Lamar Advertising (NASDAQ:LAMR) is an outdoor advertising company with a large network of billboards (over 150,000). Fear that LAMR may default on its senior credit facility or may be unable to meet its obligation on its converts maturing 12/31/10 pushed down the prices of all of the company’s securities. This fear drove LAMR’s equity value down over 50% in 4Q08 while its senior subs and converts began trading in the high-60s to low-70s. The fear of default reached a high point during 4Q08 and the company felt compelled to include a supplemental indebtedness schedule in its press release for 3Q08 results to address a “certain amount of misunderstanding and misinterpretation with [LAMR's] credit agreements and [its] outstanding debt.”
As described on the 3Q earnings call, “There are three common misunderstandings in the investment community.” Two of these market misunderstandings pertain to whether the company will violate the debt-to-EBITDA covenant in the credit agreement controlling the senior credit facility (the “Credit Agreement”) and whether LAMR will be able to pay its debts as they come due. In the past month, a series of corporate events have transpired that support a scenario that could prove favorable to equity: LAMR survived any violation of the debt-to-EBITDA covenant and is able to pay off the converts, its nearest maturity debt obligations.
As described by management, the number one market misunderstanding “is that our senior credit facility total debt ratio test steps down from 6-to-1 to 5.75-to-1.” The stepdown to 5.75-to-1 from 6.00-to-1 in LAMR’s debt-to-EBITDA (the “Total Debt Ratio”) is listed on page 95 of the original Credit Agreement, dated 09/30/05, controlling the senior credit facility. On the 3Q08 earnings call, management stated the stepdown was “in the original agreement and we amended that ratio to remain at 6 to 1 for the life of the credit agreement . . . It is at 6 to 1 today and will remain 6 to 1 for the life of the loan.” What created this market misunderstanding? While not entirely sure, we’ve noticed that although page 87 of LAMR’s latest 10-K clearly lists three amendments to the Credit Agreement as exhibits 10(g)(2), 10(g)(3), and 10(g)(4), Capital IQ only lists the first amendment among the “Security Holder Rights and Agreements” in LAMR’s “Key Documents” section. This may be a source of market misunderstanding, since it is the third amendment, dated 03/28/07, to the Credit Agreement that states, without qualification, “The Company will not permit the Total Debt Ratio at any time to exceed 6.00 to 1.”
“The second misunderstanding is that [LAMR's] convertible notes . . . are included in total debt for covenant calculation purposes.” What created this market misunderstanding? There’s nothing to indicate that anything beyond the Holdco/Opco, Lamar Advertising/Lamar Media structure is to blame. The Credit Agreement only includes debt at Lamar Media for the Total Debt Ratio covenant. Lamar Advertising is the borrower on the converts due 12/31/10 that aren’t included in indebtedness for the Total Debt Ratio covenant.
The importance of the Total Debt Ratio has become particularly relevant. On 03/19/09, LAMR announced that it was “in the process of seeking an amendment to [its] senior credit facility,” and it was proposing a private placement of senior notes. The offering size of the senior notes was increased on 03/20/09 to $350 MM from $250 MM and offered at 89% of face value with a 9.25% interest rate (for a 12.56% YTM). Following on the stated purpose of the private placement to repurchase some or all of the converts, LAMR made a tender offer, expiring 04/17/09, for the converts at 92. The converts were trading around 75 immediately preceding the tender offer. The new senior notes are at the Lamar Media level and will count towards the Total Debt Ratio. Pro forma, as of 12/31/08, LAMR’s Total Debt Ratio would have been at 5.6-to-1. This has driven the company to seek an amendment.
Although management previously believed a 2009 with revenues down 10% YOY would constitute “the bottom falling out,” they mentioned that they’d never experienced that type of drop and would have to manage the two biggest costs: headcount and lease expense. Management also that stated that they weren’t planning on having to aggressively cut those costs in order to offset a (10%)+ decline in revenue. Now management is forecasting revenue down (15%) for 1Q09, and they’ve already begun drastic cost cuts (see the 4Q earnings call): 10% of the workforce has been cut and lease renegotiations have saved $10 MM on an annualized basis. All in, management estimates a (5%) decrease in opex.
Notwithstanding these significant cost cutting measures, that forecast indicates increased chances that EBITDA decreases swiftly and leads LAMR to violate its Total Debt Ratio covenant. With LAMR having cut back its digital deployment strategy and placed itself squarely in free cash flow generation mode in order to delever, the company’s lenders are likely to be willing to amend the senior credit facility. Management has stated that the bank group has said they’ll work with LAMR on an amendment—while obtaining a higher interest rate and taking in a pound of flesh in fees. JP Morgan is the administrative agent on the senior credit facility and led the purchase of the new senior notes, taking 60% of the issue (see Schedule 1 in the Purchase Agreement).
If an investor gets comfortable with the covenant default/amendment situation and the potential scenarios, a very simple estimate of EBITDA for 2009 of $400 MM and a stated maintenance capex of $15 MM puts LAMR at 10x its depressed 2009 free cash flow, assuming a (15%) decline in revenues for 1Q and (10%) for the balance of 2009 and a (5%) decrease in opex from 2008. Although LAMR is experiencing one of the worst environments it’s ever faced, one which management has never experienced before, it has an irreplaceable network of billboards with an opportunity for attractive incremental returns, beyond 2010, from investment in digital billboards and significant operating leverage through higher occupancy.
[double-click to enlarge]