Hemisphere Media (HMTV) Shareholder Edenbrook Capital Sends Letter to Board, Says Transaction is Unfair to Public Shareholders

May 16, 2022 4:49 PM EDT

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Edenbrook Capital, LLC (together with its affiliates, "Edenbrook"), one of the largest public shareholders of Hemisphere Media Group, Inc. (NASDAQ: HMTV) ("Hemisphere" or "the Company"), with ownership of approximately 14.94% of the publicly traded A shares and 7.65% of the total company, including the privately held, super-voting B shares, today announced that it has delivered the following letter to the Hemisphere Board of Directors.

May 16, 2022

Peter KernChairman of the BoardHemisphere Media Group, Inc.c/o InterMedia Advisors, LLC228 Park Avenue South, PMB 67521New York, NY 10003-1502

Dear Peter:

Our firm, Edenbrook Capital, LLC, is a large shareholder of Hemisphere Media Group, Inc. ("the Company" or "Hemisphere"), with ownership of approximately 14.94% of the publicly traded A shares and 7.65% of the total company, including the privately held, super-voting B shares. We have been patient, supportive shareholders for nine years, and in that time, we have enjoyed a collaborative, productive relationship with the Company. But following last week's surprise announcement of a proposed transaction for the Company to be taken private by insiders at a price that significantly undervalues the Company (the "Insider Takeover"), we feel compelled to share our views publicly for the benefit of all shareholders. In short, we believe this transaction is unfair to public shareholders as it undervalues the Company and allows insiders to disproportionately benefit from the very share price erosion they are responsible for. In our view, a deal to take the Company private at anything less than $12.00 per share is indefensible and would raise serious questions about the process, motivations and conflicts of interest surrounding the Insider Takeover.

Valuation

Based on the cover numbers of the Company's most recent Form 10-Q, filed on May 10, there are 20,680,326 publicly traded A shares, and 19,720,381 privately held B shares, for a total of 40,400,707 issued and outstanding shares. At the proposed $7.00 deal price, the Insider Takeover yields an equity value of approximately $282 million. After accounting for net debt of approximately $212 million, per that same Form 10-Q, the proposed enterprise value would be approximately $494 million, a dramatic undervaluation of the Company as demonstrated by our analysis below.

Sum of the Parts Analysis
  1. Legacy broadcast and cable network businesses: These include Puerto Rico's leading broadcast network, WAPA, and cable networks (WAPA America, Pasiones, Cinelatino, CentroAmérica TV and Television Dominicana in the United States, and Pasiones and Cinelatino in Latin America). We estimate, based on the Company's annual report and fourth quarter 2021 earnings press release, that these high quality, cash-generative businesses produced approximately $64 million in EBITDA in 2021, after backing out the operating losses for Pantaya, discussed below. Further, we expect an election-year bump in 2022, with projected EBITDA for the core business to be approximately $70 million. While we believe WAPA is the majority of the EBITDA and deserves a premium multiple given its market share, we will use a conservative 6x multiple for all of these assets and an average of the two years, or $67 million. This yields a value for this segment of $402 million.
  2. Pantaya, the Company's streaming platform: Hemisphere acquired the remaining 75% of Pantaya that it did not already own in April 2021 for $124 million, putting a valuation on the business of approximately $165 million. This acquisition was made because of strong growth prospects and expectations of a considerably higher valuation in the future.
  3. Canal Uno, the Company's joint venture in a Colombian broadcast network: Hemisphere has invested approximately $130 million in Canal Uno in recent years. These investments were made because of the growth prospects and expectations of considerably higher valuations in the future.
  4. Other Assets: Includes equity stakes in Snap Media, a content distribution business, and Remezcla, a Latin American cultural media company. While we would expect these investments to have some value, given the lack of disclosure, we'll take the conservative route and, for purposes of this analysis, we will not ascribe any value to them.
  5. Net Debt: As previously stated, net debt is approximately $212 million.

Adding up the assets yields an enterprise value of approximately $697 million. After subtracting the net debt, we are left with an equity value of approximately $485 million, over $203 million above the $282 million equity value in the proposed transaction. On ~40.4 million shares outstanding, this would yield a conservative equity value of approximately $12.00 per share, more than 71% higher than the price offered by the proposed Insider Takeover. Notably, the two primary sell-side analysts who covered the Company each had a $12.00 price target on the Company prior to the Insider Takeover announcement. It is worth noting that these price targets were derived based on simple trading multiples, without taking into account the potential for higher transaction multiples.

The Company's Recent Actions Indicate They Agree This is a Bad Deal for Public Shareholders

But don't just take our word for it, look at the Company's actions. In September 2021, the Company bought back its own shares for $11.00 a share. A $12.00 transaction price would therefore represent less than a 10% premium to the price the Company paid for its own shares mere months ago.

Further, as the B shares are held by insiders and related parties who benefit from, and are participating in, the take-private transaction, the additional deal compensation would only be paid to public shareholders. An additional $5.00 per share for 20.7 million public shares would be approximately $103.5 million, about half the difference between our estimate of equity value and your proposal. Let's split the difference in equity value, shall we?

And let's not forget why the share price fell so precipitously in advance of your proposed Insider Takeover. To recap, business operations were quite promising six months prior to your proposed Insider Takeover, when the stock was in the mid-$11 range after third quarter earnings (closing prices the five days after earnings ranged from $11.25 to $11.70).

The Company clearly agreed that its future was bright as its third quarter earnings release on November 5, 2021 included the following statements from CEO and Board member Alan Sokol:

  1. "I am very pleased with our third quarter performance, as we continue our momentum from the first half of the year. Pantaya continues to grow its subscriber base, WAPA had another tremendous quarter, and our cable networks maintained their leadership positions".
  2. "Pantaya reached one million subscribers during the quarter and we are excited about our growth prospects. We have significantly ramped up our series production and have an unprecedented lineup of series and movies scheduled for 2022. In addition, with Pantaya's recent launch on YouTube TV, along with the potential to launch on several other major distribution platforms, we are confident about reaching our long-term goal of 2.5 to 3 million subscribers by the end of 2025."
  3. "Our portfolio of unique and powerful assets has delivered yet another successful quarter. We are transforming the business, while building on the performance we have delivered through difficult market environments. We have proven that our business is resilient and represents an underserved, but high growth and essential part of the media ecosystem."

On the third quarter earnings call, Sokol provided the following additional operational color:

  1. "Pantaya…continued to perform very well, as we expected when we acquired the business on March 31" and "Pantaya has an exciting future and with an incredibly compelling content pipeline for the next year, we are well-positioned as a clear market leader."
  2. Further, with respect to the disconnect between the Company's share price (then north of $11) and its undervalued nature, Sokol said on the third quarter earnings call, "We're confident that over time our continued execution and enhanced investment in Pantaya will unlock value and minimize the dislocation in our current market value."
  3. In response to a question from a sell-side analyst about ongoing content investments in Pantaya, Sokol said "we expect that to deliver a significant return on investment."

On this same call, CFO Craig Fischer said, "We are pleased with our third quarter performance and are on track to finish the year strongly. Pantaya's future is promising, and together with the ongoing rebound in Puerto Rico, we look forward to continuing to create value for our shareholders." Fischer also noted that the "revolver is currently undrawn" in discussion of the balance sheet capacity to continue investing in growth.

We Believe the Company's Missteps Drove its Stock Price Down

On November 15, just ten days after the third quarter 2021 earnings, however, Hemisphere announced a surprise secondary offering with no express purpose. Companies that do secondaries usually do so either from a position of strength, after a big run in the stock or because there's an immediate use for the capital that will drive accretive returns in the near future. Absent those two cases, companies doing secondaries are perceived to be doing so from a position of weakness, including potential liquidity concerns or worsening business prospects.

As the announcement did not come on the heels of a big run and as there was no case made for an expected return on the raise, we believe that investors and the market were left concerned. In contrast with your upbeat earnings call just ten days earlier on November 5, the offering felt like a knee-jerk move in the opposite direction.

In our view, given the low liquidity of the stock, the lack of explanation for the secondary offering and the fact that the Company had purchased stock as recently as two months prior at $11.00, the stock tanked over the next two days before the secondary was pulled on November 17, and over the remaining six weeks of 2021, the stock sold off 36% to end the year at $7.27.

Was this sell-off driven by concerns about board and management credibility, given this poorly conceived financing? Or was it because of concerns about the ability to finance Pantaya's growth? If it were the latter, the fourth quarter earnings call on March 8 should have alleviated those concerns. It was another strong quarter, and despite continued investment in Pantaya, the balance sheet was substantially the same as it had been the prior quarter, with the revolver still undrawn, suggesting continued ability to fund the growth of Pantaya from existing operations.

Again, notable comments from Alan Sokol in the March 8, 2022 press release highlighted the improving operations and continued dislocation in price versus value:

  1. "Our networks continued to perform at high levels in the fourth quarter and finished the year strongly. Our performance was highlighted by WAPA, which had an extraordinary year, with the highest advertising and retransmission revenue in its history. WAPA's dominant ratings performance, combined with Puerto Rico's emergence from bankruptcy and the strongest local economy in many years, should drive outstanding results in 2022."
  2. "We continue to secure new launches for our U.S. cable networks, including, most recently, the launch on fuboTV of all five of our networks on March 1, a reflection of the quality and appeal of our programming. The fuboTV launch, as well as the impending YouTube TV launch, should drive subscriber growth."
  3. "We have an incredible high-quality portfolio of assets, including the clear market leader in Spanish-language streaming and a consistent and market-leading networks and production business, all with tremendous upside potential. Yet our market value has little correlation with our true underlying value."

Sokol went even further on the March 8 earnings call, saying:

  1. "Before I dive into our performance, I want to briefly address the market value of our business, which has deteriorated in recent months. Very simply, our stock price does not in any way reflect the fundamental value and strength of our company. We have consistently delivered strong results in growth and in particular during 2020 and 2021, we delivered industry-leading growth, and despite the headwinds relating to the pandemic, we set all time revenue records."
  2. "Last year we acquired the leading Spanish-language streaming platform in the U.S., which will be a major growth engine for us over the coming years. A very talented and seasoned team has continued to prove its ability to perform with speed, creativity and agility despite difficult macroeconomic circumstances, including successfully navigating through hurricanes and earthquakes in Puerto Rico and a global pandemic. Our business model is proven and has tremendous runway for growth. We have never been more excited about the prospects for Hemisphere."
  3. "We are managing an extraordinary portfolio of assets and believe we have a tremendous value creation opportunity in front of us. Pantaya's upcoming slate of content is unprecedented. We are producing the kinds of premium series and movies that have never been available until now, and we have the ability to monetize and license that content outside of the U.S. We are well-positioned to dominate this unique and untapped market from multiple angles and are confident that our transformed business will prosper as a result, creating significant long-term shareholder value."

This all sounds great. A well performing company, with a seasoned team and an "extraordinary portfolio of assets" all geared toward creating significant shareholder value. Except you apparently don't want the public company shareholders to participate in this upside. Instead, you propose an Insider Takeover at a discount to a price deemed undervalued by the Company itself in your November earnings report, and even below the price the stock cratered to at the end of 2021 after your ill-conceived secondary.

What's more, after public shareholders have borne the cost of buying and building Pantaya, the Company also proposes, per the May 9 transaction press release, to sell Pantaya to TelevisaUnivision at a discount to the value Hemisphere itself ascribed to the business in 2021, just as TelevisaUnivision is getting into the streaming business itself. As Hemisphere has significant private shareholders who are also significant shareholders of TelevisaUnivision, this deal is highly problematic. Who is getting the better deal for the market-leading asset? Certainly not public shareholders.

In addition, the May 9 press release states that "Hemisphere contemplates using the net cash proceeds from the TelevisaUnivision transaction to promptly prepay Hemisphere's outstanding senior secured term loans." Bully for you. Essentially, you're openly admitting that while public shareholders financed the growth of the business, only the insiders will benefit from the deleveraging.

The Deal Price Should Be Increased So Even Truly Independent Shareholders Can Support It

If the Insider Takeover is as bad as we say it is, why don't we just vote it down? Simple. We don't believe the election will be a fair one.

The Insider Takeover must be approved by a majority of the disinterested shareholders, which purports to be fair because it removes the super vote from most of the private holders, who are interested in the transaction. We suspect, however, that certain key class B shareholders, whom the Company counts as disinterested and who will likely determine the outcome of the vote, are, in fact, not disinterested at all due to related party transactions and economic ownership, as well as business and personal relationships. But rather than get into an argument over that at this juncture, we are instead proposing that you pay public shareholders a fair price that allows them to benefit from a portion of the bright future they have financed.

The private investors can then still make long-term investments in the Company as a private entity and create more value for themselves down the road, and, because they are rolling their stock, they don't have to pay more for their own shares, only for those of public shareholders who can't otherwise participate in this opportunity given the proposed discounted, insider-led take-private transaction. A fair deal for Hemisphere shouldn't be half a world away.

Sincerely,

Jonathan Brolin Founder and Managing Partner



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