June, 1999

Public radio could significantly strengthen and enlarge its public service by increasing broadcast spectrum committed to public service and by extending core values and content through new programming and into new technologies. At the same time, public radio faces critical challenges to its basic operations, including protection of current broadcast channels, conversion to digital operations and transmission, and creation of the next generation of an interconnection system.

Public radio's response to these opportunities and challenges will be shaped, in large part, by its access to significant capital funding.

Some of this capital will be raised station-by-station through conventional capital campaigns. Additional funds will continue to come from governmental sources at the federal and state level. But we anticipate opportunities that will require investments across multiple communities, that will require much shorter time lines than a local capital campaign can address, and that are unlikely to command tax-based dollars.

This report presents findings from an initial exploration of opportunities for public radio stations to access or leverage significant capital funds from non-traditional sources for such areas as spectrum acquisition, new ventures, new technologies and working capital. The SRG study was supported by the Corporation for Public Broadcasting Radio Future Fund.

Background & overview

SRG launched this study with a belief that public radio, and indeed public broadcasting, needs new ways to accumulate capital if the industry is to expand and remain competitive in an increasingly complex media environment. Where will stations go if, as has happened in the past few years, they have an opportunity to buy another station? Where will stations go to finance new buildings, development of new towers, or extension of service into new technologies such as the Internet or other distribution technologies?

SRG's planning work has identified several areas in which access to capital is especially important.

A Larger Delivery System. Millions of listeners cannot hear some of public radio's strongest formats and most successful programs because there are simply not enough public radio stations to deliver them. With virtually all FM channels in well-populated areas already assigned, the only option is to obtain outlets from those who already have them, including commercial, religious, and educational broadcasters outside the public radio system.

Secure Core Assets. Public radio must insure the preservation of its core assets--the noncommercial public radio stations that broadcast public radio programming. Many of these stations are licensed to public school systems, colleges, and universities. Many of these licensees are reexamining how operation of a public radio station supports their overall educational mission. Some may decide to sell, while some may decide to refocus on student training and programming. The public radio system as a whole has generally not been able to work with institutions to find long term solutions that enable the institutionally-licensed stations to prosper and provide the best possible service to listeners. Capital funds will enable public radio to work with institutional licensees and to offer options to acquire or manage these vital public service frequencies.

New Operating Models. Public radio currently consists of primarily independent licensees. As a system, public radio is beginning to explore new operational models that make the most sense--consolidated membership operations, underwriting partnerships, and the merger of stations in North Dakota are examples of how stations within the public radio system are rethinking how they operate. Access to capital will play an important role in helping to rearrange the economics of the public radio system to insure the long term viability of stations and the services they provide.

Development of New Media. New technology presents a host of potential opportunities to reach more people with more public radio programming. How do we pursue these opportunities in a way that makes the most sense for the public radio system, and for public radio listeners? Access to capital could help to finance public radio's entry into nonbroadcast delivery systems.

Through this project SRG initiated discussions with leading public and commercial broadcasters, bankers, and investors that helped identify financing models that both overcome some of the unique circumstances of nonprofit organizations and build upon the distinct benefits that nonprofits have in the financing options that are available to them.

The report is organized as follows:

Financing in commercial radio

Implications for public radio

Public radio capital options

The Public Radio Capital Fund

Next steps in development of The Capital Fund

Financing in commercial radio

Public radio primarily has used federal facilities grants, state appropriations, and self-financing as ways to finance major projects. But in a fast-moving environment, public radio was not able to develop a competitive bid for WDCU, a noncommercial FM station that sold in Washington, D.C. This is likely to be true of other opportunities for stations, as well as start-up investments that may be needed in Internet development or other new technologies.

The position of public radio is similar to the state of financing for commercial radio less than 20 years ago. With the early ownership caps on radio (initially 7AM/7FM, and no more than one AM/FM combination in a single market) and the intangible nature of a radio station's value (the FCC license), radio owners found financing of acquisitions difficult up to the early 1980s. Since banks could not put a lien on the FCC license, the most valuable asset associated with a station, they were reluctant to provide loans for station acquisitions. As a result, most station owners had to carry a note if the prospective buyer could not pay all cash. Acquisitions and major projects for commercial radio were self-financed in the way that they currently are for public radio.

A few key changes in the radio industry helped attract debt and equity sources to radio in the 1970s and 1980s. Ownership limits were lifted to a total of twelve AM and twelve FM stations. This helped station owners, particularly those in large markets, build a critical mass of stations to support new sources of financing. With the growth of these groups, radio as a business began to be national in scope. This multi-market nature of the operations, and the national ownership control, began to align with the national scope of financial markets.

As national companies, a few radio groups became much more sophisticated in their approach to the financing of acquisitions. Cap Cities, Infinity, SFX Broadcasting and others learned that building revenues and cash flow margins, for both individual stations and a group of stations, could be used to leverage debt and equity sources. The historic appeal of radio and its ability to target audiences contributed to a steady growth in radio revenues. These factors, in turn, led to an increase in radio station prices. All of these factors combined to draw the attention of bankers and investment firms to radio.

At the same time, a few large money center banks developed a more sophisticated approach to broadcast lending and bank loans for larger radio deals became more common in the 1980s. In addition, a few venture firms began to see the value of radio, and sources of equity became available from firms like TA Associates. In this period small radio group owners began evolving into larger, radio-only companies. These groups, such as Infinity, SFX Broadcasting, Emmis and Clear Channel established significant radio operations in major markets. They readily adapted to changing financing markets, moving from high yield bonds to bank loans and public equity markets.

These large companies began to use a variety of financing tools beyond banks and venture capital sources of equity. Robert Sillerman and Mel Karmazin were early to move into the public bond and equity markets to finance the growth of their companies. As they became successful, investment banking firms such as Merrill Lynch followed their lead and put together public partnerships through which they raised significant pools of money for media investments (Merrill Lynch Media Partners I and II).

Many of these companies, and the individuals that run them, remain today as some of the largest radio group owners. Their ability to finance growth through a variety of financial tools was as significant to their growth as was their skill in operating radio companies.

Over the past five years, the combination of a changing regulatory environment and the development of new financing options has produced the most dramatic change in the structure of radio ownership since the industry began. The change in the ownership rules, first lifting the national ownership caps to twelve AM/twelve FM and then eliminating any national caps at all, produced an explosion in the consolidation of radio station ownership. Groups that were successful in using a variety of national sources of financing excelled in this new environment. Most of the major radio groups are now public companies. As public companies, these groups are able to reduce their cost of financing and raise more capital for acquisitions. Since most of the major acquisitions of stations or groups now use stock, the public companies have the added advantage of being able to do tax-free exchanges in acquisitions.

This, in turn, has made radio much more competitive against other traditional and emerging media. Infinity, which recently spun off as an independent company from CBS, produces more cash flow than the television network. These large group owners can effectively compete against new media, and are heavily investing in new forms of distribution that complement radio.

At each step in this process, the radio companies that were able to use the most effective and cheapest forms of financing emerged as the most successful competitors in a media environment that faced an accelerated pace of change. These successful companies combined their skills as good radio operators with astute financial skills.

Implications for public radio

One can argue the relative merits or negative implications of consolidation in the commercial radio industry. But this industry change was driven by the significant positive financial impact that consolidation produced, and the leverage that this financial impact has given radio in competing with other traditional and new forms of media. There are some issues faced by public radio that draw parallels to the changing environment in commercial radio.

In some ways, public radio's success is setting the stage for increased competition. As the audience for public radio both grows and attains sharper definition, the interest in that audience and the media services provided by public radio is drawing the attention of other media. Will public radio, as now configured, remain the core provider of public radio programming and services as individual programs become available on the Internet, or on Direct Broadcast Satellite services? Will the stronger financial players within the public radio industry be better positioned to compete in these new media environments?

How can public radio expand its current offering of services when stations individually don't have the capital to acquire other frequencies or other means of distribution? Will public radio audiences become increasingly frustrated with the limited one or two channels available in most markets, and therefore be drawn away by Internet or other media services that target these unmet needs?

The public radio entities that have a significant finance base are best positioned to survive in an increasingly competitive environment. Financial resources, combined with a stable, core business, strong civic leadership in the form of an effective board, and strong management have helped an increasing number of public radio groups to grow, and to form the foundation needed to expand and prosper. As with commercial radio, these public radio groups are most likely to have the range of resources and skills to thrive.

Financing became the tool that catapulted commercial radio owners that were successful in the old media landscape into the dominant companies in the new media environment. A fundamental premise in this project to explore capital options for public radio is that the environment is changing, and that to survive and flourish in the future public radio must also develop new sources of capital.

From a financing perspective, public radio has audience, financial, and asset strengths that are similar to those of commercial radio. The audience for public radio continues to grow, revenues are growing significantly in large and small markets, and the programming assets of public radio continue to grow and mature. The stations operated by public radio have an increasingly significant market value, and the demographics of the public radio audience are highly attractive. Part of what is missing is the ability to act, particularly in the financial world, as a national group or industry. Currently, the only truly national public radio institutions are CPB and the networks. The stations, the primary holders of both the assets and the core revenue streams of the business, are essentially local or regional in focus.

As with any business, public radio cannot grow unless it can expand and strengthen the services it offers to its constituents. The growth of the cable industry would have been stunted if it had not developed more channels. Infinity broadcasting could not have grown unless it acquired more stations, or began, as it just has, to launch services on the Internet and through Direct Broadcast Satellite or by developing a partnership to develop and launch in-band digital radio.

To continue its growth, public radio must also pursue the development of more public radio stations and the expansion of public radio services into other existing and developing media. To accomplish this needed growth, public radio must develop new sources of capital that can be accessed and deployed quickly.

Public radio capital options

Based upon discussions with a number of individuals in the investment and finance fields through the course of this project, we believe that it is possible to develop sources of capital for public radio, as a system, that have not generally been used in the past. The two major issues that we examined are how best to pursue and assemble capital, and the best options for holding and placing that capital in projects within the public radio system. On the sources of capital, we looked at options that focused on tax-exempt bonds, and that most likely will involve banks and investment banking firms in providing bridge financing, and letters of credit for the bonds. A third important player in the potential development of this form of financing will be foundations, other institutions, or even individuals that can provide loan guarantees, or the equivalent of letters of credit, to help secure investment grade ratings for the bonds.

As with most examinations of financing, we found that to accomplish the goal of developing capital for public radio we must look to multiple sources of financing to provide the lowest possible cost of funds. The best sources of funds for public radio are tax-exempt bonds. These bonds are long term debt issued through state or local bonding authorities. The interest on the bonds is exempt from Federal and State taxes. Since they are tax-exempt, investors buy bonds at a lower interest, or coupon rate, than taxable bonds. Investment grade bonds, those that are considered lower credit risks, typically have an interest rate of less than 5%. The bonds are most often interest-only for an extended period of time, up to 30 years.

Some public broadcasting entities have used tax-exempt bonds to finance building and acquisition projects. These were used by Minnesota Public Radio to acquire a commercial radio station in Minneapolis, by WBEZ to finance the construction of their building on Chicago's Navy Pier, and by National Public Radio to acquire and renovate their current headquarters building. While some of the forms and sources of the financing will be the same, an important goal of this project is to assemble a national capital source instead of replicating the experience of each of these entities on a local level.

A second institutional player in bond financing is a bank. To achieve a low interest rate on a bond and secure an investment grade credit rating, which significantly improves the ability to sell the bonds, institutions placing tax-exempt bonds typically get a bank letter of credit to guarantee the bond issue. While this adds to the initial cost of the financing, it significantly reduces the long-term cost of the bonds.

Another way that banks need to be involved in developing sources of capital for public radio is as a source of bridge loans for acquisitions. These loans provide short-term financing that is needed for acquisitions and are then replaced by the bond financing, typically within 18 months following the closing of an acquisition.

Foundations, individuals, and businesses may also play an important role in the development of capital for public radio. For example, many large foundations have what are called program-related investments. These are low-interest or no-interest loans that foundations use to support groups. Sometimes these are given in addition to grants and sometimes they are given independently of grants. In assembling capital for public radio, foundations could be used in the place of banks to provide the letters of credit, or loan guarantees, needed for the bonds. These guarantees from foundations would reduce the total cost of borrowing, since they don't carry the fees typically charged by banks for letters of credit.

These kinds of guarantees could also be provided by individuals (or groups of individuals) who may already be supporters of public radio and can extend special credit arrangements based on their personal or company assets.

Based upon our conversations with a broad range of financial institutions, attorneys, investment bankers and other nonprofits, a pooling of these sources of financing will create the capital needed to pursue a vital range of public radio projects, with the goal of extending more public radio service to existing and new audiences.

What makes these sources of capital distinct from those typically used within public radio is that these are debt sources, not grant sources. We believe that, as an industry, public radio has matured to the point of generating the net revenues that are needed to service debt. The capital sources suggested in this project would primarily be used to acquire or start revenue-producing assets--radio stations as the prime example. It will less likely be a source of financing for program development or for other projects that don't have a clear and historically-supportable revenue stream. Given the nature of this form of financing, stations will still need to continue to expand all of the traditional sources of revenue--namely, listener support, underwriting, foundations and various sources of earned income.

The Public Radio Capital Fund

In our examination of parallel nonprofit corporations that we could use as models for a public radio capital source, we focused on the Trust for Public Land as the closest model to what we envision as a mechanism for securing and placing capital in public radio.

The Trust for Public Land (TPL) was established as an entity that could move quickly to acquire land that would ultimately be acquired by a public entity to be held as open space. TPL uses a variety of financing sources to acquire land from private owners. The land is usually acquired at below-market values using the nonprofit status of the Trust. This status gives the owners the ability to take a tax deduction on the donated portion of the land they are selling to TPL. TPL holds the land until they can sell it to a local, state or national public agency. Public-use land planners found that public entities could not move quickly enough to acquire land, and TPL was created to bridge the gap between marketplace realities and the constraints of public entities.

In a similar way, we envision a Public Radio Capital Fund as an entity that would assemble sources of capital on a national level, with the ability to deploy this capital quickly for individual, station-driven projects, or for projects that the Capital Fund itself would identify and pursue. The Capital Fund would be a financing source for all of public radio, with the ability to support the financing of station acquisitions, or the acquisition of other tangible assets such as buildings and equipment.

A Financing Scenario

Using the sale of WDCU in Washington, D.C., we can provide a specific example of how the Capital Fund might have played a role in the preservation of an asset for public radio. The University of the District of Columbia offered WDCU for sale through a negotiated bid process. When the station went on the market the Capital Fund would have begun to assemble the resources and partners needed to submit a competitive bid. The steps in this process would be:

Operating Partner

Identify an operating partner in the market. The cost savings for acquisitions come primarily from the combined operation of two or more stations together--the same operating structure now used by commercial radio. The Capital Fund would approach a single station, or group of stations, in the market to negotiate a joint operating agreement that would be put in place if WDCU were acquired.

Business Plan

Based upon the operating agreement, a business plan would be developed for operation of the station.

Bridge Financing

Using the business modeling, the Capital Fund would go to its banking partner to put together a bridge-financing loan for the bid. This loan would be in the form of a line of credit that would be used for the initial acquisition.

Bond Issuer

The Capital Fund would then identify the tax-exempt bond issuer it would work with to provide long-term financing for the acquisition. If, for example, it had established a relationship with Merrill Lynch (one of the investment banking firms SRG has talked with about this concept) we would then begin the process of drawing upon existing financing that was in place, or preparing to issue bonds for this acquisition. The business plan would establish a debt structure based upon the cost of the short- and long-term financing that the Capital Fund would draw upon for the acquisition.

Could public radio compete for an acquisition in the range of $13 million, the price for which WDCU was sold?

Based upon a cursory look at revenues in the Washington, D.C., market, public radio may have been able to make a competitive bid with a financing package that included tax-exempt bonds.

The 1998 revenues for three commercial stations that have public- radio-type formats are:

WGMS-FM Classical $10.5 million

WJZW-FM Smooth Jazz $9.0 million

WTOP-FM News $18.0 million

The 1998 revenues for the public radio stations in these formats are:

WETA-FM Classical/News $6.4 million

WAMU-FM News/Bluegrass $5.2 million

WPFW-FM Pacifica News/Jazz $1.0 million

The revenues of WETA are approximately 60 percent of those of its closest commercial counterpart, WGMS. The revenues of WAMU are approximately 30 percent of its closest match, WTOP. WPFW's revenues are approximately 10 percent of its closest commercial counterpart, WJZW.

If we:

• Select a cohesive format, such as a full-fledged jazz service or a straight-ahead news and information service
• Assume middle-of-the-road performance in terms of revenue generation (30 percent of the closest commercial match)
• Use the low end of the commercial radio counterpart stations as the benchmark for revenues ($9 million)

a very rough estimate of potential revenues for a fourth public radio format in Washington, D.C. is approximately $3 million.

Based upon operating cost estimates done for other stations in top 10 markets, the operating cost for WDCU, assuming it were operated as a second service by an existing public radio station, would most likely be $500,000 to $1,000,000. This lower cost of operations comes from being able to combine management, operations, development, technical and studio functions.

Debt service for WDCU, at a purchase price of $13 million, could be broken down as follows:

Initial bridge financing: $13 million at 8% for one year: $1,040,000

Annual bond payment on $15,000,000: $750,000 (x 20 years)

(Initial bridge plus the interest is paid by issuing tax exempt bonds at 5% for 20 years. Interest is paid annually with a balloon due at the end of 20 years.)

Final balloon payment in 20 years: $15,000,000

Assuming it takes three years to build the revenues of the station, the Capital Fund would also have to secure sources of working capital for these startups, and most likely the operating partner would need to contribute working capital for the initial station operation. During the first three years of operation, assuming the operating cost were paid by the station partner or from a Capital Fund venture pool, the debt service would be paid from the revenues generated. If the station built its annual revenues to the $3 million level suggested above, operating costs and debt service could be paid and still leave excess revenues of more than $1 million.

There are several ways in which the station could handle the $15 million balloon payment in 20 years. A portion of the revenues could be set aside each year starting in the fourth year. It would take an annual set-aside of $600,000 (invested to earn a return of 5 percent per year) to build savings of $15,000,000 by 20 years after the initial investment. Alternatively, the station could launch a capital campaign at some point in the intermediate years, say ten or fifteen years out. Or the station might choose to refinance the loan as the balloon comes due.

While these are rough projections, they highlight the interaction of additional public radio service, lower borrowing costs, long-term financing arrangements--all within a framework that is realistic in terms of known public radio operations.

The Capital Fund could assume three distinct roles in a WDCU-type situation. The Capital Fund could act as a loan source for a financing request by public radio stations. In the WDCU example, WETA could approach the Capital Fund and request financing for the acquisition of WDCU.

A second option would be for the Capital Fund to act as the principal in the acquisition. Under this option the Capital Fund would submit a direct bid to buy the station, and then, in turn, negotiate an operating agreement with another public radio station to operate WDCU under an local management agreement (LMA).

Or, the Capital Fund would acquire WDCU and hold the station for a limited period of time until another station could acquire WDCU from the Capital Fund. This last option is how the Trust for Public Land functions. It acquires land from a private seller, then sells the land to a public agency when the agency has the funds to complete a public land acquisition.

Next steps in development of
The Capital Fund

The mission of the Capital Fund requires that it be established as a strong and effective national entity. The financial markets that must be approached for this are national, the ability to attract the commitment needed from major foundations will require a project with national impact, and success will in part be dependent on building an organization with effective national professional and lay leadership.

The ability to pursue opportunities for public radio has, in the past, been hampered by the current organizational divisions. National production and programming groups like NPR and PRI are not the right groups to pursue the acquisition of stations. Individual stations face the limits of their licensees, their financial ability, and their scope of operating interest. The Capital Fund will offer public radio the ability to move forward effectively on significant needs and opportunities with much-needed sources of capital.

Creating a Public Radio Capital Fund will entail a complex series of financial, organizational and business planning steps that should be undertaken in the next twelve-month development phase of the Capital Fund:

• Create the legal and organizational structures for the Capital Fund
• Develop start-up and financing capital from foundations, corporations, investment banking firms and banks
• Recruit an effective national board for the Capital Fund
• Complete a detailed business plan for the Capital Fund
• Build an understanding of, and support for the Capital Fund within the public radio system.

Legal and Organizational Structure

The next organizational phase for the Capital Fund will require a combination of legal and organizational expertise to create the most effective and efficient structure. The structure must address a host of complex organizational and legal issues. Some issues are related to building a strong national public radio entity and others are tied to the needs and complexities of the financing sources that will be used by the Capital Fund.

The Capital Fund must be an effective and nimble national entity. It must be able to identify opportunities and pursue a variety of broadcast and nonbroadcast distributions means for public radio. It must have an effective lay leadership that can provide a high level of access to funding and financing sources, colleges, universities and other public radio licensees, and add the business and financial sophistication needed to apply new forms of financial and business modeling to public radio.

Start-up funding and financing

To be effective the Capital Fund must aggregate a combination of debt, grant, and venture financing sources. One model that provides a good illustration of the mix of financing sources needed for the Capital Fund is the New York City Investment Fund. This fund was established by Henry Kravis as a venture investment fund to finance neighborhood business development and job creation in New York City.

The New York City Investment Fund has raised more than $70 million to date. These initial funds came from interest-free loans from individuals (about $20 million in 15-year, no-interest loans), insurance company investment funds, New York City bond funds, and foundation grants. This combination of financing sources gives the Fund the ability to make both venture investments and loans to start-up businesses. The fund is a nonprofit corporation that also has a for-profit subsidiary.

The Capital Fund must also, on a national level, draw from a variety of financing sources. A major aspect of the work during the next development phase will be to pursue and secure the debt and grant sources needed to finance significant opportunities within public radio. Based upon our discussions to date, we expect these funds to come from foundations and corporations (grants and loan guarantees in the form of program-related investments), individuals (donations or long- term interest-free loans), other public radio stations (a public radio venture investment pool), banks (bridge financing loans, tax-exempt bond letters of credit) and investment banking firms (tax-exempt bonds and bridge financing). Together these sources will collectively contribute the capital needed to operate the Capital Fund, and to pursue significant delivery capacity investments.

A host of legal and organizational issues must be resolved to incorporate this complex mix of funds for the Capital Fund. The next phase in the development of the Capital Fund will involve the legal and business development planning needed to establish and operate the Capital Fund.

Recruit an effective national board for the Capital Fund. The Capital Fund will need effective lay and public radio leadership. Board members with a mix of national contacts, financial and business skills, and links to colleges and universities will be essential to the success of the Capital Fund. An important part of this next development phase will be identifying and recruiting this effective national leadership.

Complete a detailed business plan. Since a major component of the capital for the Capital Fund will come from tax-exempt bonds and other debt sources, a business plan that identifies the opportunities and risks associated with various delivery capacity options is essential. The ability to repay the bonds is dependent on generating both operating and excess revenues for public radio. A detailed business plan completed during this next development phase will help target opportunities and create revenue models that will be essential to attracting financing from banks and investment banking firms.

Build an understanding of the Capital Fund within public radio. The Capital Fund is essential as the public radio system moves forward into an increasingly complex and competitive environment. An important part of this next phase will be building an understanding of the Capital Fund within national production entities such as NPR and PRI and to clearly outline the positive impact of the Capital Fund on individual station operations. This process will be critical to the long-term viability of the Capital Fund and to making the Capital Fund an integral part of the public radio system.