Overview
— U.S. TV broadcaster Gray Television has reduced its
leverage and improved its liquidity, and we expect the company
to benefit from good operating performance in the foreseeable
future.
— We are raising our corporate credit rating on the company
to ‘B’ from ‘B-‘.
— The stable rating outlook reflects our expectation that
Gray’s lease-adjusted debt to average trailing-eight-quarter
EBITDA will approach 7x over the coming year.
Rating Action
On April 4, 2012, Standard & Poor’s Ratings Services raised
its corporate credit rating on Atlanta, Ga.-based TV broadcaster
Gray Television Inc. to ‘B’ from ‘B-‘. The rating outlook is
stable. All related issue-level ratings on the company’s debt
were also raised by one notch in conjunction with the upgrade,
while all recovery ratings on the debt issues remain unchanged.
Rationale
The upgrade reflects the company’s progress in reducing its
gross debt to average trailing-eight-quarter EBITDA, and our
expectation that leverage will continue to decline toward 7x in
advance of Gray’s 2014 revolving credit maturity. We also expect
the company to make continued progress refinancing or repaying
its costly 17% preferred stock–a major risk to its capital
structure. The ‘B’ rating reflects company’s still-high debt
leverage and weak discretionary cash flow, as well as our
expectation that the company will maintain adequate headroom
with its financial covenants in the absence of any further
tightening of covenant thresholds.
The stable rating outlook reflects our expectation that Gray
will maintain lease-adjusted debt to average
trailing-eight-quarter EBITDA below 7.5x. We also expect the
company to generate modest positive discretionary cash flow in
2012. Our rating on Gray also reflects our assessment of the
company’s business risk profile as “fair” and its financial risk
profile as “highly leveraged,” based on our criteria. We view
Gray’s business risk profile as fair because of its relatively
good EBITDA margin compared with peers’, despite a lack of
adequate critical mass and its concentration in small-to-midsize
TV markets. Factors in our assessment of Gray’s financial risk
profile as highly leveraged include its weak EBITDA coverage of
interest, high debt leverage, and minimal discretionary cash
flow. The company’s debt to average trailing-eight-quarter
EBITDA of 7.6x and funds from operations to debt of 5.2% are in
line with Standard & Poor’s financial risk indicative ratios of
greater than 5x and less than 12%, respectively, for a highly
leveraged financial risk profile. Gray operates 36 TV stations
in 30 small and midsize U.S. TV markets, reaching only about 6%
of U.S. TV households. The company generates the majority of its
revenue and EBITDA from TV stations affiliated with the CBS and
NBC networks. Stable, market-leading local newscasts and overall
ratings of the company’s TV stations–many in state capitals or
in cities with major state universities–are key supports to its
business profile, help attract political advertising, and
contribute to the company’s relatively good EBITDA margin
compared with peers’.
At the same time, the cyclical nature of TV advertising, the
mature long-term growth prospects of TV broadcasting, and
increasing competition for audience and advertisers from
traditional and nontraditional media limit upside potential for
Gray and other TV station groups. Under our base-case scenario
for 2012, we expect Gray’s revenue to grow at a high-teens
percentage rate and EBITDA to rise by 40% to 45%, mainly because
of sharp increases in political ad revenue and retransmission
fees from recently renewed carriage contracts, despite only
low-single-digit growth in core ad revenue.
We also expect substantial EBITDA margin expansion, as the
proportion of political advertising in the revenue mix is
significantly higher for Gray than for its peers, leading to
higher revenue and EBITDA variability between election and
nonelection years. Gray’s operating performance in the fourth
quarter of 2011 was in line with our expectations. EBITDA
dropped 46% on a 26% revenue decline because of lower political
ad revenue in a nonelection year. Local and national ad revenue
growth was minimal, at slightly under 3%. For full-year 2011,
the EBITDA margin was 32%, down from 39% in 2010, as high-margin
political ad revenue declined more than 75% in a nonelection
year. This was a sharper margin decline than many of its peers’,
because Gray had a relatively higher proportion of political
advertising in its revenue mix in 2010. As of Dec. 31, 2011,
Gray’s debt (adjusted for leases, pensions, and preferred stock)
to EBITDA ratio was very high, at 9.0x, up from 6.6x a year ago.
Using average trailing-eight-quarter EBITDA to smooth the
differences between election and nonelection years, Gray’s
lease-adjusted debt to EBITDA was still steep, at 7.6x, but down
from 8.6x at year-end 2010. EBITDA coverage of interest
(including preferred stock dividends) was weak at 1.4x in 2011,
marginally weaker than 1.6x in 2010. Both of these credit ratios
deteriorated because of lower EBITDA related to the election
advertising cycle.
We expect leverage and interest coverage to improve in 2012
with the rebound of political ad revenue and steep increases in
retransmission fees from recent carriage contract renewals.
Leverage, on a trailing-four-quarter EBITDA basis, could drop to
6.0x at the end of 2012, in our view, and, on an average
trailing-eight-quarter basis, could approach 7x. Conversion of
EBITDA into discretionary cash flow was extremely low, at about
7.4% in 2011, because of negative working capital changes,
higher capital expenditures, and cash dividend payments on
preferred stock.
We expect discretionary cash flow to improve significantly
in 2012 because of higher EBITDA and slightly lower capital
spending. We anticipate that the company will redeem some of its
preferred stock and pay accrued dividends in connection with the
repurchase. However, we do not expect the company to pay cash
dividends on the remaining preferred. Gray has been deferring
cash dividends on its preferred stock at a rate of 17% per
annum.
Liquidity
Based on our criteria, we regard Gray’s sources of liquidity
as “adequate” to cover uses over the next 12 to 18 months. Our
assessment of the company’s liquidity profile incorporates the
following factors, expectations, and assumptions: — We expect
that the company’s sources of liquidity over the next 12 to 18
months will exceed its uses by at least 1.2x. — We expect that
net sources will be positive, even if EBITDA drops 30%, which is
normal for a local TV broadcaster in an odd-numbered nonelection
year. — The company has sufficient covenant headroom for EBITDA
to decline by 30% or more without breaching its financial
covenants. Covenants are calculated on a trailing
average-eight-quarter EBITDA basis. — In our view, the company
has the ability to absorb, with limited need for refinancing,
low-probability, high-impact events over the next 12 months. —
Gray has good relationships with its banks, in our assessment,
and has a good standing in the capital markets.
Liquidity sources include cash balances of $5.1 million as
of Dec. 31, 2011 (the company typically maintains minimal cash
balances), modest discretionary cash flow, and availability of
$31 million under its $40 million revolving credit facility
maturing in March 2014. These liquidity sources will be more
than sufficient to fund the company’s modest working capital
needs, annual capital expenditures of between $15 million and
$20 million (per our assumptions), preferred dividends, and
scheduled term loan amortization of about $4.8 million.
For 2012, we expect the company to generate $25 million to
$30 million of discretionary cash flow, mainly when political ad
revenue peaks in the second half of the year. Gray’s credit
facilities contain a first-lien leverage covenant and a
fixed-charge coverage covenant. The covenant calculations use
EBITDA calculated on an average trailing-eight-quarter basis. As
of Dec. 31, 2011, the company had a 38% EBITDA cushion under its
6.5x first-lien leverage covenant and a 19% EBITDA cushion under
its 1.0x fixed-charge coverage covenant. There is no further
tightening of either covenant. With the benefit of political
revenue, we expect the margin of compliance to further improve
this year, and that the company will be able to maintain
adequate covenant headroom.
Recovery analysis
See Standard & Poor’s recovery report on Gray Television, to
be published on RatingsDirect as soon as possible following the
release of this report.
Outlook
The stable rating outlook reflects our expectation that
Gray’s leverage, based on average trailing-eight-quarter EBITDA,
will approach 7x over the coming year and that financial policy,
especially with regard to acquisitions, will remain in check. We
regard an upgrade or downgrade as equally unlikely at this point
in time. That said, we could lower the rating if a decline in
core ad revenue or other revenue pressure in a nonelection year
cause the EBITDA cushion of covenant compliance under Gray’s
tightest covenant to thin to less than 10%. An expensive
debt-financed acquisition that drives leverage higher could also
lead to a downgrade. Alternatively, we could raise the rating if
EBITDA growth momentum and debt repayment reduce the company’s
lease-adjusted debt to average trailing-eight-quarter EBITDA to
the low 6x area.
