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Is Joining Forces the Only Path to Survival for Tribune (TRCO) and Sinclair (SBGI)?

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Shares of Tribune Media plummeted 16.7% Monday after FCC Chairman Ajit Pai announced that he has “serious concerns” about media giant Sinclair’s (SBGI - Free Report) proposed acquisition of the firm. Sinclair stock was hurt as well, sliding 11.7% on the day.

TRCO has since regained over 5% in morning trading Tuesday after the firm issued a response to the FCC.

Sinclair’s Oversized Slice of the Media Pai

Pai’s unease stems from Sinclair’s plan for the divestiture of nearly two dozen of its stations. The firm announced its intention to do so in May, seeking to ease regulator concerns about it gaining too large a market share in the US. The $3.9 billion deal, which was announced over a year ago, would have seen the combined company reach 72% of US households. Now, Sinclair projects a 10% decrease to a reach of 62%.

Specifically, Pai expressed doubt about the entities purchasing the stations through Sinclair’s proposed joint sales agreement. A number of the parties involved have direct ties to Sinclair and its Executive Chairman David Smith, leading regulators to believe that Sinclair could still control those stations “in practice, even if not in name.”

Pai has drafted an order for a hearing on the divestiture situation in front of an administrative law judge. According to Wells Fargo (WFC - Free Report) analyst Marci Ryvicker, the ALJ could potentially be asked to review not just the divestitures but the entire transaction, throwing it into jeopardy. Based on historical trends, the FCC taking this sort of measure usually leads to the proposed transactions falling apart.

The Tribune noted in its response to the FCC Tuesday that it was “disappointed” about Pai’s recommendation to bring the matter before an ALJ, but that it “expects to work with the FCC to explore ways to address the concerns identified.” Although the future of the deal is still uncertain, the announcement slightly eased investor sentiment. Meanwhile, Sinclair continued its losses, ticking down another percentage point in morning trading.

What if the Deal Falls Through?

Shares of Tribune have underperformed for some time now, losing nearly 50% over the last five years compared to a 77% average increase amongst its competitors. SBGI has also suffered, slipping 5% in the same period.

Sinclair would gain exposure in markets where it is currently weak should the deal go through, gaining the ability to leverage its newfound presence to negotiate more lucrative sponsorship and advertising arrangements. Both companies have suffered at the hands of Facebook and Alphabet (GOOGL - Free Report) , which offer flexible and effective platforms on which to advertise to a massive user base.

Competition with much larger cable networks such as Comcast (CMCSA - Free Report) has also hurt Sinclair’s bottom line, especially since it mainly operates in smaller markets. Its top five markets are Washington DC, which ranks 6th in the US by population, Seattle/Tacoma area (12th), Minneapolis (15th), St. Louis (21st), and Portland (22nd), according to its 2017 annual report.

Tribune, while smaller, owns or operates local television stations in each of the nation’s top seven markets, including DC. It also owns WGN America, which according to Nielsen, reaches over 77 million households, and has investments in Food Network, Fox affiliates, and real estate.

Broadcasting used to be a lucrative, high-margin business. However, media is now being consumed in more ways than ever, and companies like Tribune and Sinclair are feeling the burn. Below, we can get a better look at how these firms’ figures have been hit in recent years.

Sinclair is heavily exposed to advertising revenue and affiliate performance. But in the last five years, the number of cord-cutters (those who cancel their cable subscriptions) has tripled to 14.1 million households. While this may not be a very large number yet, it is very significant and only continuing to grow.

Other blockbuster merger attempts in the industry such as AT&T (T - Free Report) with Time Warner and Disney (DIS - Free Report) with 21st Century Fox (FOXA - Free Report) are part of the broader fight to capture shrinking advertising revenues and increasingly discerning audience. With players like Netflix (NFLX - Free Report) and Amazon (AMZN - Free Report) throwing their hats into the ring with streaming and a growing catalog of original content, consumers have more choices than ever, and they’re keeping the industry on its toes.

If the Sinclair-Tribune deal falls through, it doesn’t necessarily spell death for the firms, but their weaknesses will become more pronounced as time goes on. Sinclair needs to tap into bigger markets and Tribune faces similar advertising concerns, along with difficulties involving programming costs and affiliate contract renewals.

Outlook

Many broadcasters are fighting for survival through a “united we stand, divided we fall” approach. Competition is only growing fiercer, and the prize pool is shrinking. Given recent performance and overall structure, Sinclair would likely last longer than Tribune independently, but neither would be in a position to thrive.

This deal could be a major turning point for both firms’ futures. But there is still a lot that could happen, therefore it would be prudent for interested investors to continue monitoring the firms for any new developments.

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