A Bad Seed in the Profitable Advertising Industry

GuruFocus.com

Clear Channel Outdoor Holdings Inc. (CCO) has been a popular investment in the advertising industry so far, as it shares more than 70% of domestic billboard revenue with competitors Lamar Advertising Co. (LAMR) and CBS Corporation (CBS). However, CC Media's recent holding position of 89% of the advertising firm has made many shareholders uneasy, in addition to bumping the uncertainty rating from medium to high. Therefore, investment gurus Paul Tudor Jones (Trades, Portfolio) and Jeremy Grantham (Trades, Portfolio) reduced their participation in the company, which leaves me wondering what will happen looking forward.


Expect Growth, but Minor Profits for Shareholders

After finalizing a ferocious five year acquisition period in 2002, Clear Channel Outdoor reached its current scale, which operates 908,000 advertising displays worldwide. Focusing on large cities, where the company shares an equal sales rate with CBS, the U.S. market acts as the main growth catalyst, reeling in two-thirds of overall cash flow ($198 million). The firm is set to roll out its digital billboards over the next decade, which will allow advertisers to pick specific times of the day for their message displays, as well as permit immediate display changes, leading to profit boost.

However, structural differences in the international market are worrisome. Since most foreign countries do not grant outdoor advertisers a leasing permit, the permit owners gain larger profits through revenue sharing and payment agreements. Also, the short-term billboard contracts leave Clear Channel to absorb all costs of switching out the content, thereby hurting profit margins (net margin was at -1.64% for 2013).

The aspect which makes me the most sceptical about investing in this advertising company is CC Media's majority stake. Clear Channel Outdoor lends to its parent firm via a $1 billion unsecured revolving promissory note, which could lead to the company becoming an unsecured creditor if CC Media were to declare insolvency. And since minority shareholders have little to no say at all, they could suffer greatly in the case of a downhill scenario. Also, the 89% stake makes the company's financial position dependant on the parent company, which is overall very disconcerting. Moreover, this recent change put a steep hole in Clear Channel's balance sheet, nearly doubling debt levels and causing EPS to decrease by 18.6%.

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Time to Step Away

While domestic sales and technological advances will help boost revenue, driving the annual average to a 5% growth rate, versus the current 1.5%, and EBITDA margins are expected to 27.5% by 2018 (peak level was 2007's 29%), I feel bearish about Clear Channel's long term future. Given that most of the firm's growth is sustained on the gradual rollout of digital billboards, I believe there's yet little certainty regarding the strategies success. In fact, the firm could face some regulatory hurdles from local governments, as concerns have risen regarding motorist safety.

Furthermore, returns on assets are very weak at -0.72% compared to the industry median of 4.02%, and the -1.64% net margin is also very discouraging. I find it very hard to believe that an investment in Clear Channel will bring any serious profits, and its very sluggish balance sheet simply confirms this point of view. Therefore, I recommend investors stay away from this firm going forward, despite its bargain price of $9.09.

Disclosure: Patricio Kehoe holds no position in any stocks mentioned.

This article first appeared on GuruFocus.

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