Management’s string of value destruction maneuvers in recent years led to an expected dose of investor skepticism.  When shares reached $6+ in early March, MEG management did what it always does – give the shaft to shareholders – with a pathetically worded announcement that it could give no assurances of reaching an agreement to refinance with its lenders.  Just one week later management wanted to let investors know it was back on track but by then the damage was done as shares continue to be pressured to $3.

However, last week shareholders experienced a shock…for once management’s action did not make things worse.  In what I see as an extremely fortunate event, BH Media acquired the entire portfolio of MEG’s newspaper divisions except for the Tampa Tribune for $142MM.  This is an acceptable multiple and the overall cash used to reduce debt is worth a great deal to MEG investors.

In addition, BH Finance is providing a market rate Term Loan (market rate for MEG’s credit quality and where high yield bonds were trading).  The Term Loan carries an interest rate of 10.5% but will be priced at a discount of 11.5%.  In addition Buffett gets a 20% stake in MEG.  The stock reaction from last week suggests that investors may have thought this was great deal as it means MEG will not be saddled with the operational drag of the newspaper division but then after a few days may have believed that the overall terms were not that appealing.

The reality is that the refinancing and sale combination is phenomenal in terms of cleaning up the company’s operations and balance sheet in an expeditious manner.  When factoring in the warrants’ dilutive impact and discounted term loan, this is still a good deal for MEG.  In addition, in some respects it is actually much better than what a potential financing deal would have entailed.  There are a few positives to discuss with regards to BH Finance’s deal as opposed to what a typical arrangement could have yielded.

1) MEG is in the Term Loan B market – institutional investors which include hedge funds.  In a typical syndication a number of investors – some passive and others with a more aggressive stance – would hold the debt.  In instances where there is some sort of credit issue, the more aggressive holders can force conditions that may be pernicious to shareholders.  The BH Media deal looks appealing in that Buffett looks to be taking down the entire deal.  MEG essentially has “one bank” as a result with that same creditor now also being a significant equity investor.

2) The terms of the new financing do away with the leverage step-downs that Bank of America’s (“BAC”) prior deal had as well as what a new deal would have probably included.  Investors will recall that BAC’s initial deal had a leverage schedule which fluctuated based on the political cycle.  The new deal does not have this covenant and keeps it simple enough even for the company’s sorry management team at the helm.  Pricing came come down significantly from 10.5% when leverage is above 3.5x EBITDA to 9.0% under this level.  As with the prior financing, BH Finance gets first dibs on any asset sales.

These are two better qualities of the Berkshire deal relative to what JP Morgan would have achieved heading out to other institutional investors on MEG’s behalf.   The batch sale of MEG’s newspaper division was also a big positive.  Heading into MEG’s deadline for refinancing, there was a possibility that MEG had to refinance while still maintaining its newspaper segment which had become an operational drag since 2008.  A combined newspaper and television operation would have probably resulted in a more difficult refinancing with respect to the overall terms.  The ability to sell off pretty much the entire division for an acceptable valuation is another great result because in one fell swoop – all due to Buffett – MEG was able to streamline operations and secure very acceptable financing.

So how much is MEG now worth?  I’d say a hell of a lot more than the $3.50 or so where it currently is valued.  I think MEG will pursue selling off the Tampa Tribune and it may in fact get a halfway decent price for it.  Table I presents my estimate of how MEG’s capital structure will look following the closing of its newspaper sale and refinancing with BH Media and BH Finance, respectively.  As per MEG’s press release, the company will retain $25MM on its book and then use the balance to redeem some of its 2017 high yield bonds.  I also expect about $20MM in various cash fees/expenses that MEG will pay out from the newspaper proceeds and further estimate that the Company currently has about $10MM of cash on its books through Q2 2012.  Q1 had a cash balance of $12MM which was largely after the banks raided the company for management’s mistakes requiring covenant waivers and refinancing efforts.  I think between an additional $2MM off the books and then deducting another $20MM from the newspaper proceeds that I am being quite conservative in where MEG’s cash balance will be.

TABLE I: MEG CAPITAL STRUCTURE POST CLOSING ($MM)

MEG retained the pension from the newspaper sale which is consistent with what the New York Times Company (“NYT”) did when disposing of the Regional Media Group.  When excluding the pension, MEG’s debt is quite manageable based on my estimate for 2012 EBITDA.  I would also argue that peers such as Gray Television (“GTN”) and LIN TV (“TVL”) which also have defined benefit plans that require funding are not valued based on these obligations.  Even CBS Corp (“CBS”) maintains a benefit obligation liability of $1.8B which would increase its total leverage by 31% if it was included in its enterprise value but for the most part it’s only until a company is facing issues where the pension issue arises.  This makes sense from the perspective that if a company is forced into restructuring, pension beneficiaries are claimants so their “weight” from the perspective of further reducing the equity value of a currently distressed company’s equity valuation would be more acute.  However, I would argue that when a company is in a better financial position, the overall pension shortfall may not warrant as much consideration, particularly given the long tail aspect of the plans and how the values can shift through various actuarial assumptions.

I also believe that MEG’s overall pension liability may have a true eventual “cash” cost below what is recognized on its books.  In 2010 and 2011, MEG recognized experience losses or actuarial losses of $19MM and $42MM, respectively.  These two factors boosted the overall benefit obligation to $451MM.  However these actuarial gains and losses can fluctuate considerably due to the return on plan assets, expected versus actual health care costs, discount rate changes, etc.  The main point is that these adjustments can be volatile and lumpy but over time; if the actuaries are relatively accurate and the plan utilizes conservative estimates, then these significant adjustments will be smoothed over time.  For example in 2008 and 2007, MEG recognized very large actuarial gains ($50MM+ in total over those two years)  while the actuarial loss in 2009 was rather insignificant.  It would not be inconceivable to recognize large actuarial gains which could reduce the pension obligation in the future.

In addition, MEG’s plan in the past two years has not performed well.  However, the plan has a 66% allocation to equities and while there may be more immediate issues regarding today’s equity markets, market historians would probably expect that the secular equity bear market may end in the next 2-5 years which would get towards the length of the longer secular bear markets (14-18 years).  This would mean that MEG’s retirement plan could be in position to perform well and MEG’s overall plan obligations may be smaller than what the books currently recognize.

In any event, with the company’s financing issues resolved, MEG should start to be valued closer towards pure play broadcast companies.  Table II provides a breakdown of how I calculate MEG’s 2012 EBITDA.

TABLE II: MEG 2012 ESTIMATE ($MM)

In 2012, I assume MEG’s television division brings in about $331MM in revenue while its failed DealTaker and other internet businesses generate about $32MM in revenue.  I assume MEG can generate ~34% EBITDA margins for its broadcast division while the Digital segment breaks even on an EBITDA basis.  If management can make sure about one thing, it’s that they get paid no matter what so I assume a $10MM corporate overhead – consistent with what MEG projected in a recent 8-K when showing how the business would look without a newspaper segment.

On this basis, MEG would generate about $106MM in EBITDA in 2012 and crank out about $12MM in free cash flow.  Recall that I have already deducted $20MM from the total proceeds from the newspaper sale for various fees related to these transactions so the pro forma free cash flow may actually be close to total cash flow for 2012 if the estimates are correct.

At $3.50, MEG has a market capitalization of about $95MM assuming full dilution and an Enterprise Value of what could be estimated to be $617MM based on the figures in Table I.  This means MEG is valued at about 5.8x EV/2012E EBITDA.  However, the EV incorporates the Tampa Tribune or lack of a sale in terms of further debt reduction while the EBITDA figure gives no credit to it.  Given that the Republican National Convention will be held in Tampa, FL and the importance of FL as a battleground state I think that Tampa Tribune may do better than what investors may expect.

In Q1 2012, MEG’s FL division generated $32MM in revenue and $2MM in EBITDA.  This represents a 7% EBITDA margin and compares to the -$2MM EBITDA and $34MM in revenue MEG’s FL division generated in Q1 2011.  So the improvement in generating cash from the struggling segment is a good sign but more importantly the margins compare somewhat favorably against Q1 2010, the last time there was a strong political component.  In Q1 2010, MEG’s FL division generated $38MM in revenue and $3MM in EBITDA which translates into an 8% EBITDA margin.  More importantly, on the Q1 2012 conference call management mentioned a $1MM one-time charge in FL associated with consolidating a packaging and distribution center.  Excluding this one-time charge would boost FL’s Q1 2010 EBITDA to $3MM on $32MM of revenue, which would represent about a 10% EBITDA margin.

This is very good news because FL has been a massive drag on the company.  While revenue degradation can still occur I would expect a trend similar to 2010 for the FL division.  Like 2012, Q1 2010 experienced a sharp decline in sales against Q1 2009 (-9+%) but was flat by Q2 2010 and notched slight gains against each subsequent comparable quarter in 2010.   What this means is that Q2 2012 should be close to matching Q2 2011 in terms of revenue, perhaps even higher in preparation for the Republican National Convention, and H2 2012 could potentially be a bit higher (+2%) relative to H2 2011.  In summary the FL segment could generate revenues equal to or slightly higher than the $133MM generated in 2011.

The difference will be that the EBITDA margins should be much higher.  In 2011 FL notched -$0.33MM EBITDA.  MEG should be able to generate EBITDA margins comparable to 2010 given the evidence in Q1 2012.  This means EBITDA ranging from $15MM-$20MM from FL should be very possible with most of the EBITDA generated in H2, particularly Q4 as television ads will drive operating leverage.  The challenge is determining how much of this will be from the Tampa Tribune operation.

The Tampa Tribune is a significant part of MEG’s newspaper division.  The FL segment as a whole represents 22% of MEG’s revenue but the company does not break out the contribution from broadcast and newspapers at the geographic level.  More importantly, Tampa was the initial focus of management’s failed convergence strategy which interwove MEG’s broadcast, online, and newspaper presences in the Tampa market.  Assuming about 22% of MEG’s 2011 newspaper segment would suggest a topline of $66MM.  This seems possible based on circulation figures.  MEG has just one broadcast affiliate in FL which is the 14th ranked designated market area (“DMA”) in the U.S. and MEG’s highest DMA station so it can generate significant revenue.  Another factor to consider is how much TBO.com generates in topline and EBITDA and whether it falls under the newspaper or broadcast segment.

For simplicity, let’s assume the Tampa Tribune generates revenues of $60MM.  If the changes management implemented stick, perhaps the newspaper can realize EBITDA margins of 10%.  This would be below comparable peers but would still bring in another $6MM of EBITDA.  This would boost MEG’s total EBITDA for 2012 to $112MM, implying a valuation of 5.6x EV/2012E EBITDA.  More importantly it would boost overall free cash flow by that same amount.

TABLE III: MEG 2012 PRO FORMA ESTIMATE INCLUDE TAMPA TRIBUNE

MEG has historically traded around 6.8x EV/EBITDA but this valuation was tethered to a company with a significant newspaper and broadcast operation.  With most of the newspaper operations sold and the prospect that the Tampa Tribune could be sold, MEG should command a higher multiple.  In addition, as the year progresses, MEG’s capitalization should continue to improve as it should be able to reduce its debt load by about $10-$20MM (depending on the Tampa Tribune).  This means by year-end MEG will have about $500-$510MM in net debt against $106-$112MM in EBITDA, which would put the company at or below 5.0x leverage with no prospect of as intense a decline in 2013 that it had when it still owned all of the newspapers.  While broadcast revenues will decline in 2013, margins in off years are still very strong (30+%).

A 6.8x multiple would imply a valuation of about $8.50/share when using my estimates for how MEG’s capitalization will look post the BH Media transaction and accounting for BH Media’s warrants.  By year-end, it is possible that another $10-20MM in debt is reduced which would bring share value up close to $1. The reason the jump is so significant is because each dollar of cash flow erases some very expensive debt.  In addition, pure-play broadcasters are valued from 6-9x EV/EBITDA and one could argue that MEG deserves a valuation closer towards the mid point or higher for its peers when factoring the disposal of newspapers and accounting for the high quality locations of its key stations.

Another potential value creation avenue is the sale of the Tampa Tribune.  Owning just one newspaper operation is probably not very efficient and given the actions to sell off all of the other newspapers, the Tampa Tribune could be fixed up for sale.  Once again, if the newspaper can generate EBITDA margins of 10%, then a valuation of $20-30MM could be possible.  Any valuation above $25MM, achievable if operations can be further improved, starts to become a value creation event for MEG.

Lastly, as I’ve repeated in each prior post, another potential value creation event would be selling off the entire company.  BH Media will now occupy a Board seat and I don’t expect the blind subservience other Board members have.  Management has demonstrated a clear lack of competence in every facet of managing MEG.  The only thing they have done thus far is get lucky in terms of finding a buyer for their assets and providing them financing.  As an owner of MEG, BH Media will get an up close look at the type of  management this team brings and I suspect will compare the value management adds or detracts.  To any sane observer, management is just pitiful and MEG’s value suffers for it.

Just three weeks ago, TVL paid $342MM to acquire New Vision.  New Vision was reportedly valued at just under 10.0x EBITDA but TVL believes it’s acquisition multiple is closer to 4.5x EBITDA.  This is consistent with what Sinclair Broadcasting (“SBGI”) recognized when acquiring Freedom Communications in November 2011 where it paid about 9.0x EBITDA as far as the seller was concerned but was paying closer to 6.0x when factoring in synergies and tax benefits.  MEG’s stations are in the same valuation range implying a $950MM valuation based on an average EBITDA of $95MM when accounting for political and non-political years.  Add on the Tampa Tribune for $30MM and an investor would walk away with $8-9 after retiring corporate and pension debt.

Overall the BH Media deal is a major win for MEG investors.  The high yield bonds, which traded at roughly $95 before the announcement are now around $104, a very strong move.  This move is not just a reflection of better credit quality but also a move towards the pricing of pure-play television broadcasters in the high-yield space.   There are a number of positives ahead for MEG this year given the Summer Olympics, both Democratic and Republican National Conventions in key MEG regions, and the forthcoming ad spending set to ramp up as the General Election gets in gear.  More importantly the overhang of refinancing risk is now removed as is the overall operational drag as the bulk of newspapers have now been sold.  Prior to these actions, the combination of horrid management, bad assets, and high leverage warranted the heavy short interest in the stock.  At this point the company has a cleaner balance sheet, the ability to generate cash flow, sell off additional asset sales to deleverage, and does not have a segment with the prospect of becoming a massive operational drag in 2013.  Nonetheless, the stock’s valuation is actually a bit cheaper from a valuation perspective despite all of the positive benefits stemming from the BH Media transaction.  I expect that the valuation multiple should improve as investors begin to understand this inefficiency.

DISCLOSURE: AUTHOR MANAGES A HEDGE FUND AND MANAGED ACCOUNTS LONG MEG.

MEG’s voting structure with A and B Class shares is very favorable to the Company’s incompetent management team.  Class B stockholders are able to place six Board members while Class A shareholders can only vote for three Board members.  While this limits the influence of Class A shareholders, MEG shareholders can still send a loud message to management and the Board.

MEG is encouraging shareholders to vote for the following Class A directors.  I have included my recommendation next to each suggested Board member for investors to review.  MEG investors can refer to the proxy on page 36 to get the full bios as my commentary and recommendations will focus on the ability of the suggested Board member to actually add value to MEG.

Scott D. Anthony – Managing Director, Innosight LLC:   MEG investors should know that Mr. Anthony is based in Singapore.  MEG is facing numerous financial and operational challenges so having a Board member located and operating in a business environment far different than MEG’s only allows this member to be the typical “yes man” that management seeks.  I cannot find any record of Mr. Anthony every purchasing a single share of MEG stock, further suggesting he has little confidence in the Company.  The only ownership stake Mr. Anthony has in MEG are 47,045 deferred stock units along with collecting an annual cash fee of roughly $30,000 for his “guidance”.  Mr. Anthony is also known to have specific experience in innovation and digital platforms.  This is a sad commentary on Mr. Anthony’s contribution to MEG given the Company has destroyed significant value through Blackdot, DealTaker.com, and NetInformer.  I recommend that shareholders withhold their vote for Mr. Anthony.

Dennis J. FitzSimons – Chairman, McCormick Foundation: Mr. FitzSimons, like Mr. Anthony, is another Board member that has pillaged the Company, earning undeserved compensation at shareholders’ expense.    As with Mr. Anthony, it is difficult to find any data indicating that Mr. FitzSimons ever purchased a single stock of MEG for himself.  His only interest in MEG is a piddly 28,821 shares “awarded” to him by the Company.  Mr. FitzSimons is well known in the “old media” industry, having served as CEO of the struggling Tribune Company.  His reputation fits nicely with MEG’s management team which should be a significant concern to shareholders.

Mr. FitzSimons was accused by the Chandler family, a significant owner of his prior company Tribune, of “of not moving decisively enough” and in an open letter per reports from the Los Angeles Times, the Chandler family claimed Mr. FitzSimons ”failed to generate a viable strategic response” to changes in the industry and had allowed “value to deteriorate.”  During his tenure, Tribune lost nearly 50% of its value.  Mr. FitzSimons was then later named in a lawsuit when he steered Tribune into a leveraged buyout to Sam Zell, whereby FitzSimons walked away with tens of millions.  The lawsuit stated that the Tribune LBO was “among the worst in American corporate history. The LBO was designed to cash out the large shareholders of Tribune and to line the pockets of defendant Samuel Zell and Tribune’s directors and officers.”

This background suggests that Mr. FitzSimons is apparently kindred spirits with CEO Marshall Morton and his cadre of harlequins but his professional experience is nothing more than a further blot on MEG’s reputation.  I recommend that shareholders withhold their vote for Mr. FitzSimons.

Carl S. Thigpen – CIO, Protective Life Corporation: I am somewhat disdained that Mr. Thigpen holds the CFA designation.  This designation includes an ethics and fiduciary component which Thigpen clearly demonstrates little adherence to.  How can one have tenure on a Board such as MEG’s whereby management has delivered failure after failure and remain so complicit?  Mr. Thigpen is deemed an “audit committee expert” yet a cursory look through MEG’s SEC filings reveals a number of incidents whereby the Company did not properly comply with SEC reporting guidelines.  Once again, more wasted time was spent on responding to SEC comments due to errors made in filings that could have been spent on strategic efforts.  Thigpen owns just 26,671 of deferred MEG shares, demonstrating like all insiders, that he has no confidence in management or the Company.  I recommend that shareholders withhold their vote for Mr. Thigpen.

Unfortunately for Class A shareholders, the Board is only allowing Class B holders – essentially Chairman Bryan III – the opportunity to vote on executive compensation.  While the Board is determined to show that it’s only allegiance is to CEO Marshall Morton, withholding votes for the Class A directors is simply another way in which investors can express their dissatisfaction with MEG insiders.

DISCLOSURE: AUTHOR MANAGES A HEDGE FUND AND MANAGED ACCOUNTS LONG MEG

There are a few factors  that are currently limiting MEG’s movement to the upside.  The first is that while BAC has provided an extension and amended the existing credit facility, the deal is contingent on JP Morgan (“JPM”) raising at least $225MM in additional notes which will be used to reduce the existing BAC facility by May 25th.  Investors are hesitant to drive the value of MEG upwards given management’s track record while short sellers are probably equally unwilling to further short the stock given the potential upside of a successful notes issuance.

Another potential obstacle is the specter of the credit agencies attempting to appear relevant.  I have covered the actions of both Moody’s and S&P in relation to MEG and its equity and bond prices and suffice to say the credit agencies have generally been laggards.  Nonetheless, Moody’s was quick to remind investors following the announcement of the credit extension that it was still determining how to finalize its overall rating of MEG.   While Moody’s and S&P ratings are generally worthless for the long-term, they can be causes of volatility in the short-term.

Aside from the waiting period and possibility of credit agencies having their say, what really needs to be done?  First, JPM needs to amend the existing bond indenture to allow for additional issuance of debt either above or pari passu with MEG’s high yield notes.  Once this is done, JPM would also probably arrange a roadshow for management to present to potential debt investors.  Right now, I would guess that BAC and JPM have AlixPartners and Capstone both helping management in streamlining the overall business and incorporating those improvements into MEG’s projections for the roadshow.  AlixPartners could be suggesting that obscenely excessive management compensation be significantly reduced as an area to boost cash flow or that MEG’s Blackdot or DealTaker businesses are shut down as they generate losses.  Once these and other steps are accepted and incorporated into the roadshow presentations, MEG should be able to secure a finalized debt structure and if the terms are attractive, the stock could be poised for a nice move up.  While this management team is capable of epic failure, the deadline appears to allow MEG to come in with a new deal by early May, providing a cushion of a few weeks.

What is an attractive deal?  I think the stock currently reflects an expectation that MEG can secure new notes for about 11-13% excluding fees whereby total interest expense on annualized basis is about $74MM.  For 2012, this would mean total interest expense of about $65-70MM given one quarter was basically at the older deal.  In previous posts I have presented MEG mainly on a pro forma basis under the assumption of a full calendar year under a new deal but the reality is that 2012 actual interest expense will be lower than the pro forma projections given most of Q1 was under the old, more favorable BAC deal.  As Exhibit I illustrates, MEG could generate about $25MM in free cash flow in 2012.

EXHIBIT I: MEG POST JPM 225MM NOTES ISSUANCE

Unlike previous posts which presented figures under the assumption certain transactions were in effect at the start of the year, Exhibit I attempts to get as close as possible as to what the true costs for MEG would be in 2012 and 2013.  The following are the assumptions used in Exhibit I:

1. JPM amends the high yield indenture to allow for the $225MM notes to be issued pari passu with the existing notes.  Given that the bonds are trading at par, the issuance of notes at 11.75% could be possible.
2. The Revenue and EBITDA figures for 2012 are based on my original estimates but if AlixPartners and Capstone are worth their fees, I would expect some operational and efficiency changes to occur to boost both the bottom and topline in 2013.   In 2011, MEG generated about $616MM in revenue and $89MM in pro forma EBITDA so my estimates in 2013 are not too much greater than what MEG’s own management team achieved without the assistance of any recognized turnaround firms.
3. Interest expense is based on the deal changing in Q2 2012.  In Q1, bank interest expense was roughly $4.5MM under the original deal while high yield interest was about $9MM.  New notes under 11.75% and the new Term Loan deal would be in effect for just 3 months so total interest is about $70MM in 2012 before being in full effect for 2013.
4. CapEx and Pension are kept consistent for both 2012 and 2013 and the 2012 figures are MEG’s own estimates.  In 2013, I assume similar figures.  The 10K discusses potential pension outlays in future years while the BAC term loan allows for about 80% of the maximum pension annual pension contribution.  Given how these figures can shift, I have left the contribution amount for the pension the same in 2013.
5. MEG has stated that it is not expecting to be a cash tax payer.
6. I assume all free cash flow is used to pay down the existing bank debt.  BAC appears to want to get out of this deal by 2015 and have MEG be financed primarily with high yield and/or Term Loan B and a minimal revolver.
7. The Cash Balance segment is the cash reported from MEG’s 10K.  I estimate fees will total about $18MM in 2012.

The main focus for potential debt investors will be to understand how MEG performs in 2013 given it’s an off-political year.  In 2011, MEG generated pro forma EBITDA of roughly $89MM.  As previously stated, MEG has hired AlixPartners and Capstone to assist in improving its overall business.  I would expect that these two firms will be able to find cost savings and implement operational initiatives that can result in key savings in both 2012 and 2013.  As it currently stands, MEG should generate about $125MM in EBITDA in 2012 but if AlixPartners and Capstone can work some magic, EBITDA and cash flow could perhaps be a bit higher.  The same can be said with 2013.  If the consulting firms can find areas to improve upon that management missed, MEG will be in a much better position.  Even with my conservative estimates, MEG would come in needing to just slightly draw $4MM off its $45MM revolver.

Assuming those firms can provide assistance to this management team, then MEG should be in a solid position to lock up relatively attractive financing terms.  The overhang from the stock would be removed.  In addition, in late April investors should receive MEG’s Q1 report.  The figures from Q1 2012 should benefit from a number of contested Republican primaries in key MEG states – most notably FL – as well as ad dollars from the NBC broadcast Super Bowl.  Removing the overhang of financing will allow the attractive fundamentals to resonate with investors.

What’s more, once MEG removes the financing overhang, it may be possibly to focus on selling off its newspaper division.  I believe management will aggressively pursue a sale given the new debt terms and the types of investors that will hold MEG’s paper.  As I’ve stated before, a sale of the newspaper division is really where MEG can experience a major upward valuation revision.  Similar to Exhibit I, Exhibit II attempts to get a closer look at how MEG would look if it could sell off its newspaper segment by the end of Q2 2012.

EXHIBIT II: MEG POST NEWSPAPER DIVISION SALE

As with Exhibit I, Exhibit II attempts to present MEG as close to reality as possible in terms of timing of transactions.  The assumptions are as follows:

1. Same financing assumptions as in Exhibit I whereby MEG announces a sale of its newspaper division for $115MM with the deal set to close at the end of Q2 2012.
2. The proceeds are used to pay down BAC’s $138MM term loan resulting in just $23MM in the BAC facility.
3. Revenue and EBITDA are based on my estimates for a broadcast and newspaper MEG in H1 2012 followed by a broadcast only MEG (also includes its web based ad division) in H2  2012.   In 2013, I assume broadcast revenue would decline by about 11% (consistent with its decline from 2010 to 2011) with EBITDA margins contracting from 35% to 32% on a platform level (consistent with 2011 levels) and assume the DealTaker segment generates about $30MM in revenue and is cash flow neutral.  I assume that a combination of the consulting firms and MEG being a smaller company can result in overhead reduced from $26MM to $11MM yielding EBITDA of $87MM.
4. Interest expense is based on Q1 being under the original deal, Q2 being under the new deal, and then Q3 and Q4 under a bank facility reduced by the proceeds of the newspaper sale.
5. CapEx is $15MM in 2012 under the assumption that H1 capex was $10MM based on a broadcast and newspaper MEG while H2 capex would be half given the sale of the newspaper division.  In 2013, I assume CapEx is half of the annual $20MM as a broadcast-only MEG.
6. Pension expense is constant as I assume MEG retains the legacy costs associated with the newspaper segment.

Exhibit II is the slam dunk scenario for both equity investors and BAC.  BAC’s actions demonstrate that it wants to be out of the MEG credit over time.  It scaled down its credit facility and any asset sales are used to further reduce debt.  In a scenario where MEG gets the financing squared away and then can sell off its newspaper division for a decent price, equity investors can win big and so does BAC.   Under Exhibit II, MEG can still generate about $19MM in free cash flow in 2012, greatly reducing its bank debt, and allowing the company to fully retire its bank loan in 2013 despite an off-political year.  While the volatility in free cash flow is still fairly high, MEG is still free cash flow positive and enjoys much higher margins.

This scenario is what longs are hoping for while the skeptics are betting on MEG coming up short and as a result, the stock price appears to be in a tight range.  It should be apparent in the coming weeks how prospects are looking for both sides of the MEG trade.

DISCLOSURE: AUTHOR MANAGES A HEDGE FUND AND MANAGED ACCOUNTS LONG MEG.

In late January, I discussed incentives driving MEG and BAC to reaching a refinancing deal:

“Credit profiles matter but so do incentives.  In the current market, bankers have a lot of incentive to avoid writing down debt.  MEG’s Term Loan A puts its paper in the hands of typical banks with BAC serving as the lead bank.  BAC and others in the lending group would likely prefer to extend rather than write down MEG’s debt.  BAC probably also recognizes that credit markets could improve in terms of health so an extension could give its borrower some more time whereby it could refinance out into a healthier market, should a window like last spring’s emerge in the coming years.  In structuring the right amendment and extension, BAC could generate up front cash fees, avoid any write down of debt, have a higher yielding performing asset on its balance sheet, and ultimately when credit markets thaw, be made whole when MEG refinances.”

As for refinancing terms, almost precisely one month ago, I presented my thoughts on MEG’s potential refinancing terms, stating that BAC would be:

“..hitting MEG up for $3-5MM for amendment/extension fees and pricing its new debt at L+700 w/a 150 basis point LIBOR floor, MEG would be looking at $31MM on the new loan, $5MM in fees, and then $35MM in interest expense tied to its high yield bonds totaling $71MM in annualized financing expenses.”

This is actually quite close to what was realized in the new facility.  Per MEG’s latest press release:

“The amended bank term loan facility has an interest rate of LIBOR with a 1.5% floor plus a margin ranging from 5% to 7% (and commitment fees ranging from 2.25% to 2.50%), determined by the company’s leverage ratio, as defined in the agreement. In addition to this cash interest, the company will accrue payment-in-kind (PIK) interest of 1.5%.  PIK interest increases the bank term loan outstanding, is accrued on outstanding balances and is payable in cash on amounts outstanding at loan maturity.”

Based on MEG’s leverage ratio, total interest expense will range from 8%-10%. with up front cash interest expense ranging from 6.5%-8.5%.  The extension is contingent on MEG issuing at least $225MM in new notes by May 25, 2012 and using the majority of proceeds to take out the Term Loan.  I had expected a high yield offering of about $125MM so the expected offering is significantly higher and also suggests that the offering could be along the lines of a Term Loan B offering.   JP Morgan (“JPM”) is arranging the deal and is well regarded in the leveraged loan and high yield markets.  One would guess that the $225MM in notes was already loosely discussed by JPM and BAC’s syndication desks and is reflective of strong appetite for the credit.

This is playing into the incentives I discussed earlier in the year.  BAC is replacing its existing low-return asset with a higher yielding one while also taking advantage of a healthy credit market to reduce its exposure to MEG.  The amended facility may also telegraph what JPM is ultimately able to arrange for MEG.  The current deal structure in terms of a LIBOR floor, PIK component, and small revolver are consistent with a Term Loan B (“TLB”) offering and I believe the amended facility is an A Loan in name only.  As a result, one can take an educated guess that the deal arranged by JPM may match the terms of the extended facility albeit with a longer maturity.

EXHIBIT I: MEG SUMMARY FINANCIALS POST $225MM TERM LOAN B ISSUANCE

Exhibit I is a crude pro forma estimate of what MEG’s capital structure and free cash flow will look like after JPM arranges the $225MM TLB.  The TLB deal would be used to take out a good portion of the existing Term Loan based on the parameters laid out by BAC to amend the existing facility.  The interest rate is at the midpoint of the L+500-700 range with a 1.5% LIBOR floor but should be towards the lower end of the range in 2012 and higher in 2013 as the spread is based on MEG’s leverage ratio.  Exhibit I also presents MEG under the assumption of it operating “as is” meaning with the newspaper segment still attached to MEG and incorporates my 2012 and 2013 revenue and EBITDA estimates.

In 2012 MEG should do quite well.  Even with the new, higher cost deal, MEG could generate $31MM in free cash flow.  Part of this increase is due to $5MM in non-cash PIK interest interest which will accrue until maturity as well as the updated full year capex estimate of $20MM in the latest MEG press release.  I initially anticipated about $25MM in capex but the amended credit facility sets a maximum capex level of $20MM – a good thing given the track record of those in charge at MEG.   I also assume MEG uses all cash flow to pay down bank debt including any accrued PIK interest.  Under the 8-K filed which covers the amended facility, a cash flow sweep ranging from 50%-100% could be required.

The amended facility also provides significant covenant relief to MEG, especially for 2013 when operating performance will be reduced due to a lack of political ad revenue.  The amended credit facility allows for a maximum leverage of 9.5x by year end 2013.   Assuming about $650MM in year end debt in 2013, MEG’s 2013 EBITDA would have to fall under $68MM or so before tripping these covenants.  In conjunction with MEG’s minimum consolidated interest coverage ratios, MEG’s 2013 EBITDA basically needs to be above $71MM although from a practical standpoint in terms of funding capex and other needs, MEG still needs to do a bit better.  MEG could tap its $45MM revolver for capex as well but in either event, the company should have some cushion to skirt by in 2013.  This is actually very good news as investors have been particularly concerned with how MEG would perform in 2013 given the covenants that were in place in the original facility.

The first step MEG needed to take was to get BAC to amend and extend the existing deal.  This was done and for this new deal to go “live” it’s up to JPM to arrange a deal for the BAC facility to be reduced/taken out.  This two step process will go a long way towards removing the overhang on MEG’s stock and allowing the strong fundamentals in 2012 to drive the stock.  With the refinancing overhang removed,  MEG could be valued around its historical 6.8x EBITDA level which for 2012 would imply a share price of $8+ assuming 2012 EBITDA of $125MM.

While those gains would represent 50%+ upside from current prices, stakeholders such as equity investors and MEG’s lending group should not allow management to be complacent one the refinancing is complete and should continue to press management on selling the newspaper segment.  Selling the newspaper segment as a third step could completely alter MEG’s valuation profile in a very positive and substantial manner.

As I’ve stated in the past CEO Morton Marshall and his team are the absolute worst in class.  This team’s unwarranted complacency in H1 2011, during a very large refinancing window, has now officially cost MEG investors $15-20MM in additional interest expense.   Poor acquisitions and strategy over numerous years have nearly destroyed the company yet they run MEG unaccountable to anyone.  Let’s face it, it’s a great gig for this team whereby they pay themselves millions and are never held accountable.  Once JPM can execute the $225MM TLB, the stock will have some overhang removed and the management team will be ready to get back on the gravy train.

Incentives are always critical and understanding incentives is what allowed me to deduce what BAC would ultimately do with respect to MEG’s refinancing.  Management’s incentives are not on shareholder value as much as preserving their undeserved compensation.  We know this because MEG has admitted that it has been approached regarding its various assets – the company stated this in recent press releases.  In the Q3 2011 conference call, Mario Gabelli along with other analysts continued to harp on asset sales to unlock value and asset sale questions also followed on the Q4 2011 call.  Since 2011, a number of transactions in the broadcast and regional newspaper sectors occurred which would suggest much more value relative to where MEG is trading if the company were to sell off its assets.  A skeptic would expect management has been approached numerous times regarding MEG’s assets.

However, management has always remained noncommittal with regards to asset sales.  This makes sense from management’s perspective because they would potentially be losing their jobs.  This team pays themselves millions while having no accountability.  Management also demonstrates their own lack of confidence in their strategy through the dearth of insider purchases of MEG stock.  There appears to be not one purchase of MEG stock by this management team in years.  For management, it’s option is to keep collecting millions in compensation or sell the company to benefit shareholders while taking an early retirement.  This skewing of incentives is why MEG stakeholders need to maintain pressure on disposing of the newspaper segment.

I have been very adamant about this because the upside is so significant, even relative to where MEG could be valued post-refinancing, and it is clear that unless management is being dragged by the collar, it is hard to execute value creating transactions.  All one has to do is look back to last year.  If management seized upon the refinancing window from anytime from Q4 2010 – Q2 2011, MEG stock at this moment would be higher.  Instead, management waited until the last minute dragging investors through a difficult process.  If MEG sells its newspaper segment, MEG could be worth $8/share in off-political years.

One potential positive is that the refinancing process seems to be maintaining pressure on management to sell the newspaper segment and the 8-K covering the latest refinancing terms provides a few clues.  First, BAC seems to be setting MEG up to enter into the TLB market.  I actually expressed this to MEG in the Q3 2011 conference call and this was my initial expectation in January 2012.  The overall “look” of the amended facility – LIBOR floor, negligible revolver, and PIK component – are more common with TLB deals as opposed to TLA.  What this means is that management will be in for a big surprise in regards to who the new investors in TLB deals are.

TLAs typically have standard bank debt investors.  These parties are willing to work with a borrower when troubles arise.  TLB investors tend to be much more aggressive and in some cases can get pretty excited about a borrower experiencing potential troubles.  If MEG were to experience any challenges once under a TLB deal, I have little doubt that some of those investors would move quickly to push MEG into bankruptcy.  In fact, if MEG were facing this same situation in recent months with TLB investors, those TLB investors could very well have waited/hoped for MEG to break covenants and then force the company into serious trouble.  MEG management will be aware of who their new lenders are as JPM prepares this deal and that knowledge should encourage management to pursue a sale of the newspaper segment to further reduce MEG’s debt load.  Getting rid of the newspaper segment would reduce debt and improve the overall cash flow profile of MEG, allowing for an upwards valuation revision.

The PIK component could also be another “positive” in pushing management to sell the newspaper segment.  The PIK interest will accrue and raise the overall debt balance and by improving MEG’s debt profile through asset sales, the overall debt load and accretion of PIK interest would be reduced.  A broadcast-only MEG could also potentially refinance the entire deal post newspaper sale into far better terms.

The other positive piece of data in the 8-K was the indication that BAC seems to have forced MEG to hire AlixPartners.  AlixPartners is a very well regarded turnaround advisory firm.  Over the past several months, short sellers have had a chance to get excited in recent 8-Ks, first when Capstone Advisory was hired by BAC, and now with AlixPartners, under the far stretched assumption that these parties were hired to escort MEG through bankruptcy.  BAC would not be  going through the trouble of extending and amending the existing deal and then having JPM involved to arrange and syndicate a new deal if this was the case.  I would guess that AlixPartners is directly involved with determining how to efficiently carve out the newspaper operations from the broadcast operations to set up a smooth future sale of the newspaper segment as well as advising MEG on how to improve flagging operations.

In fact, the operational separation has been occurring to some extent.  According to MEG’s Tampa Tribune rival the Tampa Bay Times:

“Media General has moved so decisively in recent months to separate resources and staff between WFLA and sister outlet The Tampa Tribune newspaper.  Officials promised TV staffers — who had long complained that the extensive convergence with the newspaper was hurting their performance — the broadcast arm would get its “swagger” back.”

This swagger has actually started to come back which could portend some decent news for MEG’s Florida division in 2012 as MEG’s Tampa NBA affiliate racked up top ratings for its 6AM, 6PM, and 11PM slots in February.  Given the embedded value in MEG’s assets, it appears that BAC and the various advisory firms could be serving equity holders better than management.

Finalizing the refinancing through JPM will undoubtedly be welcome news but selling the newspaper segment could result in MEG being worth well over $10/share.  Exhibit II assumes MEG can sell its newspaper division for $100MM and presents how the company would look going forward.  Total debt would be reduced by $100MM while EBITDA based on my estimates using MEG’s own filings would only decline by about $20MM.    Capex could also be less than what I think is a conservative $15MM in annual expenditures.  In either case, what is clear is that MEG can generate positive free cash flow even in off political years.  MEG would also be valued like pure-play broadcasters such as Gray Communication Systems (“GTN”).

GTN is currently valued at 9.5x 2011 EBITDA.  2011 was a non political year and GTN generated EBITDA margins of 33%.  In 2011, MEG’s broadcast unit had EBITDA margins of 32% with EBITDA of $88MM.  Given the similarities in size, MEG as a standalone broadcast unit should be able to obtain GTN’s valuation.  In Exhibit II I also assume MEG maintains its weak Dealtaker and Blackdot divisions but I would also favor having those shuttered given the losses they generate.   There is also some additional overhead to be expected given MEG runs less efficiently than its competitors which I expect AlixPartners to assist with.  In either case, I think $80MM in EBITDA in 2013 – an off-political ad years – is a reasonable estimate for a MEG freed of its newspaper segment.  Using GTN’s “off-political year” valuation of 9.5x EBITDA, MEG’s off political year valuation would be about $8.50 – a stark contrast to where MEG is currently valued.  In the first post Citizens United election in 2010, GTN on average was valued at 7.5x 2010 EBITDA of roughly $137MM. Using a non-newspaper MEG estimated 2012 pro forma EBITDA (full year estimate) of $106MM, MEG would be valued at $10.

EXHIBIT II: MEG SUMMARY FINANCIALS POST NEWSPAPER SALE

This valuation estimate is actually quite conservative with regards to using GTN’s metrics.  GTN has about $827MM in net debt against trailing EBITDA of about $101MM.  Total debt is 8.2x which is higher than what a post-newspaper sale MEG would carry.  GTN also has about $25MM in costly preferred equity which MEG does not.  These two items alone could warrant a post newspaper sale MEG valuation of 8.0x EBITDA in 2012 or $12+, and an off political year valuation of 10.0x EBITDA or $10+ assuming a $100MM newspaper segment sale.

As previous stated, on a fully integrated basis, MEG could be valued around its historical 6.8x EBITDA level or $8+ once the refinancing overhang is removed.  That reflects a nice nearly 50% gain from current prices.  However, assuming a reasonable sale of the newspaper segment with proceeds used to reduce debt, MEG could be worth 100% more than current prices.   While the final step in the refinancing process will be a welcome event, I am hopeful that MEG can potentially squeeze out a pleasant surprise in selling its newspaper segment.

DISCLOSURE: AUTHOR MANAGES A HEDGE FUND AND MANAGED ACCOUNTS LONG MEG

I believe that the lenders’ potential involvement in forcing the exploration of a sale of MEG’s newspaper division along with improving credit markets may ultimately result in the company overcoming its “worst in class” management team.  I also think the delay in the 10K along with the accompanying 8K covering the ongoing refinancing discussion may have resulted in investor overreaction whereby investors are rushing to the exits while overlooking some potentially good news that can be inferred from the 8K.  The 8K states the following (emphasis mine):

“The Company continues to negotiate with its lenders to reset certain covenants under its credit agreement, to amend certain other terms of the agreement and with respect to the Company’s proposal to extend for a period of two years the March 2013 current maturity, with any such extension being conditioned on raising a set amount of new secured financing, a significant portion of which would be applied towards the repayment of the term loan under the credit agreement. It is expected that these negotiations will also result in a reduction to the lenders’ revolving credit commitments. As these discussions are ongoing, there can be no assurance that a definitive agreement will be reached between the Company and the lenders with respect to any or all of the modifications referred to above or as to the terms of any definitive agreement that may be reached.”

In my prior posts, I initially assumed MEG’s lenders would force the company into the Term Loan B market.  This would mean an entirely new deal and more critically, a higher interest rate attached to the typical TLB deal.  This was still good news given the improvement in credit markets and the strong performance of MEG’s secured notes.  In Q3 2011, credit markets were pricing in a high teens if not more expensive cost of financing for MEG which tightened to potentially 10-11% as credit markets thawed, benefiting the bonds and equity.  While MEG’s management team cost investors about $15-20+MM in additional interest expense due to its bumbling in 2011, MEG’s operating model could still support an interest expense at this level, which would potentially total $72MM in annual interest expense under a 10.5% priced Term Loan B deal along with its existing secured bonds.

Since the start of 2012, credit markets have continued to improve and the bolded portion of the 8K suggests that MEG is working with its lending group to extend its existing deal.  My inference is based on the notion that MEG is pushing to get a two year extension, which would mean that it would keep the current Term Loan A but price it relative to MEG’s current credit profile along with some changes to its existing covenants.  If the lenders were interested in pushing an entirely new deal (TLB) on MEG, I think the option of an extension would have long passed by now and commentary in the 8K would have been covering structuring a new TLB as opposed to covering a two year extension.  So this point in the 8K about a two year extension hints to me that MEG and its lenders are still working on how to maintain the TLA but in an adjusted structure.

The 8K also mentions that the extension is contingent on raising new secured financing which suggests to me that MEG’s lenders want to have an additional financing piece that would reduce the overall size of the TLA.  Right now MEG has $363MM in TLA and I would guess that its lenders would be comfortable if a portion of that – say $125MM – is issued in a second set of senior notes to downsize the new TLA.  This actually could work out very well for MEG as opposed to a new TLB deal and I think investors may be missing the implications of this.

In my prior posts, I guessed that a new $363MM TLB deal that would take out the existing TLA would run about 10.5% in interest expense based on some market comps.  MEG’s $300MM bonds cost the company 11.75% resulting in total annual interest expense of $73MM under this new deal scenario.  Since that time, credit markets have improved, further bringing interest costs of a future deal down.  In addition, S&P recently upgraded MEG’s recovery rating, potentially making a secured deal easier to execute.

Now back to the present situation – investors know that MEG is trying to refinance and is working on a two year extension of its existing TLA deal provided it can raise secured financing to defray the size of the TLA.  Credit markets are healthy now meaning execution of this deal should not be very difficult.   Using some basic numbers, BAC may try to raise $125MM in senior notes, reducing the TLA size to about $238MM.  What this would do is bring MEG’s TLA leverage down, whereby there is a good chance it prices around 5-6% (no LIBOR floor) given its size and potential BB facility rating.  Investors can also check on the pricing of MEG’s 2017 senior notes, which are now trading at par and even traded above par (100.5) in recent weeks.  This means a new senior notes issuance could price at the same level or 11.75%.  When you factor in a reduced size TLA of $238MM priced at 5%, a new $125MM senior notes offering at 11.75% and MEG’s existing 2017 senior notes priced at 11.75%, total interest expense would be about $62MM or about $10MM less than what a decent TLB deal would cost.

This would be very good news for MEG investors as that $10MM in additional interest expense savings would directly benefit MEG’s free cash flow.  In addition, once MEG locks a deal like this in place, any proceeds from the sale of its newspaper segment would be used to further reduce the size of its TLA per the asset sale carve out provision in MEG’s bank debt.   As I previously discussed, MEG’s entire newspaper division could be valued at $70-$150MM using public comps as well as the very relevant NYT Regional Media Group transaction.  Any proceeds from that sale would be used to reduce the TLA debt, which under a $100MM sale would result in total interest expense of just $57MM.  This is serviceable even in off-political years for a Broadcast-only MEG.  The result would be a company that does not have solvency risk every odd year, which could result in a significant upward shift in MEG’s valuation range.

MEG has a number of very positive tailwinds:

• Improving credit markets resulting in reduced financing costs.
• Healthy M&A markets for regional newspapers as evidenced by the NYT’s Regional Media Group transaction which valued the segment at 0.6x EV/LTM Sales and 4.1x EV/LTM EBITDA.  While I have remained very conservative in my valuation estimate of $70-$150MM, using the NYT RMG transaction comp would point to a valuation of $115MM-$$175MM.  Investors should note that MEG’s newspaper division is a bit larger than RMG on a revenue basis and until 2011, performed very favorably against RMG.  An adept management team could very likely put the newspaper segment back on track.
• Strong political spending in key battleground states, RNC and DNC conventions in the heart of MEG’s operations, 2012 Summer Olympics, improving retransmission revenues.
• Potential to be a broadcast-only play allowing for healthier valuation and higher share price.

DISCLOSURE: AUTHOR MANAGES A HEDGE FUND AND MANAGED ACCOUNTS LONG MEG

Yesterday, MEG announced that it was going to explore a sale of its Newspaper division.  The company has hired its bankers to solicit interest from buyers and more importantly have received inquiries from several third parties in recent months.  Regional newspaper transactions have been heating up and this is great news for MEG investors, possibly representing a real game changer in terms of MEG’s valuation.   Before addressing that, let’s first cover the recent “story” behind MEG.

From late 2010 through June 2011, MEG had a massively wide window that it could have taken advantage of to refinance its $363MM of bank debt due in 2013.  Instead, management floundered and showed no sense of urgency.  MEG’s $363MM bank debt carries a rate of L+450 which equates to an annual interest cost of ~$17MM, extremely attractive for a company with MEG’s credit profile.  This is why if one looks back to the conference calls in those periods, investors were constantly mentioning going to market to refinance that debt and secure something similar to those terms to avoid a potentially troubling credit crunch.  Given that MEG management is worst in class, no progress was made on refinancing and the world got caught in the Euro-zone crisis resulting in credit spreads blowing out.

Since October, credit spreads have come in significantly but lenders are still nowhere near where they were in late 2010 and H1 2011.  As a result, even under the attractive current credit market, MEG’s new term loan will likely carry an interest rate around 10-11% meaning there will be about $20MM of additional cash interest when the new debt is rolled over.  This is what I have discussed in a number of previous posts – highlighting that management has without question cost investors $20MM due to its bumbling.   This has not been news to investors however, and the $5 stock price more than reflects the additional expected interest burden.  MEG’s management team has also felt it deserves to be rewarded for this “achievement” as highlighted by CEO Marshall Morton’s recent option award.

MEG’s ability to obtain a short-term bridge amendment and no extension left longs somewhat concerned and short sellers thrilled.  Further, the 8-K discussing the amendment mentioned Capstone Advisory, which is a well known restructuring shop, adding further ammo for short sellers to suggest MEG would be facing imminent bankruptcy.  While Capstone is known for restructuring, it seems the short sellers were getting a bit desperate.

It is not uncommon to involve a firm like Capstone for valuation assistance as well as to strong arm the borrower on the behalf of the lender to rationalize costs as well as consider asset sales.  In my previous post I also covered why Bank of America (“BAC”) would favor only an amendment rather than an extension.  BAC’s main goal is to avoid taking a hit on the bank debt.  With the Term Loan B (“TLB”) market on fire, there’s a good possibility that BAC can now roll MEG off its Term Loan A into the TLB market whereby BAC has no credit exposure to MEG going forward.  As counter intuitive as it sounds, if credit markets were worse, there would be a higher likelihood in my cynical view that BAC would have taken the “delay and pray” approach and have extended MEG’s loan.  But with credit markets much more robust, BAC can squeeze MEG out into TLB and things work out for everyone where BAC secures some arranger/syndication fees, takes no hit on its credit, and walks away with no future credit exposure to MEG.

This is why the idea of bankruptcy does not make sense despite what short sellers may have been hoping for.   Going in court would make no sense if the debt is trading in the mid to high $90s because the lenders would now be hit with various ongoing fees and just the overall hassle and time sorting out the various creditor claims.  There’s no near-term issue that would really prod lenders to pursue bankruptcy, particularly when MEG’s bank debt is not due until March 2013.  As demonstrated by a number of recent deals such as Spanish Broadcasting Systems (“SBSA”) which had a significant amount of debt due in the coming months, lenders are not that excited about taking a company into bankruptcy if they can avoid it.

Another reason MEG would fight aggressively to avoid bankruptcy is because management has a major incentive to avoid bankruptcy.  This may seem like an obvious statement but the reality is some management teams inherit bad situations.  These management teams might come in too late to save the company so when the company does get into Chapter 11, the lenders and a firm like Capstone would probably be fine keeping management as the firm restructures.  MEG’s management team is pathetic and created all of its current problems from poor acquisitions to missed financing opportunities.  Due to the voting structure of MEG, this management team has been able to remain in place while others – whether it’s employees, shareholders, or creditors – suffer for management’s failures.  It would not be unreasonable that MEG’s creditors, if MEG did restructure, would force CEO Morton and his team out the door.   Finding a new team would be another headache BAC would not want to deal with and Morton and his team likely realizes that they are finished if they ever leave MEG.

This chain of events and various incentives have led MEG to take steps that may finally enable the company to achieve a much higher valuation than it currently carries.  As those familiar with MEG are aware, prior conference calls yielded numerous questions asking whether MEG was exploring asset sales.  MEG management would always provide a response that led MEG investors to believe that there was little enthusiasm on management’s part to pursue a sale.  This makes sense as most management teams like to manage large companies and can therefore justify higher compensation.  MEG management would also claim a certain synergy existed between its regional papers and television stations.  However, everyone involved with MEG knows this team has no credibility and its competence from execution of strategy, acquisitions, and financing are all laughable.

This is probably where Capstone came in during the current refinancing process and quickly demonstrated that a healthy market for all of MEG’s properties – broadcast or print – exists, and that pursuing a sale could help defray MEG’s financing issues.  So in spite of MEG management avoiding any sale opportunities in the past, MEG equity holders are getting lucky between healthier financing markets and now what is likely a forced effort by BAC and Capstone to dispose of its Newspaper division.  MEG’s bank debt also has a special asset carve out provision which gives it seniority over the bonds so the proceeds of the Newspaper segment would immediately benefit BAC and the rest of the bank group.  If MEG can get a decent valuation for its Newspaper segment, MEG’s valuation could improve markedly from current levels.

TABLE I: MEG 2011 SUMMARY FINANCIAL DATA ($MM) (SOURCE: MEG Q4 2011 EARNINGS RELEASE)

Table I highlights basic information regarding MEG’s various divisions.  What is clear is that its Digital division, which MEG’s management team embarked on several years ago, has been a total failure and value destroyer, and the Newspaper division generates margins on a platform basis that detract from MEG’s key Television segment.   Nonetheless, the Newspaper segment is cash flow positive on a platform basis and a number of buyers could improve upon what MEG management has achieved.  The question is what price does the Newspaper segment command?  A September 2011 conference by the Jordan Edminston Group (“JEGI”) illustrates what typical Newspaper multiples have been.  As JEGI notes, the lack of transaction data leads to a composite of publicly traded data for valuation support.  This data along with current public comps of regional pure play newspaper companies suggest there could be significant value for MEG’s Newspaper division.

EXHIBIT I: MEDIA TRANSACTION MULTIPLES (SOURCE JORDAN EDMISTON GROUP 2011 PRIVATE EQUITY FORUM – SEPTEMBER 22 2011)

TABLE II: PUBLIC NEWSPAPER COMPARABLES

Table II demonstrates the difficulty in comparing pure play regional newspaper comps due to varying capital structures and as a result includes both Enterprise Value and Market Capitalization metrics based on sales and EBITDA.  Even with the extreme discrepancies between the companies’ capital structures (AHC and DJCO have no debt while LEE and MNI are extremely levered), Table II can still  help establish a floor for the value of MEG’s Newspaper division.

LEE and MNI may be the most appropriate comps given their scale and leverage.  The Price/Sales multiples they both carry can be instructive for establishing a worst case valuation for MEG and I believe MNI’s P/S multiple of 0.2x is a good lower bound for MEG’s Newspaper division.  This would translate into a valuation of $60MM or about 2.0x MEG’s LTM EBITDA.  As I have mentioned in prior write ups, I believe this division can be sold for a conservative 2.0x-4.0x+ EBITDA so this is actually consistent with the lower bound of my cautious estimate.

While the public comps establish a very conservative floor, I think there is one very recent transaction that is near ideal for MEG’s Newspaper division to comp to, providing a lot of potentially positive and relevant information regarding the potential value of MEG’s Newspaper division.  On January 6, 2012, The New York Times Company (“NYT”) sold its Regional Media Group (“RMG”) which consists of 16 regional newspapers for about $150MM.  Exhibit II provides RMG’s segment data for recent fiscal years and compares it to MEG’s Newspaper division.

EXHIBIT II: RMG 2011 FINANCIAL DATA

As recently as 2010, MEG’s Newspaper division compared very favorably to RMG, with lower operating costs and higher EBITDA margins.  In 2011, MEG’s segment took a hard turn downwards with a nearly 9% decline in revenues in the Newspaper segment.  However, a competent acquirer could be very willing to pay a similar valuation relative to what RMG was sold for.  The sizes of both RMG and MEG’s Newspaper division are comparable and it was not long ago when MEG’s Newspaper division performed better than RMG.  Better overall strategy relative to MEG’s management could probably yield a turnaround that has eluded MEG’s management team.

RMG owns properties in Florida, North Carolina, Alabama, as well as California.  Halifax Media, with its own operations in Florida and other southern states, was the buyer of RMG and could very well be a suitable buyer for MEG’s Newspaper division.  Matching geographies would allow significant cost savings for the combined company, provided there were limited antitrust issues.  One favorable sign is that the FCC has been relaxing rules related to newspaper-broadcast overlap so perhaps combining newspapers in similar regions, primarily when a case can be made for poor chance of survival on their own, would allow these deals to breeze by.  In either case, RMG and the valuation of public comparables suggest that MEG’s Newspaper division can fetch a pretty attractive price.   If a valuation can be realized close to what RMG sold for, then MEG’s aggregate valuation stands to significantly improve.

TABLE III: MEG NEWSPAPER VALUATION SENSITIVITY ANALYSIS

Table III helps illustrate how an attractive sale for the Newspaper segment can help MEG with the yellow highlighted range as where I think a deal could shake out.  If MEG’s Newspaper Platform EBITDA figures are the “real” segment figures, then it is very possible for MEG to sell the division for a valuation similar to RMG.  If the company can realize $100+MM for the division, those proceeds would go towards reducing its bank debt, per the carve out provision that the bank debt has over the high yield bonds.  This is reflected in the Post Newspaper Transaction Capital Structure segment of Table III where the pro forma (“PF”) bank debt is reduced by the sale proceeds.

Given MEG’s credit rating, state of the credit markets, and cash flow profile, it is very likely that MEG’s refinancing would yield interest rates in the 10-11% range or about $38MM related to the $363MM in existing bank debt.  I believe this has been more than priced into shares in the $5 range.  The current interest rate yields about $17MM in interest expense on that same piece.  By reducing the bank debt by $100MM, MEG’s overall credit profile could improve, resulting in both cheaper rates for MEG to refinance along with a lower aggregate debt burden.

The major benefit is that MEG gets rid of an asset that would be a perpetual drag on its operations.  After 2012, MEG would face a challenging 2013 without the aid of a strong political year, the Summer Olympics, and NBC broadcast Superbowl.  This is the concern most lenders have as the Broadcast division would have a reduction in revenue.  However, if MEG keeps the Newspaper segment it is likely that this segment continues to wither away in 2013, becoming an increasing operational drag.

EXHIBIT III: MEG POST NEWSPAPER SEGMENT SALE ANALYSIS (KINNARAS ESTIMATES)

EXHIBIT III is a crude presentation as the closing of a sale is not assured and terms of the refinancing would vary based on the sale process but it nonetheless helps illustrate the benefit of selling the Newspaper segment.  Exhibit III assumes MEG’s Newspaper division is sold for 4.0x 2011 platform EBITDA generating $113MM which is used to pay down $363MM of existing bank debt.  I also take a leap of faith and assume MEG’s credit rating would be improved through divesting its Newspaper segment and paying down debt.  With an improved rating, MEG’s reduced size $250MM TLB could be priced at L+700 with a 1% floor or effectively 8%.  For 2012, I assume the Television segment increases revenues by 23% over 2011 segment revenues while the Digital (Dealtaker) segment declines by 4%.  I assume Digital generates a $1MM EBITDA loss while Television generates 35% platform EBITDA margins.  When television ad demand is robust, broadcasters experience significant margin expansion.  In 2010, MEG’s Television segment generated platform EBITDA margins of 34%.  I also assume that if MEG is able to sell off its Newspaper segment, it’s corporate overhead will be reduced by roughly 50% or $13MM.  This could be over or understated, it’s a guess primarily in that I assume a number of corporate functions in Richmond dedicated to the significant size of the Newspaper segment could dissolve.

I also assume capex tracks at $15MM with the Newspaper segment sold.  Public pure play broadcasters have capex that runs anywhere from 3-6% of sales and I assume MEG will run capex at roughly 4.5% of sales.  Public pure play regional newspapers run capex at <3% of sales so, which highlights the fact that MEG has run capex at much higher levels than peers.  I am guessing that the higher historical capex by MEG could be related to the maintenance of printing assets related to third party print jobs.  In either case, one can see that MEG should be able to deleverage on a steadier basis once the Newspaper segment is sold, potentially generating $22MM in free cash flow in 2012 and remaining cash flow positive in 2013.

If MEG keeps its Newspaper segment its overall EBITDA levels for 2012 should still be fairly strong.  The problem is 2013, and if the Newspaper segment continues its recent history of annual sales declines of ~8%, it could become a major drag.  The No Newspaper Sale scenario projects that MEG’s Newspaper segment will decline by 7% in 2012, improving against the 9% decline in 2011, and then decline by 8% in 2013 along with an estimated 15% decline in Television from 2012 figures.  The problem is that MEG appears to have reduced expenses per its corporate cost structure by as much as it can.  In 2011, it reduced its operating costs by about 4% by aggressive headcount reductions and furloughs.  I assume MEG will maintain 2012 expenses in line relative to 2011 and then assume it can miraculously find 5% in cost savings in 2013.

2012 will not be an issue at all in either scenario but 2013 is where MEG would face some challenges.  By keeping the Newspaper segment, MEG will have no chance for an improvement in credit rating and will be in line to refinance in the 10-11% range given current market conditions.  In addition, CapEx will be where MEG announced in its earnings release.  As a result, MEG could potentially be cash flow negative in 2013.  This may not be the end of the world as MEG would try to incorporate covenants structured to allow some breathing room in off political years, something the current 2013 maturity does not have, during the refinancing process.

While there are a number of wide ranging assumptions to consider, Exhibit III still explains how MEG can benefit by shedding the Newspaper division.  Keep in mind, even if MEG’s credit rating is unchanged after selling its Newspaper division and its $250MM TLB is priced at ~10.5%, it would still generate about $17MM in free cash flow in 2012 and still be cash flow positive in 2013.  Another benefit to MEG investors if the Newspaper segment is sold is that MEG could benefit from valuation expansion due to an improved credit standpoint as well as becoming a pure play broadcaster.

TABLE IV: PURE PLAY REGIONAL BROADCAST COMPS

With just the Broadcasting and Digital divisions, MEG could start trading closer to broadcasting peers.  BLC, GTN, and SBGI are the most appropriate comps as TVL owns a number of MyNetworkTV and CW affiliates relative to the major affiliates MEG and the other three comps maintain.  A satisfactory sale of MEG’s Newspaper segment would almost assuredly yield a post transaction capital structure for MEG that is superior to GTN but it’s a stretch (but not impossible) to assume it would be as good as the other peers.  As a result, one simple way of valuing MEG would be to use a composite of its peers EV/2012 Revenue metrics.  With valuation pointing to a 2.2-2.7x range for MEG’s relevant peers, MEG could be valued at $830MM-$1020MM before excluding debt when using the 2012 revenue estimates in Exhibit III.  Assuming a reasonable sale price of 4.0x MEG’s Newspaper platform division, MEG’s shares could be valued between $7-$15 when accounting for MEG’s pension and its reduced debt.

The Net Debt/EBITDA figures in Table IV do not include pension liabilities which in some cases are significant.  For example, if net debt included BLC’s pension liabilities, it’s Net Debt/EBITDA would be 5.1x.  So the MEG share price estimate I have provided is more conservative in that it is netting out all debt – corporate and pension – from MEG’s share price.  The reality is that equity prices don’t seem to incorporate those pension liabilities.  If MEG’s valuation were to exclude those pension liabilities, as the comps in Table IV do, shares could be worth $13-$21.

These valuation figures may sound as though they have materialized from an insane asylum but they can be supported by hard, actual trailing figures as well.  Referring back to Table I, MEG’s earnings release reported a combined Broadcast and Digital revenue of $317MM in FY 2011.  The public comparables in Table IV provide EV/LTM Sales metrics and the range for the relevant comps is 2.3x-2.8x EV/LTM Sales.  Using these metrics for MEG’s reported 2011 non Newspaper revenue of $317MM and assuming MEG’s debt would be reduced by a sale of its Newspaper division for 4.0x its platform EBITDA would suggest a share price between $8-$16.  The big question is whether a sale close to $100MM+ can be realized for MEG’s Newspaper division.

To some extent, it does not matter given where MEG’s share price currently is.  With the Newspaper division now being up for sale, market participants have had a couple of days to determine where MEG should trade based on the expected value MEG’s Newspaper division will fetch.  At about $5.50 per share, MEG’s EV is about $770MM, meaning market participants think there will be no sale of the Newspaper segment or the value will be essentially $0.  Referring back to Table II, one could make the case that the floor valuation for MEG’s Newspaper division is about $60MM or 0.2x the Newspaper segment’s 2011 sales.  If MEG were to execute a sale at this level, MEG’s stock, using the pure play relevant broadcast metrics, would still be reasonably valued at $6+.

A share price near $10 is further supported by recent transaction multiples in the broadcast sector and the disposal of the Newspaper segment could make a future sale of the broadcast segment a possibility.  As discussed on MEG’s Q3 2011 conference call and various industry reports, broadcast television companies have exchanged hands at 8-10x cash flow.  Analysts have suggested MEG can generate about $100MM in average three year broadcast platform cash flow and in one of my prior pieces, I suggested a four year average including two off political years, one Congressional year, and one Presidential year, could yield average cash flow of $95MM.  If MEG could sell the Newspaper division for a little over $100MM, a valuation of 8-10x $95MM could support a double digit share price.

This is what the notion of game changer means in the context of MEG if it can sell off its Newspaper division.  If MEG can get a decent price for its Newspaper division, the credit profile improves, the ongoing operational drag disappears, the valuation becomes simplified, and other transaction opportunities emerge.  The overall range of MEG’s share price could shift as well, from flirting with $1 due to concerns about solvency in Q3 2011 and on going concerns regarding the Newspaper division, to now having a potential bottom valuation in off-political years of about $4 and a potential high in the $10-12 area in strong political years.

For example, pure play broadcast companies are currently valued at 7.2x-8.0x EV/LTM EBITDA with the LTM essentially being 2011 – an off political year.  Excluding the Newspaper segment, MEG generated $87MM in platform EBITDA in 2011.  If my assumption of corporate overhead allocations is correct and thus pro forma overhead can be reduced by half, MEG’s off-political year EBITDA could be $75MM-$80MM, potentially higher if the Digital segment can stop losing money.  At the top end of the EV/LTM EBITDA metrics and assuming a $100MM+ sale for the Newspaper division, MEG’s off political year share price could be around $5…basically where MEG is currently trading at the start of what will be a strong performance on-political year.

Also, with the Newspaper segment shed from MEG, it could be possible for the company to now be sold off to another broadcast company.  I have a healthy level of cynicism when its comes to MEG management and I would not be surprised if MEG has been approached about both its broadcast and newspaper divisions in recent years.  However, MEG management probably scoffed at any sale of either division in the past because they would be stuck managing a struggling Newspaper segment and may actually have to be paid far less for a Newspaper-only MEG to survive.  Conversely, they probably passed on selling the Newspaper division because even though it struggled in 2011, overall, as illustrated in Table I, it served to essentially subsidize a very very fat corporate overhead cost structure.  Of the $26MM in total corporate overhead, it appears based on MEG’s proxy (page 13 and 27) that 14% of total corporate overhead goes to just the salaries of MEG’s top five executives along with cash fees to directors.

Due to the voting structure of MEG’s equity, the management team has been able to remain unaccountable for any of its actions.   I suspect during this refinancing process, Capstone was able to strong arm management by prodding them to dispose of the Newspaper segment and if this was the case, I also expect that Capstone and BAC will play an active role in evaluating offers.  In the press release MEG revealed that it has been approached by third parties for the Newspaper division so I would not be surprised if it was approached regularly over the past year as valuations for the segment heated up, yet management avoided selling primarily because it enabled them to maintain exorbitant compensation.  If the Newspaper division received expressions of interest, it is very likely that crown jewel of MEG – Broadcasting – has received inquiries for a potential sale.  If MEG sells the Newspaper division it may be easier for a potential acquirer to more publicly approach MEG shareholders about acquiring it in the future.

MEG has had a very interesting past twelve months as reflected by the stock price performance and in spite of abysmal performance by management at nearly every level (strategy, execution, financing), MEG shareholders may get very lucky.  Credit markets have improved significantly, allowing management to be bailed out with what should be attractive pricing of its new debt.  While credit markets have improved, I believe MEG’s lenders have also gotten tougher on MEG management through possibly taking an active role in the exploration of selling the Newspaper division.  Recent transaction comps such as the RMG sale to Halifax Media suggest the Newspaper division can lock in quite an attractive sale price which would improve MEG’s overall credit profile and future outlook.  If these things can occur in what’s expected to be a phenomenal year for broadcast television, particularly in the regions where MEG operates, the stock could be poised to experience a dramatic shift upwards.

DISCLOSURE: AUTHOR MANAGES A HEDGE FUND AND MANAGED ACCOUNTS LONG MEG.

Let’s cover the ratings agencies first.  Moody’s is reviewing MEG for a potential credit downgrade given MEG is in the refinancing process and was able to secure just a short-term amendment.  MEG’s Corporate Family Rating is at B3 as are its 11.75% bonds due 2017.  It’s a little bit of a joke mainly because MCO downgraded MEG in early October 2011 to B3, which led to a stock drop of over 30% in a single day.  MCO was followed by S&P which out did MCO by downgrading MEG to CCC a few weeks later.  S&P and MCO have been trying to stay relevant since the housing bubble implosion so have been far more active in screaming “fire” whenever they can.  Part of the problem is that their research always seems to lag price action and they embarrass themselves even more.

In the fall of 2011, MEG’s bonds were trading in the $70s, having dropped from prices well above par in June, when MCO and S&P decided to downgrade MEG’s credit.  It took a 30+% decline in MEG’s bonds before the downgrade, and while any savvy investor could care less what S&P or MCO’s credit rating was, there were obviously plenty of squeamish equity investors that fled MEG stock once the agencies downgraded MEG’s credit.  The credit agencies served both short sellers, who were able to capitalize on a random event in terms of timing of the downgrade, as well as opportunistic buyers that could acquire MEG equity and fixed income for attractive prices.

Earlier last week, MCO came along waving the threat of downgrading MEG’s credit, trying to “catch up” to S&P’s CCC rating by placing MEG in the Caa family.  This news rattled the stock on Wednesday, February 15, with shares dropping by nearly 16% before rallying sharply to finish the day down roughly 5%.  Since that period the stock has continued to climb.  MCO and S&P’s October downgrades were a pathetically lagged reaction to MEG’s price action on its bonds and bank debt (which  subsequently recovered strongly after the downgrades) and while MCO looks like it now wants to be proactive, the expected credit downgrade will largely be meaningless given that S&P already rates MEG at CCC.  The overall question is does this even matter relative to MEG’s stock price?

Market pricing provides far more information than irrelevant credit agencies and MEG’s bond pricing suggests that MEG debt investors are comfortable with where MEG stands from a credit and potential refinancing standpoint.  Interestingly enough, MEG’s equity holders seem more cautious than bond holders.  First, let’s review MEG’s bond prices.  MEG’s 11.75% high yield bonds have traded above $90 since November 2011.  Since MCO and S&P downgraded MEG’s credit, MEG bonds rallied from the $70s to the upper $90s.  From December 2011 through February 2012, MEG’s bonds have consistently traded in the mid to upper $90s with recent trades as high as $97 (February 13 2012).  This implies a yield to maturity (“YTM”) of 12.6%.

The Q4 2011 conference call had investors such as Third Point and Knighthead Capital, both familiar and active investors in distressed credit.  These investors represent the likely holders of MEG’s high yield bonds and the current pricing of those bonds and the historical track record of MCO and S&P with regards to MEG suggest that equity investors are better off ignoring any changes to MEG’s credit rating by the agencies.  The types of holders of MEG’s bonds are not the typical stuffees that would ride the bonds to a hefty loss.  Basically if MEG bonds are in the upper 90s, bondholders feel that MEG has little risk of bankruptcy and/or the bonds are close to “money good.”  Also, given the high price of MEG’s bonds, current bond investors are more likely to lean towards the former rather than the latter.  This is because a vulture investor would want a higher margin of safety on those bonds.

Another reason to be unconcerned with a credit downgrade is because once MEG refinances, it is possible that MEG could be in line for a credit upgrade.  The biggest obstacles for MEG in regards to its debt is the $363MM bank debt maturity in March 2013 and the leverage ratio step downs.  Ideally, BAC would have amended and extended the existing credit deal but BAC instead chose to provide a short-term amendment.  I was surprised by this action but the pricing of MEG’s bonds and broader leveraged loan market suggests that the climate for leveraged entities has been thawing.  In this instance, rather than take a “delay and pray” approach, BAC wants to take advantage of this refinancing window and place MEG into the Term Loan B (“TLB”) market.

In my most recent write-up, I expected BAC to amend and extend MEG’s $363MM loan.  I thought BAC would hit MEG up for a high 1-1.5% in amendment/extension fees or basically $3-$5MM and price the debt at L+700 with a 150 basis point LIBOR floor.  The fees would be a proxy for a typical original issue discount meaning on a combined basis, the fees and interest expense would represent a higher overall yield.  BAC instead is working with Capstone per the MEG 8-K in arranging a TLB but the all in cost to MEG may not be that different.

In my original scenario of BAC hitting MEG up for $3-5MM for amendment/extension fees and pricing its new debt at L+700 w/a 150 basis point LIBOR floor, MEG would be looking at $31MM on the new loan, $5MM in fees, and then $35MM in interest expense tied to its high yield bonds totaling $71MM in annualized financing expenses.  The TLB option could work out with a similar total expense or perhaps even lower.  Given where MEG’s high yield bonds trade, a TLB should be priced better than the ~13% implied yield on those bonds.  The TLB should also have a better credit rating than the CCC/B3 (eventual Caa area) the bonds are assigned because of the seniority and asset coverage the term loan would have.

While there are not many perfect comps for what a new MEG deal could look like, there is one recent deal that may provide some valuable insight on where MEG’s TLB could shake out.  In late January, Spanish Broadcasting System (“SBSA”) announced a refinancing of its term loan with 12.5% in $275MM in secured notes priced at $97 maturing in April 2017.  The yield on these notes was 13.3% and the notes were rated B-/Caa1, pretty much the the same as MEG’s bonds if its S&P and MCO ratings were reversed.  I think MEG could obtain better terms than this for a number of reasons.

First, SBSA is all radio assets while MEG is primarily considered a television broadcast/newspaper company with the majority of its value driven by its broadcasting division.  Broadcast TV is a better credit than radio and will be reflected by better pricing for MEG.  SBSA had more difficult timing as well given its loan matured in the early part of 2012.  As a result, it raised its notes via a 144A private placement which prices at a premium.  MEG’s TLB will be a syndicated loan and this is another area which should result in better pricing for MEG relative to the SBSA deal.  Another area where MEG would be better than SBSA is its total leverage profile.

SBSA reported $45MM in LTM pro forma EBITDA which added back as many one-time charges as possible (severance fees, uncapitalized transaction fees, legal fees, etc.) when it announced its refinancing.  SBSA has $387MM in total debt when accounting for $275MM in secured notes and $111MM in preferred stock and accrued preferred stock dividends.  With net cash of $33MM post refinancing net debt is $353MM so SBSA is levered at 8.6x gross debt and 7.9x net debt.  SBSA also appears to have little room for error as well with $45MM in EBITDA, an expected $36MM in interest expense and $10MM in CapEx.  The company will need to improve its operating results to avoid being free cash flow negative out of the gates.  Yet despite all of this, it was able to quickly issue a significant amount of capital at pretty attractive pricing.  If there was not a looming maturity issue, SBSA could have potentially had even better pricing.

In comparison, MEG should have EBITDA close to $95MM in Q1 2012 as it prepares to refinance with the possibility that EBITDA for 2011 eclipses $120MM.  It has about $663MM in total debt and about $640MM in net debt equating to 7.1x gross debt/EBITDA and 6.8x net debt/EBITDA.  This is another significant difference for where MEG’s $363MM TLB should yield better pricing relative to SBSA.

In comparison to SBSA, MEG has better assets from a credit/pricing standpoint, better approach to market via syndication as opposed to a 144A, and better total leverage ratios.  With MEG’s bonds trading in the high $90s and yielding less than 13%, the debt market appears to be saying that MEG’s TLB offering should price quite strongly yet equity participants appear much more cautious.  In this context, BAC’s actions in a short-term amendment make sense.

The credit markets have continued to improve and a fresh TLB could also do better in terms of matching MEG’s cash flow profile.  A fresh TLB could be a 5 year offering, longer than what BAC would want to extend MEG’s existing term loan for.  This means the TLB would be due in early 2017 which would be ideal for MEG.  One issue with BAC providing a modest three year extension would be maturity in an off political year (2015) which would make deleveraging difficult and a shorter extension problematic.  However, a fresh TLB could bring maturity to early 2017 which would coincide with the end of a presidential election year in 2016 which would typically yield MEG’s strongest operating performance and cash flow.

While there is still near-term uncertainty regarding MEG’s refinancing efforts, equity holders can look to recent deals such as SBSA that set a floor in terms of what MEG could obtain.  In comparison to SBSA, MEG has better assets  which receive better pricing for leverage, better leverage ratios, and better approach to market via syndication and since January, when SBSA priced its offering, an even better climate for its offering.   The TLB should secure a rating in the Bs which given the asset coverage and seniority relative to MEG’s high yield bonds, which should further influence better pricing.  As a result, while equity investors appear rightfully cautious regarding MEG’s refinancing efforts, they should also feel that things may work very well due to fortuitous timing with regards to a thawing credit market, in spite of a horrific, grossly incompetent management team.

DISCLOSURE: AUTHOR MANAGES A HEDGE FUND AND MANAGED ACCOUNTS LONG MEG