the Clinton years. People demanded at least 25% per year profit on their “investments”, or it wasn’t worth spending time talking about. It was the age of “irrational exuberance”.
For Big Radio, the belief was the value of radio licenses would go up forever and the notion of paying back that borrowed money was silly and naive. The increasing value of licenses would provide ever increasing collateral for the loans, and the cash flow of the stations would pay the interest. As licenses increased in value, that would justify further borrowing which would further bid up the value of station licenses. Selling an unimportant station in a minor market for $20 or 30 million could provide cash in an emergency. It was impossible to lose at this “game”!
The Clinton-era bubble burst in the fall of 2000, which slowed the urge to merge. One major company after another was found to be based on fraud, or at least overly optimistic forecasts.
In response, the Congress and President Bush created the Sarbanes-Oxley Act in 2002 – to reform the abuses of the past and to add in criminal penalties for accountants and management if they misrepresented the value of assets on their balance sheet of publicly traded companies or tried to conceal negative financial information.
What is a radio station really worth? The real estate, the tower, the buildings, the money in the bank, the equipment are pretty easy to put a value on, but what about the FCC license? That’s where most of the value of the radio station is – the piece of paper from the government saying that you have an exclusive right to broadcast on a specific frequency to a specific community.
Figuring out the value of an FCC license is not an easy question to answer – as auditors and bond rating companies started getting nervous, they told radio companies they must “write off” the “value” of those licenses beyond what can be readily proven they could be sold for at market prices. Each writedown of license values further cascaded requiring the licenses of other radio companies to be written down again. Where is the bottom?
Undermining the radio business model was new competition. Young people started downloading music on the internet and stuffing it into MP3 players (think iPod), millions of people showed they would pay Sirius and XM to have commercial free radio in their cars, and technologies like Internet Streaming created new ways for people to listen to “radio”.
Clear Channel was in the middle of “going private” when this collapse in license values became obvious. Sarbanes Oxley does not apply to “private” companies, which I believe is at least part of the motivation for a number of radio companies to “Go Private”. They could use borrowed money to buy up the existing publicly traded stock and no longer be obligated to tell the public about their financial condition and not be subject to Sarbanes Oxley prosecution when/if the bottom fell out.
The banks funding the deal wanted to back out as license prices started to plummet – but Clear Channel and the Private Equity firm putting the deal together took the banks to court and forced them to honor their commitments to fund the privatization. Ultimately the folks selling their interest in Clear Channel agreed to take less than their agreement to get the deal “done” before it collapsed completely.
The group of banks had to cough up around $18 billion to buy the Clear Channel’s bonds – knowing they could only resell them at a fraction of that amount. It turned out worse than their worst nightmare – at $.60 on the dollar, the banks still couldn’t find buyers even though the bonds carry a “coupon” rate of 10.75% (which works out to 18% if you incorporate the discount).
This was happening exactly at the time the entire investment banking crash happened. I’m not saying for certain that it was cause and effect – $18 billion is not that much money in the world of investment banking, but it might have been the flapping butterfly wings that started people wondering if the entire Leveraged Buy Out (LBO) game was over. When levers start to work in the opposite direction (against you), things do fall apart very fast.
People still holding out hope that this will problem will turn around and solve itself point to EBIDTA (Earnings Before Income Tax, Depreciation, Taxes and Amortization). In plain English, this is usually described as “Free Cash Flow” – the amount of money that flows into your bank account from your ongoing business operation. It’s an important measure, but to focus only on EBIDTA is like saying “My family budget is completely under control if you ignore my mortgage payment and that my house is now worth less than my mortgage”.
The best way to “find” the “real value” of a license is to point to a sale of a comparable license. To sell a station now to raise cash at a low price would cost them even more in accelerated writedowns of all their other stations. So the big guys work out deals to trade stations to each other where no cash changes hands. An arbitrary “value” is placed on the trade, but has no reality to the real cash sale value of either station.
Cash flow is the other main way to put a value on a radio license (but only should be used if there isn’t a liquid market in comparable sales). Looking at multiples of cash flow has the effect – that a very small downturn in revenue gets amplified as a huge loss in value of the license. It also encourages irrational short term expense cutting like firing your sale people or shifting costs from the individual stations to the corporate parent (think syndicated programming).
To ignore the carrying costs of the loan is to basically say that there is no intent to ever pay back the loan. The increase in value of the collateral will do that, or we’ll just declare bankruptcy some day if it doesn’t work out, or we’ll just borrow more money to pay the interest, or we’ll walk away and it becomes “someone else’s problem”… and that’s not even taking into account the Common Stock owners (who are the actual owners of the company, in theory) would expect a dividend or at least that the stock price goes up as earnings are retained inside the company.
Sound familiar? Maybe Tim Geithner can be talked into buying some Radio Company bonds. Then again, Mr Geithner and the Federal Reserve are playing exactly the same game.