Description

Bottom Line:

From Clear Media’s current price of HKD 6.49 (USD $0.83), we see upside potential of 149% to our $2.07 estimate of fair value.

Fair value estimate = EV/EBITDA multiple of 10x est. 2019 EBITDA of $105M (assumes 40% EBITDA margin on $263M sales) = EV of $1.05B, plus $69M net cash, = $1.12B equity value, divided by 541.7M shares outstanding = $2.07 per share.  Equates to market cap. net of cash / FCF multiple of 21x est. $50M in FCF for 2019. We ignore the 20% minority interest in their core operating subsidiary in China, because management claims the entity was established (and funded by the company) to satisfy regulatory requirements for a local joint venture partner, but with an agreement that the minority partner, White Horse Advertising, would not be entitled to economic benefits. Clear Media has an option to buy back the 20% minority interest at a negligible cost until 2030.

Background and Opportunity:

Clear Media is one of the largest outdoor advertising firms in China, and is the largest bus shelter advertising panel operator, with 54,000 panels in 24 cities. The Hong Kong-listed firm has grown sales over the past ten years at a 4.8% CAGR, and now has market share of more than 70% in China’s top-tier cities like Beijing, Shanghai, and Guangzhou.  Concessions to operate in these locations usually run 10 years. Weighted average remaining term of current concession rights is approximately 7 years as of 12/31/18. The company pays an upfront concession fee, and for initial bus shelter site’s construction cost of ~$8,500 each and fixed rental fees annually to government agencies granting the concessions. Clear Media avoids overpaying for concessions in competitive bidding by sticking to a minimum 15% IRR target.  Major clients include P&G, Uniqlo, Alibaba, Coca-Cola, Samsung, Unilever, and McDonald’s.

Clear Media had some troubles in 2018, which bring to mind some classic Warren Buffett quotes:

•     “I never attempt to make money on the stock market.  I buy on the assumption that they could close the market the next day and not reopen it for five years.”

•     “Only buy something that you’d be perfectly happy to hold if the market shut down for 10 years.”

•     “If you aren’t willing to own a stock for ten years, don’t even think about owning it for ten minutes.”

Clear Media’s stock was halted by the Hong Kong Stock Exchange after March 30, 2018.  It did not open again until November 19, 2018, so while not the 5 or 10-year trading hiatus that Buffett contemplated, it was a bit inconvenient and disconcerting.  The trading halt was necessitated by the lack of a clean opinion from their auditor and to allow the HK Exchange to investigate and demand remedies for internal control failings at Clear Media that allowed a theft of HKD 77M (USD 10M) from the company’s bank accounts, most of which occurred in 2010 and was an inside job, but not discovered and reported until January 2, 2018.  The stock dropped 24% in Q1 2018 on that news prior to the halt.

After the company reinforced its internal controls to the satisfaction of the exchange, and their auditor, Ernst & Young, gave them a clean opinion, trading resumed on November 19th and the stock price predictably plunged.  Part of the reason for the drop was that just before trading resumed the company gave an intra-quarter update on sales, which showed October sales down 25% year-on-year, an unusually bad result that undoubtedly is a symptom of the slow-down in the Chinese economy.  We know it’s a cyclical business and are comfortable with that aspect of it. We took advantage of the brief panic and forced selling on November 19th and 20th by buying more stock, increasing our stake from just over 5% to 6.2% of the shares outstanding, making us the 3rd largest shareholder, behind International Value Advisors with 17.8%, and the largest U.S. billboard company, Clear Channel Outdoor (CCO) with a 50.4% stake.

On an annual basis, Clear Media has only had one down year in sales, which was 2009, an 11.3% drop, which was understandable given the macro backdrop of that time. The company still produced abundant FCF during that period.  Clear Media’s long held policy of paying out all of its free cash flow as dividends, which have aggregated to USD 242M (0.45 per share, HKD 3.46 per share) since we initiated a position in the stock at HKD 4.00 (USD 0.52) in November 2012, mitigates our concern over the incident that caused last year’s trading halt.  The dividends are a big part of the more than 15% CAGR that we’ve experienced from this investment in the 6+ year period that we’ve held it.

In fact, the company has paid out USD 241.5M in cash dividends over the last 6+ years, which is 86% of its initial market capitalization at our entry point.  We have no other company in our portfolio that has been so good about returning cash to shareholders over this period, and can imagine maybe only a handful of companies in the U.S. that have returned so much of their market cap. in cash dividends to shareholders over the same 6+ years.  Any lingering concerns investors may have about the veracity of the numbers here, due to the recent scandal, should be quelled by that history.

The following bar chart from Clear Media’s 2018 annual report shows EBITDA grew at a 6.2% CAGR over the past 6 years:.  

Clear Media (100 HK) EBITDA 2012 – 2018:

Ok, but what about China?

Regarding the macro-economic concerns about slowing Chinese economic growth, we look at history for a notable analogy.  In Japan, GDP grew 10.2% per year on average from 1961 to 1970, and the stock market there gained 8.2% annually during those years.  From 1971 to 1980 Japan’s GDP growth slowed dramatically to an average of 4.5% per year, but stocks gained 15.9% per year in that slower growth time-frame.  And the Japanese Yen, rather than weaken on the slower growth rate, strengthened dramatically during the 1970s, from JPY/USD 360 to 240, a 50% gain against the USD, despite the much slower growth rate, and despite Japan being a huge importer of oil during a time of rising oil prices.  So, despite a GDP growth rate that was less than half of what it was in the prior decade, stock market returns nearly doubled the rate of the prior decade, and the currency gained 50%. We acknowledge that China is a much different situation, with much more debt as a percentage of GDP than Japan had in the 1970s, and an over-extended banking industry.  Thus, the GDP growth slowdown apparently underway in China may not be such an easy transition for their stock market or currency as Japan experienced from the 1960s to the 1970s. Still, it need not be cataclysmic. China has more debt than Japan had when it was still a fast-growing economy, but China’s savings rate has averaged 33.5% over the past 25 years, while Japan’s savings rate averaged 10% from 1960 to 1980.  If China’s policy makers can prod their consumers to spend a little more and save a little less, consumer spending as a percent of GDP will continue to grow there, and ad spending tends to chase consumer spending, so Clear Media, at 3x EBITDA, with a net cash balance sheet, is well positioned for almost any macro-economic future that unfolds in China over the years to come. Shelby Davis made immense returns buying Japanese stocks cheaply in the 1960s and 70s, as did John Templeton.  It seemed too good to be true, significant Japanese businesses with decades of growth ahead of them at 3x to 6x earnings, while U.S stocks were at 16x. And yet it was there for the taking, for many years, while most investors shunned the opportunity. We see a very similar valuation disconnect today in Clear Media.

Potential catalysts:

There have been some encouraging private market transactions in this space recently.  In November 2018, the largest outdoor advertising firm in the world, JCDecaux SA (DEC FP), itself trading at 10x EBITDA, closed on its cash buyout of its much smaller rival in Australia, APN Outdoor (APO AU) for which it paid 11x EBITDA (AUD 1.167B EV / AUD 103M EBITDA est. for 2019).  Meanwhile APN has a lower EBITDA margin (27%) than Clear Media (42%) and it is unlikely to have better long-term growth prospects, given where consumer spending (and associated ad spend) is in Australia vs. China. And Focus Media (002027 CH), a much larger firm in China that handles indoor / in-building flat screens for advertisers saw Chinese giant Alibaba take a 6.6% stake for CNY 10.00 per share in July 2018 which was about 18x EBITDA, while the stock at CNY 6.77 today is about 13x EBITDA.  Focus Media would be a logical buyer for Clear Media if Focus Media decided they wanted to expand their network beyond their in-building offerings to the outdoor space. And Clear Media’s controlling shareholder, U.S.-based Clear Channel Outdoor (CCO) is highly leveraged and their parent company, iHeartMedia Inc., is soon to emerge from bankruptcy, and will spin-off their 90% stake in CCO to creditors, garnering CCO complete independence. Given that CCO will remain highly leveraged (8.2x net debt / EBITDA) it would seem reasonable to imagine they might like to liquidate their 50.4% stake in Clear Media, which at our estimate of fair value at 10x EBITDA would be worth USD 546M to CCO, a sizable paydown of CCO’s more than USD 5B in net debt.

In conclusion:

Despite its enviable record of growth and cash generation, and its net cash balance sheet, Clear Media stock trades at HKD 6.49 (USD 0.83) as of 5/8/2019, which is a valuation of only 3.5x EBITDA of $109M (2018), in an industry where large peers almost never trade for less than 10x EBITDA, and most of those are highly leveraged entities, whereas Clear Media has a net cash balance sheet.  The cash dividend history of Clear Media is outstanding.

Highly leveraged Clear Channel Outdoor (CCO $4.66), which owns 50.4% of Clear Media, trades at 11x EBITDA. Lamar Advertising (LAMR $81) is 15x EBITDA, and the world’s largest outdoor ad firm, JCDecaux (DEC FP €28.34) is 10x EBITDA.  We think Clear Media’s stock should at least match the low-end valuation of the comparable group. If Clear Media attains 10x EBITDA (est. USD 105M for 2019, assumed down from USD 109M in 2018 on China slow down) it would be USD 2.07 per share, up +149%.

We are long Clear Media and may buy or sell additional shares at any time. This is not a recommendation to buy or sell securities. Please conduct your own research and reach your own conclusion. We do not hold a position with the issuer such as employment, directorship, or consultancy.

Catalyst

See "Potential catalysts" noted above