After my previous series of articles on Sinclair (SBGI) I was challenged by other Seeking Alpha readers who argued that I had incorrectly classified some of Diamond Sports Holdings’s (the subsidiary holding the RSNs) preferred equity as having recourse to Sinclair, when in fact they did not. We actually got pretty deep into the issue, but none of us were able to persuade the other.
With Sinclair’s market capitalization currently hovering around $1.7 billion, after falling below $1 billion, the disposition of a $1.025 billion preferred equity stake is significant to say the least. If it has recourse to Sinclair itself and its broadcast TV division, that’s a very different financial picture than if it does not. I decided to do some intensive SEC research to see what the terms of this equity investment are.
The Item Of Dispute
We should first note that Sinclair has elected to redeem approximately $500 million of the preferred equity, which is actually an interesting topic in its own right that I will cover in the future. And everyone agrees that Sinclair invested approximately $1.4 billion of its own cash into Diamond, using loans secured by Sinclair’s broadcast assets. So the question is whether the remaining $525 million also has recourse to Sinclair. But with Sinclair’s market cap at $1.7 billion, $525 million is no small matter.
The objections from others covered two separate issues.
First, was that I had misidentified the preferred equity as coming from JPMorgan Chase (NYSE:JPM) and having a high rate, while in fact JMorgan’s offer was a backup provision that was never used and that Sinclair found new investors to issue the cash at much more generous terms.
Second, was that the preferred equity, whatever its source or rate, has no recourse to Sinclair, only to Diamond – ie., the RSNs themselves – and therefore was irrelevant to any “RSNs are bankrupt” scenario financial analysis.
The SEC Filings
Sinclair’s initial filing on May 3rd for the preferred equity did indeed specify that the company had only obtained “an equity financing commitment pursuant to a commitment letter from JP Morgan Chase.” The deal hadn’t closed yet, so Sinclair wasn’t going to secure such expensive funding for it until the last minute.
But on Aug. 23 the deal did close, and Sinclair made another filing the same day declaring that funding had been raised in the following way: Sinclair and Diamond had (bold emphasis added by me).
issued perpetual preferred equity of Diamond Sports Holdings (the “Preferred Equity”) for $1,025 million, prior to commitment and funding fees (the “Preferred Equity Financing”), the net proceeds of which were used to fund a portion of the RSN Acquisition (as defined below) to JPMorgan Chase………
The Preferred Equity ranks senior to all existing and future common equity of Diamond Sports Holdings, Sinclair Broadcast Group, Inc. (“Sinclair”), and any other direct or indirect parent of Diamond Sports Holdings…..
In connection with the Preferred Equity Financing, Sinclair entered into a guaranty of collection (the “Guaranty of Collection”) that has recourse to Sinclair, after the exhaustion of certain investor remedies, on a senior basis to the common equity of Sinclair
Diamond’s debt financing filings do not show similar language indicating that the recourse of the two funding streams is indeed different. And as you can see, JPMorgan was indeed the recipient of the equity and the source of the cash.
As to the suggestion that the Chase stake has since been closed out and replaced with other, more favorable financing, well, Sinclair issued its Q3 earnings report in November and then its 10-K last month. In both filings it referred to $1.025 billion in preferred equity issued “On Aug. 23, 2019.” The day of the sale to JPMorgan Chase.
Meanwhile, those same documents refer to a dividend rate of 8.00% plus 1-month LIBOR, which would currently be 8.4%. However, Sinclair is actually paying 8.75%, and even this is an introductory rate only. As the filing goes on to explain, Diamond pays on the equity at a rate:
Equal to 1-Month LIBOR (or successor rate) plus 8.00% per annum…In the event that the 1-Month LIBOR rate would be less than 0.75% then the 1-Month LIBOR rate shall be deemed to be 0.75%. Dividends paid in cash will be entitled to a 0.50% per annum reduction in dividend rate. The Preferred Equity dividend rate will be subject to rate step-ups of 0.50% per annum, beginning on the 3rd anniversary of the Closing Date; provided that, and subject to other applicable increases in the dividend rate described below, the cumulative dividend rate will be capped at 1-Month LIBOR plus 10.50% per annum. In addition, (x) on the date that is eight years and six months after the Closing Date, the Preferred Equity dividend rate will increase by 1.50% with further increases of 0.50% on each six month anniversary thereafter and (y) the Preferred Equity dividend rate will increase by 2.00% if Diamond Sports Holdings does not redeem the Preferred Equity, to the extent elected by holders of the Preferred Equity, upon a change of control (as defined in the DSH LLC Agreement); provided, in each case, that the cumulative dividend rate will be capped at 1-Month LIBOR plus 14.00% per annum.
I always respect fact checkers, they keep us on our toes. However, I cannot see what more evidence I can offer to assuage concerns over the accuracy of my research on this issue. I believe it’s clear that Sinclair indeed issued more than $1 billion in preferred shares to JPMorgan, at a high rate of as much as LIBOR plus 14%, which had and has recourse to Sinclair’s broadcast TV assets.
Investment Summary
If Sinclair does indeed have $525 million of preferred equity outstanding that can have recourse to its TV assets, that’s roughly $5.82 per share of obligation that will fall on Sinclair’s balance sheet as soon as Diamond can no longer pay its bills. With Sinclair currently trading around $19, that’s a very significant hit. Of course, if Sinclair’s shareholders already understand this the hit may be priced in already, but if they believe Diamond’s preferred equity is “bankruptcy remote,” the recourse may hit the stock value when it becomes official.
At any rate, the preferred equity does have recourse, and I hope knowing that can be helpful to readers as they do their own due diligence on Sinclair and assess a potential investment.
My research comes from official SEC filings, not conversations with management directly. I do not know what management could say that would possibly change this conclusion, given that the SEC filings seem pretty clear, but because it has been an issue in the past I want to acknowledge up front that I have not discussed this with management directly.
Investment Recommendation
Given how low Sinclair has fallen I’m no longer certain it’s such a good short candidate, at least in the short term. However I’m also not recommending going long, even though I acknowledge there’s some potential for a short-term bounce. Given the long-term issues hanging over the stock, however, I simply wouldn’t want to try to time that bounce and any subsequent second decline.
As always, I’m available in the comments to answer questions, at least for the next few days. Please always continue to do your own due diligence and research before making or selling any investment.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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