Outfront Media – OUT

Summary:

Outfront (OUT), a REIT that yields 5.5%, provides the opportunity for ~15% returns over the next 2-3 years as the relatively newly stand-alone company optimizes pricing of its static and digital boards, grows digital boards, continues to increase its dividend, integrates digital boards into modern TV and internet ad campaigns.

Company Overview:

Outfront Media is the former CBS Outdoors that was split from CBS and began trading March 28, 2014 at a price of around $30/share, with 120MM shares outstanding (16.5MM shares issued to existing shareholders in July 2014 as distribution of accumulated profits and reflects the bulk of the change in share count to the 137.4MM outstanding today).  The company began operating as a REIT in July 2014. 

Market Cap and EV are currently $3.4B and $5.7B, respectively, and the company generated $280MM in trailing FFO from $1.4B in revenues.  At Q1 2015 OUT had 582 digital boards and was putting up about 25 new digital boards per quarter, and had ~59,000 boards total (excluding more than 300,000 Transit & Other displays).  Digital to Total billboards represented 0.9%.  By comparison, LAMR has 2,100 digital boards vs 142,000 static boards (approx. 1.5% digital to total boards), and its digital boards generated 18% of total board revenues.  LAMR has 1,300 boards in New York, NY vs more than 32,000 for OUT.  OUT stopped disclosing digital revenues but at last look (Year end 2013) it had 0.7% digital boards that generated 7.9% of billboard revenues.

Approx 70% of OUT’s revenues are poster and bulletin billboard, with the remaining being Transit & Other displays. 90% of revenues are from the U.S. and the remaining 10% is split half and half, roughly, between Latin America and Canada.  The company raised its dividend in Q1 2015 by 4.6%.

The company acquired Van Wagner in October 2014.  OUT paid $690MM for $206MM in annual revenues, and $32MM and $64MM in OIBDA and pro forma OIBDA, respectively.   The multiple on pro forma OIBDA was 10.8x.  VW had 1,094 billboards of which 16 were digital.  They subsequently lost VW’s NYC phone kiosk contract in November 2014 that represented $6MM in revenues.   Half of VW’s boards are in Los Angeles and a quarter are in NY.  Mgmt has expressed interest in doing more tuck-in and consolidating acquisitions.

Up for RFP in the near-term is the NY MTA transit contract that represents 55% of US Transit Revenues or approx. 15% of total Outfront revenues.  This contract set to expire in 2015 and OUT management mgmt. has said that they’ll submit their RFP  by mid-2015.  Historically, the former CBS Outdoors has had good very good relations with both LA and NY.  A recent article indicates OUT had filtered certain ads that ultimately proved prudent for NY City (http://www.bizjournals.com/newyork/news/2015/04/20/mta-partner-outfront-media-controversial-ads.html ).  An older LA times article indicates they stick to their contract commitments (http://articles.latimes.com/2012/sep/18/entertainment/la-et-ct-mta-20120918 ).

Investment Thesis:

·         Outfront equity shares have an attractive 5.5% dividend yield today.  This yield is well below OUT’s ttm FFO yield of 8%, indicating room to improve the existing dividend before factoring in any growth.

·         Moreover, we think earnings and FFO growth can result from 1) under-penetrated digital presence within OUT’s billboard portfolio, 2) revenue improvements as the company re-aligns sales force incentives (mgmt. describes prior sales force compensation as less motivating and cites some personnel as simply rubber stamping their book of business) and implements technology to track and optimize inventory (software that was non-existent under CBS), 3) consolidating acquisitions and 4) industry repositioning of digital assets (and market share gains) owing to integration of digital boards with modern buying techniques and campaigns.

·         Advertising spend is particularly seasonal, and this seasonality is atypical for a REIT.  Q1 is typically the weakest industry-wise and by far the weakest in the outdoor space.  Weak Q1 results to REIT investors that track dividend coverage may have led to some selling. 

·         The MTA contract up for RFP in 2015 only adds to overhang.  The complexity of the NY MTA system, the investment that has taken place, and the good relations OUT has with MTA (and with advertisers)  indicate the company is very likely to retain this contract.

·         Little sell-side coverage exists for Outfront.  Moreover, a recent split, name change, conversion to REIT and weak Q1 results (not atypical for advertising, as mentioned) all provide little clarity for typical REIT investors.

·         Finally, it’s no secret that advertising budgets, from a broader perspective, should track inflation.  As outdoor assets hold or gain market share, and given contract pricing is relatively short-term (compared with those of MLPs and tenant-based REITs), OUT’s dividend should grow even in a rising rate environment.

Valuation:

NY MTA Retained Scenario

Key Assumptions

·         100 new digital boards/yr

·         Digital board revenues per month for Year 1 (2015) deployment fetch $19,400, for the “class of 2016” those boards fetch 95% of Year 1’s to attempt to account for less prime locations, for “class of 2017” they fetch 90%.

·         Static revenues per board per month are held flat at $1,250.  The assumption here is that as the better locations are picked off, any price increases (or price optimizations as mgmt. says or inflation) is negated by Tier 1 locations converted to digital.

·         OIBDA margins are assumed to grow to 32% by 2017 (approx. a 200 bps increase, and compares with more rural, less Transit-oriented Lamar at 40%). 

·         MTA revenues grow at 5% per annum.

As a result, FCF net of full capex spend ($70MM/yr) would be $305MM.  FFO would be approximately $350MM.  This represents approx. 7% growth per year and at 1.5x FFO coverage would imply >10% per annum dividend growth.  At a 5% yield shares would trade in the $33-34 range.  This represents 12-13% capital appreciation per annum (at 2.5 years) plus dividends.

NY MTA Lost Scenario

Key Assumptions

·         100 new digital boards/yr

·         Digital board revenues per month for Year 1 (2015) deployment fetch $19,400, for the “class of 2016” those boards fetch 95% of Year 1’s to attempt to account for less prime locations, for “class of 2017” they fetch 90%.

·         Static revenues per board per month are held flat at $1,250.  The assumption here is that as the better locations are picked off, any price increases (or price optimizations as mgmt. says or inflation) is negated by Tier 1 locations converted to digital.

·         OIBDA margins fall to 27.5% as company absorbs lost MTA contract. 

·         MTA revenues grow at 5% per annum but are cut in half at YE 2015 from current rate of approx. $400MM/yr.

As a result, FCF net of full capex spend ($65MM/yr) would be $180MM.  FFO would be approximately $220MM.  Coverage would be stressed but could but today’s dividend could be maintained at 1.2x FFO coverage.  Actual coverage on a FCF basis would fall just shy by a few pennies to $1.31/share.  Applying a 7% yield (a stab at slight rising rates or market discounting for lack of growth), to a $1.31 dividend (assumes full payout of FCF) yields $19.

From a relative value perspective, OUT’s shares have significantly lagged LAMR’s and Vanguard’s REIT ETF.  OUT carries a material yield advantage, better growth expectations, slightly better coverage, albeit at the cost of the MTA contract risk and higher leverage.

Industry background:

Historically, outdoor advertising has historically been a unique advertising asset despite cyclical revenues that are indicative of advertising spend ebbs and flows that track the broader economy’s cycles.  They provide mass reach at a very cost effective price point.   They’re high margin assets, as physical depreciation on a static board de minimis so the only real cost, besides company overhead, is sending the truck and person out to replace the banner.  Often the land under the board itself is leased.  As many know, the 1965 Highway Beautification Act and many local ordinances create strong barriers to the development of new board assets – whether by incumbents or new entrants. 

The digital board economics are slightly different.  Take down a static board and then reinforce the underlying structure, put up a Daktronics digital panel and connect and increase electricity (naturally, like high-grading your acreage to develop the best wells first in the O&G industry).  CapEx are much higher, down to as low as $200,000/board from close to (or around) $1MM a decade ago.  Like TVs, these LED panels are highly deflationary.  Given you typically shuffle through ads at 6-8 second intervals and may offer a total of 6 or 8 spots, you’ve now increased your “prime” inventory at that site from 1 ad to as many as 8 ads, with the ability to charge nearly the same and the potential to reach new clients (no longer need to commit to 1 month, LAMR/OUT/CCO offer as little as multi-day or even 1-day spots for certain digital locations).  Obviously, the negative is that if everyone put up digital in every spot, inventory would technically grow massively.  By itself, you have declining capex and pricing based on the location rather than some sort of cost-plus model tied to the underlying capex.  Fast forward to 2015, digital billboards are quickly becoming an integrated, interactive part of an ad campaign just like any other digital screen. 

And location does matter.  For Yearend 2013, for OUT specifically, the company showed revenue per digital board of $91,500 in its NY metro area vs static revenues per board of $13,000 in the same area.  Those numbers for OUT’s Dallas locations are $17,000 and $3,000.

At less than $10 CPM, Outdoor advertising (aka Out of the Home or OOH) is one of the most cost effective forms of advertising.  Only radio and online search rivals that price point. 

Outdoor is a great tool for brand awareness.  That’s why AAPL relies on the medium.  People talk about memorable TV ads and Billboards more frequently than memorable online ads.  A 2012 survey by Outdoor Media Center (take with a grain of salt?) supports this opinion.

Scarcity value?  As audiences become more fragmented, billboard and posters still have the ability to reach a mass audience in a big way.  Even the hottest TV shows have distracted viewers texting on their phone or searching their tablet or watching the show several days or weeks later via On Demand.  Online viewers, whether through an App or through internet browsing, are hip to the quickest way to click out an advertisement. With outdoor, viewers cannot turn off the ad nor change the channel nor fast forward.  It is becoming one of the few places where the consumers do not have some level of control over the ad space.

Transformational shift in utilization of outdoor digital assets

Outdoor Advertising purchasing is on the cusp of becoming more integrated and outdoor ad viewing is becoming more interactive and integrated. 

Below are some examples that highlight modern usage of digital panels or static outdoor usage by modern tech companies.  Industry contacts suggest that it 1) legitimizes many of these startups as real companies, 2) provides a medium to reach mass audience – which is important because through mobile many apps and websites can be accessed while outdoor, and 3) they can target a specific neighborhood or demographic based on commuting schedules.

·         Apple spends 10% to 12% of its total ad budget on outdoor.  AAPL is no doubt calculated, sophisticated advertiser of its brand and products.  For comparison, top 100 National advertisers spend ~2-3% of their budget on outdoor.

·         Google locked up a Times  Square digital board exclusively, for entire month of Dec 2014.  To boot, besides being a tech company, this is a company that survives off of generating ad revenues.

·         Tech companies themselves see value in outdoor:

·         Snapchat this spring launched a brand campaign on its homepage and Youtube, which shows a backdrop their brand on a billboard in the background.

·         Scruffs, a popular gay matchmaking app, did its first billboard ad outside the superbowl in Phoenix. 

Coca-cola is using a digital board at Times Square on an interactive basis, to publish facts (in partnership with Google) about names for those who tweet their name to #cokemyname.

From a purchasing perspective, standardized viewing measurement (TAB out of home ratings) coupled with programmatic digital buying allows advertisers access to digital panels in almost the same way they’d execute programmatic web or TV ads, as part of a broader campaign.  This past May in Australia, Site Tour, a digital outdoor ad exchange, has partnered with programmatic platform Tubemogul to bring outdoor digital assets into programmatic buying campaigns.  Also in May, Fliphound, a programmatic online buying platform for digital billboards, announced integration directly through Daktronics Visiconn dashboard which will give digital board owners’ inventory onto Fliphound (which carries a more local advertising client base).

Risks:

·         Cyclicality of advertising.

·         Saturation risks, for industry and OUT.  Next 500 digital board installations will look much different than the first 500 and less prime locations are converted from static.

·         Mgmt and company hardly tested in deal savviness but have expressed interest to make tuck-in acquisitions.

·         Digital boards, the key growth driver, frequently attacked as distracting and unsafe for driving conditions.

·         To grow revenues faster than inflation and costs, company (and industry) must figure out a way to stay relevant and integrated to modern technology and viewing habits.

·         MTA contract up for RFP.