The tipping point

It's rare when a nuanced and complicated story gets distilled into a single sentence. But 67 minutes into a July 14 conference call, one arranged by Sinclair Broadcast Group Inc. to address its exposure to a possible default by Cunningham Broadcasting Corp., call participant Peter Reuss nailed it. "Just so I understand this correctly," the financial adviser for Scott & Stringfellow LLC said by way of clearing his throat. "We have a privately held company, Cunningham, with a majority shareholder being the Sinclair family, whose potential pending bankruptcy could send a publicly held company, Sinclair, majority-owned by the Sinclair family, into bankruptcy as well."

David Amy, the CFO speaking for Sinclair during the call despite being flanked by chairman, chief executive officer and president David Smith, waited a beat or two before grasping the entirety of Reuss' premise. He then signed off with a well-considered, "Yeah."

But his response overlooks that the premise may also have a punch line -- that Sinclair may not be as vulnerable to bankruptcy as it and its reigning Smith family want people to think. As Wells Fargo Securities LLC analyst Marci Ryvicker puts it in her post-call update: "To be blunt, we think management is 'posturing.' We believe that management is painting the most dire scenario in a public forum as part of its negotiations with convert holders."

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This suggests that the setup Reuss laid out so deftly is itself a setup. What's really going on, Ryvicker posits (and others attest), is an orchestrated attempt by Sinclair to cram down a debt exchange of $488.5 million in convertible notes that mature within 18 months. And to do so it's using an overdue loan of $33.5 million at sister company Cunningham ("a dinky little thing," another analyst says of the liability supposedly capable of spilling over and spoiling some $1.5 billion in enterprise value) to fan fears of a Sinclair bankruptcy. These fears, the reasoning goes, could be just enough to induce pesky holders of Sinclair's convertible notes to exchange at terms that, were it not for the threat of a default at Cunningham and a cross-default at Sinclair, would seem overly coercive.

Could that really be why Sinclair is exhibiting such susceptibility, even though its bank-credit provisions designate Cunningham a "material third-party licensee" and, for that reason, dictate that a default there could trigger a cross-default at Sinclair? Does this explain why Cunningham is suddenly portrayed as such a necessity that, without its cash flow, Sinclair itself would be hard-pressed to carry on?

One can be excused for dismissing such ulterior motives as unlikely, absurd even, especially when attributed to management of a publicly traded company. Yet few would deny they make a fitting next chapter for the biggest broadcaster based in Hunt Valley, Md., near Baltimore, where television of the absurd has never lacked for precedent.

The current situation promises more material. The Smiths -- whose TV-station group has fattened margins through questionable means for years, whose public trust has made a mockery of fairness standards and whose regulation-skirting antics have been so egregious that calling the responses of the Federal Communications Commission the work of "a bloated bureaucracy" is, in the words of one longtime company follower, "too much of a compliment" -- seem likely to meet their match. It could be their debt, the economy or simply a new reform-driven FCC that catches up with them. But it could also be the charade with convertible noteholders that many contend is already under way. "Let's assume their threats actually work and they scare off all the passive investors," an analyst offers as one game-ending scenario. "Who's going to buy that stuff then? Really mean hedge funds and distressed-debt types -- foes much more formidable than whoever management is dealing with now."

Publicly traded Sinclair, the country's 12th-largest TV group, as calculated by the FCC, had $750 million in consolidated revenue last year. Among its 58 owned or operated stations are six owned by privately held Cunningham that generate less than $100 million in annual sales. Sinclair operates the Cunningham stations under local marketing agreements, which allow it to pool resources and share overhead with other stations that Sinclair owns in each Cunningham market. This means the six LMAs deliver the enviable economics that a duopoly -- two stations in the same market with a single owner -- would generate. Only they do so without being FCC-sanctioned. Some of the markets have too few media outlets or media owners even to qualify for a legal duopoly. And Sinclair itself concedes in regulatory filings that, absent a waiver, "rules would require us to terminate or modify three of our LMAs."

The companies are so intertwined that Cunningham operates out of Sinclair's Baltimore station. Yet it takes only a cursory examination of their shared history to understand how the family behind both came to rankle so many.

Sinclair began in 1971 as the Chesapeake Television Corp., whose founder, Julian Sinclair Smith, brought his four sons into the business. In 1986, with Baltimore's WBFF-TV their flagship station, they changed the company's name to Sinclair. In 1990, the sons bought out their parents' interests. A year later, they made their first acquisition, WPGH-TV in Pittsburgh, where they had a station launched by their father in 1978.

Because FCC policy at the time prohibited broadcasters from owning more than one outlet in a market, the Smiths hauled the LMA concept over the metaphorical fence from radio. They then pitched it as a means of advancing minority ownership. As Eric Klinenberg recounts in his book "Fighting for Air: The Battle to Control America's Media," Sinclair's plan on buying the second Pittsburgh station was to continue running both stations after selling one of them to Eddie Edwards, an African-American and Sinclair employee.

"The FCC, which had expressed interest in supporting minority station owners, agreed, and [David] Smith was proud of the arrangement," Klinenberg writes. " 'What an opportunity that was to give something back to the African American community!' he told me. Rainbow/PUSH saw it differently, accusing Edwards of being a front man for Sinclair, and the National Association of Black Owned Broadcasters later opposed his dealings with the Smith family."

That didn't keep the Smiths from pressing ahead with other LMAs, however. They paired Edwards with their mother as owners of second-station acquisitions in Sinclair markets and installed themselves as operators. The FCC fined Sinclair $40,000 in 2001 for illegally controlling the Edwards-Mrs. Smith venture -- founded in 1994 as Glencairn Ltd. -- but then allowed the TV group to buy outright four of the 10 stations parked in the shell company. This left Glencairn with six stations that, after a name change, equity reshuffling and some lawsuits pending to this day, became Cunningham.

One can certainly understand, if not condone, the Smiths' desire to keep Cunningham in the Sinclair fold. Cunningham's revenue, which Sinclair consolidates on its books and then passes along an LMA fee between 10% and 20%, is expected to total $77 million this year. Of that, Sinclair estimates, $26 million will contribute to its direct broadcast cash flow and $24 million to $34 million will add to synergies, cost savings and other enhancements the company classifies as indirect broadcast cash flow. At the upper end, then, Sinclair stands to boost its direct and indirect broadcast cash flow by $60 million from LMA sales of only $77 million. It's a margin so bountiful as to be pushing 80%.

Sinclair, which went public in 1995, kept adding stations to its own group, too. But its focus on midsize and smaller markets -- Tampa-St. Petersburg, Fla., is its largest -- kept it from public view until the turn of the century. That's when Sinclair started achieving notoriety for cutting corners, fiscal and moral, to advance either its economic interests or its political agenda. Fiscally, among other violations to the spirit of community service, Sinclair once flooded local newscasts with feeds from "NewsCentral," a cost-savings experiment aimed at centralizing news production at its Baltimore headquarters. The studio's sets, like the banter of on-air talent stationed at those sets, were contrived to confuse viewers in Sinclair's 30-plus markets into thinking the news on their screen had been locally produced.

Morally, there was management's directive to all of its affiliates to pre-empt regular programming just two weeks before the November 2004 election. In its place, Sinclair reportedly ordered affiliates to run "Stolen Honor: Wounds That Never Heal," which even Republicans recognized as anti-John Kerry propaganda dressed up as documentary. The planned pre-emption stirred so much outcry from advertisers, consumers and shareholders that, three days before its scheduled airing, Sinclair back-tracked and announced a more reasonably balanced special, "A POW Story: Politics, Pressure and the Media," would run in "Stolen Honor's" place. According to Josh Silver, the executive director of media-reform group Free Press, these and other stunts render Sinclair "the poster child for abuse of the public airwaves."

While the company's current woes with Cunningham are unrelated to earlier transgressions, they can be construed as in keeping with Sinclair's character. Cunningham remains a Sinclair artifice, after all, still intent on circumventing duopoly rules. Only it's now at least 90%-owned by trusts in the name of the Smiths' mother. As for the trusts' beneficiaries, they're her grandchildren. Or, put another way, they're the progeny of her four sons. So much for the independence advocated by the FCC. The sons themselves are still connected to Sinclair: Three continue to serve in executive capacities, while all four have stayed on the board. Collectively, they maintain an 87% economic interest and an 85% voting interest in the company.

Despite the brushes with infamy, and for all their decades in an industry given to celebrating itself, the Smiths enjoy relative anonymity. Of the brothers at Sinclair -- Frederick, David, Duncan and Robert, ranging in age from 59 to 45 -- only second-born David, 58, has engaged the media. And much of the coverage directed at him stems from the anti-Kerry "Stolen Honor" flap in 2004 and from Sinclair's refusal earlier that year to broadcast a "Nightline" listing of all U.S. soldiers killed in Iraq. (While the former elicited outrage from Democrats, the latter was lambasted as "a gross disservice to the public and to the men and women of the United States Armed Forces" by no less than Arizona Republican Sen. John McCain.) These incidents were enough, though, for the same Klinenberg who wrote "Fighting for Air" to offer up a description of Sinclair's CEO in a Rolling Stone article four years ago:

"An imposing man with a pink complexion and a confrontational manner, Smith comes across like an overgrown frat boy who suddenly struck it rich. ... During a daylong tour of Sinclair's headquarters, on the outskirts of Baltimore, Smith repeatedly boasts about his wealth ('I bet you wish you were my son,' he tells me. 'It would put you in a different financial bracket') and proudly shows off his travel photographs, which are mounted and displayed in the hallways of Sinclair's five-story office building. He makes no secret of his support for Bush and describes Sinclair as one of the only bastions of objectivity in American journalism."

Better known than the CEO himself, in media and political circles anyway, is Sinclair's continuing relationship with Cunningham. Yet it wasn't until last month this relationship also became a major financial issue. It came out of the blue, a challenge at once menacing and fully formed. "Why are we talking about this now?" Michael McCaffrey, an analyst with Shenkman Capital Management Inc., asked during the July 14 call. "Given the severity here, I'm kind of surprised this is just being brought to light now as something that could accelerate a default across the rest of the structure."

Sinclair CFO Amy fielded the question with equanimity. "I guess it all has to do with the fact that none of us were expecting the degree of this recession," he said. "In our discussions earlier this year with Cunningham, we were fully expecting that they would get a renewal of their bank-credit agreement. They had not indicated to us that they were not going to. Then they indicated they had a problem, and we've gone from there."

Going from there, however, didn't take Sinclair directly to the broader public via the July 14 conference call. Instead, the company admits, it first met with select holders of those $488.5 million in convertible notes that mature within 18 months. (Score one for the conspiracy crowd.) "Pursuant to these discussions," Sinclair says of its July 8 meeting with noteholders, "the company disclosed certain material, non-public information."

This non-public information was part of "a restructuring proposal" -- one more favorable to Sinclair, no doubt, although details remain private -- the receipt of which required attending noteholders to commit to a confidentiality and standstill agreement until July 10. In fact, Sinclair notified the public only after failing to strike an agreement with noteholders. It had to, in accordance with Regulation FD, and did so not only through the conference call on July 14 but in a Form 8-K on July 10.

The timing of these events hardly dispels perceptions that Sinclair wants to use Cunningham's vaguely defined default -- Sinclair's Form 8-K somewhat cryptically blames the default on "failure to timely deliver certain annual financial statements as required" -- as a stick to beat noteholders into acquiescence. Nor does it keep the company's dialogue with analysts, bankers and investors from taking an occasional surreal turn. A case in point is CEO Smith's silent presence during the July 14 conference call, notably when Scott & Stringfellow's Reuss establishes that the Smith family controls both Sinclair and Cunningham.

"Are there any conversations within the [Smith] family to avoid that happening?" the financial adviser asked about the temporarily waived default at Cunningham and a possible cross-default at Sinclair. The answer came not from the CEO, who remained mum despite appearing to be the point man on family business matters, but from the CFO, a non-family member. "That I do not know," Amy said.

An argument can be made for Sinclair's crying wolf, and CreditSights Inc. analyst Jake Newman makes it as convincingly as anyone. His case takes at face value, however, Amy's assertion that the company can't afford to focus solely on the Cunningham loan but needs to think "holistically about the entire capital structure." This means that, in addition to the Cunningham loan, Sinclair must simultaneously consider about $430 million drawn down on a three-part bank-credit facility that matures between midyear 2011 and year-end 2012, as well as two tranches of the aforementioned converts: $345 million of 3% senior notes due 2027 and $143.5 million of 4.875% senior notes due 2018.

The two tranches of converts can be put to the company in May 2010 and in January 2011, respectively. And even Sinclair acknowledges it's "highly probable" they will be put, given that each tranche's conversion price into equity is greater than $20 per share. Sinclair's stock, meanwhile, is trading at around $2 per share, more than 70% off its 52-week high. This "holistic" portion of the company's capitalization -- the credit facility, the converts, the Cunningham loan -- accounts for about $950 million of the $1.3 billion in total debt Sinclair reported for the end of the second quarter.

CreditSights' Newman, using Sinclair's own Ebitda forecast of $161 million for 2009, believes Sinclair Television Group Inc. (Sinclair's operating company and credit-facility borrower) could raise about $350 million in additional debt before bumping against the 6.5 times leverage ratio imposed by its banks. This amount of "issuance headroom," as he calls it, would cover the May 2010 put of $345 million. But it would leave Sinclair maxed out, at least in terms of debt capacity, on addressing the second put of $143.5 million eight months later. Granted, the $173 million in Ebitda that Sinclair projects for 2010, coupled with $64 million still available on its revolving credit facility, could cover or go a long way toward covering this January 2011 put. Newman's summation, nonetheless, is literally correct: "The amount of debt issuable would not be enough to refinance all of the convertible bonds at par."

The most immediate priority, Cunningham's $33.5 million loan, recently received a second extension through October. Here, though, the analyst appears more optimistic than Sinclair about the company's ability to give Cunningham a loan to take out this bank debt.

His math even challenges Amy's conference-call claim that FCC attribution rules constrain Sinclair from stepping up and bailing out its privately held sister company. Newman's reading of the FCC rule, applied to a simplified version of Cunningham's balance sheet, shows that Sinclair could quite likely cover the maturity in its entirety.

Doing so would push Sinclair's next credit challenge out to May 2010, when any or all of the $345 million first put is due. But this is the put for which Newman's analysis suggests the company has "issuance headroom."

And for the second put of $143.5 million, due January 2011, Sinclair's projected 2010 Ebitda of $173 million and the $64 million still available on the company's revolver just might suffice. If that's the case, if Sinclair can get past the two puts after first dispensing of Cunningham's comparatively modest loan, then it's home free until its $168.6 million revolver comes up for renewal in mid-2011.

A lot can happen between now and mid-2011. The credit markets could loosen up. The equity markets might strengthen to the point that even downtrodden TV-station groups accept the dilution attendant with raising capital through the issuance of additional stock. Investors could start rewarding Sinclair for its move from a weaker ultrahigh frequency spectrum, where all of its channels had been before the June 2009 switch to digital terrestrial TV, to a level-playing-field band comparable to the stronger very-high-frequency spectrum that once gave its competitors an advantage. There are so many variables, in fact, that the now-or-never approach Sinclair is trying to pass off as "holistic" may well be the strongest argument for not buying into management's assessment.

One distressed-debt expert goes so far as to interpret Sinclair's knee-jerk dismissal of setting up Cunningham with a $33.5 million loan as the most telling evidence. The real question isn't whether Sinclair can help, he says, but does it want to help? "Why not renew the LMA agreement with some big, fat up-front fee?" he asks. "Why not make a nonvoting preferred investment in Cunningham?" That Sinclair chooses instead to hide behind FCC attribution rules strikes the distressed-debt expert as rich in the extreme, given that the purpose of the rules is to prevent the sort of hanky-panky ownership games at which Sinclair has historically excelled. "So now they're saying there's nothing they can do? ... Management should have been so far in front of this that it never became an issue."

Then again, as some insist and many suspect, maybe management is in front of the issue, but in a typically Smithian way. Maybe Sinclair is now playing with noteholders the way it has always played with viewers and regulators. And if it's not really playing -- that is, if Sinclair is not crying wolf but is being straight up and proactive about its debt obligations -- that would also be a problem. It might even be a problem of dynasty-ending magnitude for television's first family of self-dealing shenanigans.

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