Description

Clear Channel Outdoor (CCO)

Summary

Clear Channel Outdoor (Ticker: CCO, “Clear Channel” or the “Company”) is the #2 out-of-home (“OOH”) advertising company globally behind JCDecaux.  Within the U.S., CCO is the #3 player behind Lamar and OUTFRONT, though these three command roughly half the market.  The Company has three segments – the U.S., Europe and Latin America.  The U.S. is the crown jewel asset with strong growth, high margins, and a highly favorable market and regulatory environment.  The Europe segment is growing well but has lower margins primarily due to mix.  Latin America is very small and does not matter to the story – it will be divested eventually.

Following its separation from iHeartMedia in 2019, CCO shares have struggled in the public markets due to high leverage and macro headwinds – first COVID and now a war in Europe and potential global recession.  In addition, CCO’s multiple has consistently traded at a discount to its U.S. pureplay peers (LAMR and OUT) given its global conglomerate structure.

However, the Company and industry as a whole are undergoing a powerful transformation towards digital OOH that is driving a significant uplift in both revenues and profits.  In addition, the Company is undergoing a strategic review of Europe with an aim to divest the segment.  Such a transaction could serve as a major catalyst for the stock as it could help delever the Company, and most importantly, transform it into a U.S. pureplay which could propel its multiple to rerate in line with U.S. peers.  With or without a sale of Europe, CCO’s long-term growth and profitability profile is vastly underestimated by the street due to a poor understanding of this digital transformation.  This is a long-term, deep value investment – we believe CCO stock has the potential to reach mid-to-high single digits (multi-bagger upside) over the next few years.

Industry Overview

OOH advertising typically refers to billboards and posters displayed alongside highways and in transit stations and airports. The business model is rather simple – for a typical billboard, the OOH company owns the display structure and permit, leases the ground site on which the display stands under a very long-term lease (~10 years) and then rents the display to advertisers for varying periods (~1-12 months).  For street furniture, transit and airport displays, the Company typically bids for long-term rights from the pertinent municipality.  As these contracts come up for renewal every 5-20 years, there is inherently more competition in this format type and therefore lower margins relative to billboards.

OOH has the broadest reach among all forms of media, reaching more adults in the U.S. on a weekly basis than radio, TV and the Internet.  You cannot “block” an OOH ad.  OOH reaches its audience while they are on the move – highly dense areas, highways, airports/subways, etc.  And in the U.S. especially, there are extremely high barriers to entry.  A complex web of federal, state and local regulations, buoyed by the U.S. Highway Beautification Act of 1965, severely limit new builds.  Permits are typically granted in perpetuity and have been collected by the three major players over the past few decades.  As a result, there is almost no new billboard construction in the U.S. today.  OOH is a very unique asset and oligopolistic in most markets.

OOH has had steady share in the overall U.S. media mix pie over the decades – roughly 4% of all ad dollars in the U.S. are allocated to the medium.  OOH and Internet have been the only share gainers and absolute growers for the past couple decades as traditional media has donated share (namely to Internet).  OOH enjoys much higher penetration in other large markets though – CCO’s second largest market, France, has OOH taking 10% of media mix share.

Traditionally, OOH advertising has been a static form of media that required a laborious process to change the printed material from one ad to the next. More recently, the industry, including Clear Channel, has been converting these print displays into digital screens that can alternate between creatives and showcase video ads every few seconds. In addition, advancements in mobile tracking have enabled a wide range of digital attribution, planning, and analysis products for savvy digital advertisers, complemented by new programmatic capabilities. Overall, the digitization of a typical billboard screen leads to a roughly 4x increase in revenue and a nearly 6x increase in profits compared to a legacy, static billboard. In the case of Clear Channel, despite having converted only ~4% of overall display inventory to digital screens to date, Clear Channel’s digital revenue now represents ~35% of total revenue, large enough to make an accretive impact to consolidated figures. The Company earns an approximate 20-40% IRR on each conversion, and there is a very long runway ahead.

As implied by the revenue uplift, digital OOH commands dramatically higher pricing than traditional print displays – in some markets up to 5x higher CPMs.  With digital and programmatic OOH solutions, ROIs to advertisers have skyrocketed as this once sleepy medium can now offer trackability and analytics comparable to that of digital advertising.  The technology powering digital and programmatic OOH is quite advanced and far more familiar to digital advertising / social media investors vs. those that follow traditional media.  As such, we believe a big part of this technological transformation and its power to drive substantial growth and margin expansion is simply misunderstood by most sellside analysts covering the stock.  This is especially true as programmatic capabilities takeover the traditional trading process for both print and digital OOH.  65%+ of global internet ad spend is now done programmatically but <5% for OOH.  Long-term we believe a programmatic approach (algorithms automatically optimizing and allocating ad budgets with virtually no human involvement) can drive far greater efficiencies for the OOH industry.  All of these advancements that drive advertiser ROIs higher can also help OOH take far greater share of the media mix pie, presenting another angle of upside.

In the meantime, digital OOH is driving nearly all of the growth in the industry.  The format is driving new advertisers to OOH for the first time and has proven to help lift efficacy of ad campaigns across multiple mediums (i.e., featuring flashy digital billboards in social media ad).  OOH is the only form of traditional media that is disrupting itself to become a digital medium, all while starting from a position of low pricing and low media mix market share.  We believe this digital transformation represents yet another major structural shift in the media world.

Company Overview and Thesis

We believe an inflection in the Company’s financials began to take hold in 2019, in conjunction with its separation from former parent company iHeartMedia. For many investors, CCO is a relatively “new” public company as iHeartMedia had previously retained voting control and 90% ownership (it originally floated 10% of its ownership back in 2005). In 2008, iHeartMedia was acquired by private equity and in 2018 filed for bankruptcy.  Through the reorganization process, iHeartMedia’s ownership in CCO was transferred to creditors and CCO was separated from the parent to become a standalone public company.  This ordeal is why PIMCO, a large credit fund, owns 22% of CCO equity today.

Following the separation, Clear Channel’s financials were muddied by numerous divestitures (including a sale of the China segment), FX effects, and multiple changes to segment reporting, making them difficult for the market to understand. This obfuscated the financial inflection buried within 2019 results where overall revenue accelerated as digital OOH finally became a big enough piece of the pie to impact consolidated figures.  In addition, Clear Channel’s high leverage worried many investors as the world entered a pandemic in early 2020. The prior decade of self-disruption through a digital transformation was quickly overshadowed by a problematic balance sheet and worldwide “stay-at-home” orders.

However, during the pandemic the Company managed to 1) refinance its balance sheet to extend out the maturity of its debt (no debt due until 2025), lower its interest expense, and improve its cash position; 2) implement a meaningful cost cutting program; and, most importantly, 3) continue digital conversions. As a result of these actions, we believe Clear Channel emerged from the pandemic stronger than ever. We believed that a rapid recovery in revenue driven by an increasing mix of more profitable digital ads, in conjunction with the reduction in G&A and interest expense, would drive impressive free cash flow generation relative to expectations. We have already witnessed this dynamic play out over the past several quarterly earnings reports as the industry returned to pre-pandemic levels.

As mentioned earlier, U.S. OOH pure plays tend to garner higher valuation multiples compared to their European counterparts. Ultimately, we believe CCO should focus exclusively on the U.S. and that its international segments would be better off under new ownership. The potential divestiture of these segments would meaningfully de-risk the Company by deleveraging the balance sheet and could rerate CCO closer to its U.S. peers’ multiples as a U.S. pureplay.

For years, management was very cryptic about their intention to sell Europe.  But in December 2021 they publicly announced a strategic review of the segment.  This announcement, combined with increased guidance and a solid Q4 2021 earnings report, catapulted the stock to $4 in early 2022.  The strategic review of Europe remains ongoing.

Shortly thereafter, Russia’s invasion of Ukraine sparked a selloff in the markets and eventually the world began fearing a recession, with a slowdown hitting Europe in particular.  This has raised concerns over whether CCO could pull off a sale of Europe.  It also did not help that Snapchat (SNAP), Facebook (META) and other digital advertising players started warning publicly of a major slowdown in their businesses.  The market has extrapolated this fear to all advertisers, despite CCO and all their peers continuing to post excellent quarterly earnings and provide bullish business updates at investor conferences.  We believe the market’s pessimism on the advertising industry due to recession fears has been unfairly applied to OOH, which we believe is still witnessing a strong “reopening” recovery and potentially taking share from digital advertisers experiencing a reversal in their pandemic-induced fortunes. However, the market has done its damage by sending CCO stock back to ~$1 in a short couple of months.

We believe this noise will be cleared up in the near-future as CCO and its peers report Q2 2022 earnings.  We are also expecting an update on the Europe strategic review, including a potential divestiture announcement.  Both can serve as major catalysts for the stock that could send CCO back to $4 and beyond.  In fact, British news The Daily Mail recently reported (7/17/22) that the Company is close to announcing a sale of Europe to a private equity firm – this article sparked a brief rally in the stock:

https://www.thisismoney.co.uk/money/markets/article-11020803/Billboard-giant-Clear-Channel-Outdoor-selling-British-arm.html

Two long-term “call options” following the Company’s potential conversion to a U.S. pureplay include an eventual REIT conversion (tax benefits and higher multiple) and a sale of the Company, likely to JCDecaux.  Over the years, JCDecaux’s founders have been very vocal about their desire to acquire Clear Channel’s U.S. assets.  The U.S. is one of the few large OOH market they do not have a strong presence in, and given the regulatory environment, it would take an extremely long time to build a competitively sized U.S. business.  Therefore, we believe JCDecaux could make a move to acquire CCO once it’s a U.S. pureplay, assuming valuation isn’t a gating factor.  Cost synergies in OOH M&A are very high as SG&A are largely duplicative between two companies.  This has supported precedent M&A EBITDA multiples well into the double-digits.  If an activist is still around at that time, we believe it would make sense for them to push the Board to consider a sale.

Model

We believe the street is underestimating CCO’s profitability.  A few things to note:

• Digital billboards carry 65-70% EBITDA margins vs. print at 40-45%

• The Company has been executing a $40mm cost cutting plan since the pandemic, of which $28mm is geared towards Europe (ongoing), $7mm in the U.S. (completed) and $5mm at the corporate level (completed)

• The Company benefited from some one-time rent abatements in during the pandemic, mainly in 2021, which will fall away – hence the minimal margin expansion modeled in 2022 vs. 2021

• CCO’s cost basis is largely fixed, making the flowthrough of any excess revenue very high

Factoring in the cost cuts and higher digital revenue mix, we arrive at a consolidated 2023E EBITDA of $705mm.  We are not factoring in any recessionary impact to this figure as it is difficult to know the magnitude, if any, of a slowdown in OOH advertising given strong fundamentals to date.

Valuation

The key U.S. peers are LAMR and OUT, and for Europe it’s JCDecaux (DEC) and APG|SGA (APGN).  LAMR has a much higher mix of billboards, hence EBITDA margins comparable to CCO U.S. in the mid-40s – this is the most appropriate comp for CCO U.S.  OUT’s revenue skews towards transit, namely in Los Angeles and NYC (the MTA is a huge contract for them), leading to lower margins.  JCDecaux is the #1 player globally and headquartered in France (CCO’s #2 market).  APG|SGA is the #1 player in Switzerland and competes with CCO there.  Both DEC and APGN are appropriate comps for CCO Europe.

Source: Capital IQ (7/21/22)

Given multiple compression year-to-date, all OOH players are trading at multiples much lower than their 5-year historical averages.  However, we will comp CCO to current market valuations.

Utilizing a slight discount to LAMR for CCO U.S. and an average of DEC and APGN for CCO Europe yield the following 2023E SOTP analysis:

Source: Capital IQ (7/21/22)

An overall 11x EV / EBITDA for CCO is more than 4x upside from current levels.  The biggest driver is the U.S. segment’s multiple – as you can see by the sensitivity table, underwriting 13x (instead of 12x) moves CCO’s valuation to nearly $7/share.

There would be further upside if Europe and Latin America are divested.  The below assumes Europe is sold for 10x EBITDA (after allocating corporate expenses) to a private equity firm (no SG&A synergies).  The analysis also shows Latin America being sold for 10x EBITDA to a strategic that can reduce SG&A by 15%.  With the transformation into a U.S. pure play, we are awarding a 1 turn improvement to the U.S. multiple (13x), yielding a valuation of ~$7.50.  While the U.S. multiple is a key valuation input, so is the sale price for Europe, which is difficult to know until announced.  At the very least, we expect CCO to sell off Europe in a leverage-neutral transaction that accomplishes simplifying the business closer to a U.S. pureplay.

Source: Capital IQ (7/21/22)

Longer term, we see significant upside into the high single digits as EBITDA continues to compound better than street expectations due to the digital transformation.  And obviously, if we assume a higher multiple for the U.S. segment, the valuation figures shown below can go much higher.

Source: Capital IQ (7/21/22)

Risks

Leverage – yes, it is high and this is probably reasons #1, 2 and 3 that keep investors away from the name.  However, they have no maturities until 2025 and no covenants, except for a springing financial covenant tied to their revolver which was recently paid off (thus not in effect).  Even in a recessionary scenario, CCO can withstand a downturn given its $432mm cash balance and ability to cut its $200m+ annual capex budget dramatically (roughly 80-90% is discretionary “growth” capex – digital billboard conversions – which can be paused).  In addition, the Company witnesses a tremendous cash influx from working capital changes during a downturn, which then reverses as the Company recovers.  We do not foresee any need for the Company to raise additional financing (debt or equity).

Recession – we are not forecasting a recession in our scenario due to reasons discussed above. While the Company can certainly survive one without any debt issues, it will certainly burn cash in the process.  As such, this will push out the upside story by a year or two as we’d have to wait for a recovery and deduct the cash burn from valuation.

Catalyst

• Europe sale
• Latin America sale
• Sale of entire company
• Continued digital transformation
• Ramp of programmatic ad sales
• Earnings