Sinclair Looks To Rebound From a Challenging 2022; Retransmission Growth Could Be a Stumbling Block 

Senior Equity Analyst

Neil Macker

Sinclair Broadcast Group is the second-largest television station operator in the United States, with 185 stations in 85 markets. Sinclair also owns 90% of Diamond Sports, formerly the Fox regional sports network group, which operates 21 RSNs. Diamond is a separate entity and has been deconsolidated from Sinclair's financial statements. As a result, Diamond no longer directly affects Sinclair’s reported financial performance and it likely holds little value for Sinclair shareholders.

Over the past decade, retransmission revenue has grown rapidly for local television stations and now accounts for about half of Sinclair's total sales. If a pay-TV distributor like Comcast or Dish Network wants to carry a broadcast network in a specific market, the distributor must retransmit the local station feed for that market and pay a fee to its owner. While retransmission revenue will continue to be an important revenue source, we project that national networks, like CBS, will also continue to raise the fees charged to local affiliates, decreasing the bottom-line benefit to Sinclair as the marginal cost for an additional dollar of retransmission revenue is relatively low. 

Broadcast advertising will also remain an important source of revenue for Sinclair. Most of this revenue is generated at the local level by selling ad time to area businesses including restaurants, auto dealerships, and retailers. Because of its size and geographic reach, Sinclair also sells advertising on a national basis to auto manufacturers, telecom firms, fast food restaurants, and retailers via their ad agencies. With increased political ad spending, the election cycle has become particularly important, especially around presidential or midterm congressional contests in even-numbered years. We expect that Sinclair will continue to benefit from political ad spending growth offsetting weaker general ad spending.

Business Strategy & Outlook

We assign Sinclair Broadcast Group a no-moat rating. Sinclair is the second-largest television station operator in the U.S., with 185 stations in 86 markets. Of the firm’s 634 channels, 154 are affiliated with the four national broadcasters—Fox (56), ABC (40), CBS (31), and NBC (25)—with another 86 channels on networks aligned with The CW (46 channels) and Fox (40 MyNetworkTV channels). Via the 2019 purchase of Fox Sports Networks from Disney, Sinclair is now the largest owner or operator of regional sports networks with 19 Bally's-branded RSNs covering 42 NBA, MLB, and NHL teams along with the new home of the Chicago Cubs, Marquee Sports Network. The firm also owns the Tennis Channel and four multicast networks. 

The U.S. broadcast or over-the-air television marketplace is dominated by the four national networks, but the actual OTA signals are broadcast by local television stations within a specific designated market. While many of the local stations in major markets are owned and operated by the broadcast networks, the vast majority of stations are owned by other businesses. As an example, ABC has over 240 local stations in the U.S. with only eight owned-and-operated stations. Many of the non-owned-and-operated stations were historically owned by local businesses that owned fewer than 10 stations. 

The 1990s saw a wave of consolidation in the local station marketplace that has continued to this day as the Federal Communications Commission has weakened its stance on media ownership concentration. Sinclair has been one of the most aggressive consolidators of local television stations over the past 30 years as it owned only three television stations in 1991. While the firm had expanded to 61 stations by the turn of the century, the buildup to 191 stations largely occurred over the past decade. 

Local affiliated broadcast stations historically generated the vast majority of their revenue from advertising sales to local businesses. With the consolidation of local station ownership, firms like Sinclair began to sell national advertising as station coverage could allow advertisers to reach a larger daytime audience. Another boost to advertising revenue for local stations was the 2010 Supreme Court decision in Citizens United v. Federal Election Commission, which struck down spending restrictions on political communications by corporations, unions, and other groups. As a result of the ruling and the increased politicization of American society, ad revenue has begun to spike in even-numbered years with larger growth in presidential election years. 

Local station revenue has also been lifted by the growth of retransmission revenue over the past 15 years. If a pay-TV distributor like Comcast or Dish Network wants to carry one of the four broadcast networks in a specific market, it must retransmit the local station feed for that market. Due to FCC regulations, a distributor cannot offer an out-market equivalent to replace a local channel. In other words, Comcast could not replace the feed from the local CBS station in Baltimore with the feed from the Washington, D.C., CBS station. Similarly, YouTube TV could not select a single local broadcast (say, Baltimore) and distribute it nationwide so that all customers can view the nonlocal content (say, The Big Bang Theory or the NFL Super Bowl). This means that any pay-TV distributor (traditional or over the top) must negotiate on a market-by-market and station-owner-by-station-owner basis in order to offer local broadcast channels. 

Local OTA stations can either choose “must carry” status (forcing carriage in a local market) or “retransmission consent” on a triennial basis. Most if not all affiliates of the four national broadcasters have migrated to retransmission consent over the past 20 years and thus receive a retransmission fee for each subscriber on a monthly basis from pay-TV operators. These fees have increased rapidly over the last decade as the owned-and-operated stations have aggressively negotiated for higher fees by leveraging their must-have content and sport rights. The broadcast networks, particularly CBS, have been pushing affiliate stations to follow suit in holding out for higher retrans fees. 

These boosts to station revenue and margins have been offset by a number of secular trends. On the advertising side, new money is increasingly flowing to digital advertising, including online video. Local stations are now fighting over an ad revenue pie that is at best stagnant to declining slowly. Additionally, the ongoing fragmentation of media means that viewers are watching less broadcast television. The shift of news online has also hurt viewership of local news, an important local ad revenue generator. 

These changes in viewer behavior are crimping the growth of ad revenue for local stations. Both ad and retransmission revenue are being hurt by the cord-cutting trend and the viewer shift to on-demand viewing options like Netflix or Hulu. The national networks have been able to offset some of this loss by either selling content to the streaming platforms or creating their own direct-to-consumer offerings, an avenue largely denied to local station owners due to the lack of a content library. Critically, the growth in retransmission revenue is increasingly being diverted to national network owners, which have begun to raise network affiliation fees and “reverse compensation” fees. Reverse comp is generally set at a percentage of retransmission revenue with some networks like CBS setting an expected retransmission amount and threatening to pull affiliation if not met. We believe that the national networks increasingly hold the upper hand in part because of the relatively higher viewing of national content versus local content and their DTC offerings. 

With the acquisition of the 14 RSNs with 21 Fox-branded channels from Disney, Sinclair instantly diversified its revenue and operating income away from its dependence on local stations. The RSNs were purchased by a joint venture between the firm (90% ownership) and Bryon Allen via Entertainment Studios. The 19 RSNs currently hold the local broadcasting rights for 14 MLB teams, 16 NBA teams, and 12 NHL teams in several markets, including three (Los Angeles, Dallas, and Atlanta) of the top 10 Nielsen media markets. All of the acquired networks hold multisport rights, which allow the 21 brands to offer live sports year-round and limits the dependence on the performance of any one team. 

While the $10.6 billion purchase price looked shrewd in comparison with the initial Wall Street estimates that Disney could get around $16 billion-$18 billion for the Fox RSNs, we think the lower price reflects some of our longer-term worries about RSNs in general. The Fox RSNs are highly dependent on affiliate fees, which generate over 90% of revenue for the segment. RSNs generally have the second- or third-highest affiliate fees in the pay-TV bundle, usually behind only the ESPN networks. Most RSNs are usually placed on the distributor’s standard programming package, allowing the channels to have the largest possible number of subscribers. 

However, these high affiliate fees when coupled with relatively low viewership of RSNs in comparison with more general entertainment channels have led some pay-TV distributors to question the price and the placement of RSNs. Dish’s iconoclast founder Charlie Ergen has long railed at the price of sports channels, and the firm’s OTT offering, Sling TV, does not offer any RSNs. Additionally, the Fox RSNs have been blacked out on Dish since July 2019, just before the close of the deal. Charter’s SportsNet LA, the home of the MLB’s Los Angeles Dodgers, has not been carried by any other distributor over the six years since its launch, and thus less than 50% of the Los Angeles market receives the network. We expect that other distributors will begin to push back on the fees and tiering structures of RSNs as the price of the pay-TV bundle declines in order to increase competitiveness with DTC offerings like Netflix and Disney+. We think that RSN owners without the ability to package RSNs with must-have cable channels (like SportsNet LA) will be in the most danger of losing a place on the basic package. Sinclair may be able to deflect some of the pressure by packaging the local broadcast networks with the RSNs, but it may need to trade off some of its affiliate fee growth to maintain the RSNs’ place on the basic tier.

Another common factor for RSNs is the relatively high costs for local sports rights. While we have been somewhat skeptical about the concept of a sports rights bubble for national rights, we do believe that local sports rights have exhibited more bubblelike behavior, particularly for single-sport RSNs like SportsNet LA or Marquee Sports, Sinclair’s new venture with the Cubs. Some of the deals in the RSN space have excessively long contract lengths; for example, Fox Sports San Diego signed a 20-year deal in 2012 with the MLB’s San Diego Padres. Additionally, some of the long-term deals carried relatively high annual fees; the Comcast SportsNet Philadelphia deal with the MLB’s Philadelphia Phillies was an average of $100 million per year for 25 years. These deals may make sense if affiliate fees continue to rise and the place on the basic tier is assured. However, these deals do not include streaming rights and only cover local-area broadcasting. Additionally, viewership for local teams is largely dependent on the success of the individual team. Unlike national sports rights holders, the RSN is stuck showing the local team’s games regardless of the actual appeal of the contest.

None

Economic Moat

Sinclair Inc

Sinclair Broadcast Group, Inc. is a media company engaged in the provision of local sports and news. It operates through the following segments: Broadcast, Local Sports, and Others. The Broadcast segment consists of television stations which offer programming and operating services, and sales and other non-programming operating services. The Local Sports segment consists of regional sports networks, the Marquee Sports Network, Yankee Entertainment, and Sports Network LLC. The company was founded by Julian Sinclair Smith in 1986 and is headquartered in Hunt Valley, MD.

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Sinclair, Inc. is a media company that engages in providing content on local television stations and digital platforms. It also owns digital media products that are complementary to their extensive portfolio. The company was founded in 2007 and is headquartered in Hunt Valley, MD.

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