Michael Burry (Trades, Portfolio), the renowned deep-value hedge fund manager, recently disclosed his investment positions for the third quarter of 2023. A key highlight of this quarter is his considerable increase in investment in Nexstar Media Group (NXST, Financial). He increased his stake by over 224%, reaching 48,651 shares. This investment in Nexstar, valued at $7 million, represents the second largest holding in his fund and constitutes approximately 5.7% of the total fund value. His recent move suggests that Nexstar seems to be a good investment with substantial upside potential.
Growing via strategic acquisition
Nexstar Media Group has a diverse portfolio that includes television broadcasting, network, and digital media assets. It operates an extensive network of 199 television stations and one AM radio station across 116 markets. This broad reach grants Nexstar significant leverage in negotiations with major cable companies for the rebroadcasting of its content. Over the years, the company has consistently increased its retransmission fees. Despite concerns about the decline of traditional cable TV, Nexstar's retransmission revenue is anticipated to grow, bolstered by rate hikes and the expansion of virtual MVPDs like YouTube TV, Sling, and FuboTV.
Perry Sook, the CEO of Nexstar, has driven the company's growth over the past decades primarily through strategic acquisitions of other TV stations at low multiples. A notable move in 2022 was the acquisition of a 75% interest in The CW Network, a national cable news network that reaches approximately 70 million homes. Notably, this acquisition did not involve direct cash payments or stock issuance; instead, Nexstar assumed The CW's debt. Management is optimistic about turning The CW profitable by 2025, leveraging strategic synergies with Nexstar's existing operations. The acquisition of The CW empowers Nexstar to exert direct control over the programming schedule of its CW-affiliated stations, particularly during prime viewing times, which is expected to enhance advertising revenue.
Sustainable growth in revenue, operating income and cash flow
Over the past decade, Nexstar Media Group has significantly increased its revenue and operating income through a strategic acquisition approach. From 2012 to 2022, the company's revenue saw a remarkable increase, soaring from $378.6 million to over $5.2 billion. Concurrently, its operating income experienced a substantial rise, growing from $100.4 million in 2012 to $1.52 billion in 2022.
Additionally, Nexstar has demonstrated consistent growth in cash flow over the past ten years. Its operating cash flow escalated from $80 million in 2012 to $1.4 billion by 2022, while its free cash flow expanded from $62.6 million to $1.25 billion in the same period, equivalent to nearly 35% compounded annual growth. This financial growth underscores Nexstar's successful expansion and operational efficiency.
Highly but comfortably leveraged
Investors might express concerns about the significant leverage Nexstar Media employs in its operations. As of September 2023, the company reported having $150 million in cash and short-term investments, with total equity at $2.35 billion. However, its interest-bearing debt was substantially higher, amounting to $6.87 billion, resulting in a debt-to-equity ratio exceeding 300%. While this level of leverage may seem high, it is relatively common in the television industry. Nexstar Media's ability to generate stable cash flows allows it to manage a high level of debt while still producing a strong return on equity. This strategy is viable as long as the company's cash flow and operating earnings can comfortably cover its interest expenses. Over the past five years, its Earnings Before Interest and Taxes (EBIT) to interest expense ratio has been robust. In 2022, for instance, the EBIT was 4.5 times the interest expense, indicating a healthy capacity to manage its debt obligations.
Significantly undervalued
To determine Nexstar's intrinsic value, the discounted free cash flow (DCF) model is used with varying growth rate assumptions. Initially, if we assume Nexstar's free cash flow will grow at an annual rate of 20% for the next five years and then settle into a stable, perpetual growth rate of 1% annually, the intrinsic value is calculated. Applying a discount rate of 10% to these projected cash flows, Nexstar's intrinsic value is estimated at around $27.78 billion. This translates to about $700 per share, given the company's 39.3 million shares outstanding.
Source: Author's table
Conversely, adopting a more conservative growth assumption of 10% annual growth over the same five-year period results in a lower forecast. Maintaining the terminal growth rate at 1% per year and the discount rate at 10%, Nexstar's recalculated intrinsic value is approximately $18.94 billion. In this more conservative scenario, the intrinsic value per share is estimated to be around $480.
Source: Author's table
Currently trading at $150 per share, Nexstar is valued at less than a third of its conservatively estimated intrinsic value. If the company continues on its projected growth path, its stock price has the potential to triple to quintuple over the next five years.
Key takeaway
In summary, Nexstar Media Group represents a compelling investment opportunity. The company has an extensive reach across the United States through its broadcasting stations and national cable network. It has consistently grown revenue, operating income, and cash flow over the past decade through strategic acquisitions and operational efficiencies. While Nexstar does utilize substantial leverage, its strong cash flow generation provides coverage for its debt obligations. Our valuation analysis indicates the stock is significantly undervalued, potentially by 3-5 times, compared to its estimated intrinsic value. If Nexstar continues on its growth trajectory, substantial upside in its share price seems likely over the next several years.
