Despite Jettison of Diamond Sports, Sinclair Remains Challenged

Senior Equity Analyst

Matthew Dolgin

We expect that industry headwinds faced by linear television and the continued transition of advertising to digital mediums will result in ongoing challenges for Sinclair that lead its business to decline.

Sinclair generates nearly half its total sales from retransmission revenue, the fees it receives from pay-TV distributors that carry Sinclair’s stations. Retransmission revenue has grown rapidly over the last decade and will remain an important revenue source for Sinclair, but we expect the decline in pay-TV customers will steadily pressure this business. Also, the national networks, such as ABC, will continually increase fees charged to local stations (reverse compensation) like the ones that Sinclair owns, reducing the bottom-line benefit to Sinclair. 

Sinclair’s other major source of revenue is broadcast advertising. Most advertising revenue is generated at the local level, with stations selling advertising time to area businesses, such as restaurants, lawyers, and car dealerships. This revenue is volatile, as it is heavily dependent on the strength of the local economy. The geographic scale of Sinclair’s station portfolio enables it to also sell advertising nationally to large corporations, such as automotive manufacturers, retailers, and drug manufacturers. While national advertising makes up a smaller portion of total advertising revenue, it is often less volatile. Also, political advertising during election cycles has grown significantly and become increasingly important. 

While parts of Sinclair’s business, like the Tennis Channel, Marquee Sports Network, and YES Network, may be able to survive the transition to a streaming-centered distribution model, they are not big enough to offset the firm’s reliance on traditional television.

Business Strategy & Outlook

We assign Sinclair a no-moat rating. While Sinclair exhibits a handful of competitive strengths, none are material enough to definitively declare the presence of an economic moat. More importantly, even if Sinclair had a durable competitive advantage, any economic profit defended by that competitive advantage is weakening as the pay-TV industry erodes. 

Sinclair earns its revenue primarily from fees it receives from pay-TV distributors and advertising revenue it generates from viewership of the content it produces and distributes. With traditional linear television viewing continuing to decline and unlikely to regain share, Sinclair’s business should weaken, especially as other industry players, often with significantly more clout than Sinclair, try to salvage more of the shrinking pie for themselves. 

The disaggregation of valuable content from pay-TV outlets and the popularity of online news offerings has meant fewer people are watching broadcast television, including local news, which drives the lion’s share of Sinclair’s advertising revenue. The national networks like ABC and CBS, which supply primetime content to Sinclair’s stations, have offset some of their own lost audiences by either selling content to streaming platforms or creating their own direct-to-consumer offerings. This avenue is unavailable to local station owners like Sinclair because they lack ownership of sufficient content breadth. 

Also, to receive rights to broadcast national content, the national networks are demanding higher “reverse compensation” fees from the local station owners. We believe that the national networks increasingly hold the upper hand, due to the relatively higher viewing of national content versus local content as well as their newer alternative ways to reach viewers via their direct-to-consumer offerings.

We expect the declines in the number of pay-TV subscribers will continue to shrink linear television’s revenue potential and threaten the existence of the broadcast distribution model as a whole. Broadcast station owners like Sinclair will continually fight over a decreasing amount of advertising sales as those are continually directed away from broadcast television and toward digital advertising, and fewer pay-TV subscribers will pressure the retransmission revenue they receive from pay-TV distributors. 

Putting aside the overriding industry headwinds, we think Sinclair has some advantages, but still not enough to create an economic moat. For many media companies, intangible assets, in part in the form of exclusive content, are the most likely sources of competitive advantage. While Sinclair does provide valuable broadcast programming, its lack of ownership of most of the content it airs leaves its position difficult to defend. Of the three types of content offered by Sinclair—local news, network programming, and syndicated fare—Sinclair only owns local news. Sinclair has retained a few sources of valuable content, such as an ownership stakes in the Marquee Sports Network and the YES Network, but this alone is not enough to justify the existence of intangible assets as a moat source.

The strongest case for a durable advantage at Sinclair derives from favorable regulation. Due to Federal Communications Commission regulations, a pay-TV distributor cannot offer a nonlocal broadcast to replace a local channel. Any pay-TV distributor, such as Comcast or Charter, that wants to carry local channels needs to negotiate a rights contract with the local station in each market. Regulation mandating the need to secure rights locally has provided demand for thousands of existing broadcast stations nationwide. Owning the second-largest station portfolio, Sinclair’s large viewer base gives access to national advertising markets that are otherwise unavailable. Currently, most production and ad selling are localized, but Sinclair’s scale provides the opportunity to regionalize news broadcasts and sales teams, which will become especially important as revenue decreases and compresses margins. FCC regulation also requires stations to acquire licenses to operate, providing a barrier to entry. The FCC is less willing to issue licenses in well-served markets, leaving only smaller and less desirable markets for potential entrants.

Sinclair, like other station owners, lacks evidence of other moat sources. The lack of access to low-cost content and diminishing buying power due to direct-to-consumer alternatives for content owners have minimized the usefulness of the little cost advantage the firm had over its smaller competitors. Pay-TV distributors have little alternative to Sinclair or other large station owners in acquiring broadcast content, and Sinclair may hold switching costs from a lack of viable market alternatives in small markets. Despite this, Charter has negotiated for access to Disney+ and ESPN+ for its cable subscribers, giving customers a viable alternative to some of the content that broadcast stations provide. While currently the exception and not the rule, Comcast and other regional pay-TV providers will likely attempt to follow suit. 

Sinclair has managed to maintain some pricing power, as pay-TV distributors have accepted pricing increases from station owners and other media companies, but not without difficulty. This has allowed retransmission revenue to grow modestly in the past, even in the face of linear-TV subscription decline. However, this distribution revenue is increasingly being diverted to national network owners that have raised the reverse compensation fees they demand for network affiliation. These increasing fees have often eroded what pricing power Sinclair has had, especially given the lack of robust owned content.

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. It operates through the Local Media and Tennis segments. The company was founded by Julian Sinclair Smith in 1971 and is headquartered in Hunt Valley, MD.

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