Newsletter Value Investor Insight carried an interview December 22nd with Robert Jaffe, who started his own fund, Force Capital, after working with Steven Cohen of SAC Capital for eight years. Force Capital now manages about $1.2 billion, and its core long-short fund has earned net returns of 17.0% per year since inception in mid-2002, versus 13.0% for the S&P 500, according to Value Investor Insight. Here's the excerpt from the interview (also with co-workers with Mark Cohen, Paul Klibanow and Eric Newman) in which they discuss Lamar Advertising (LAMR), which was trading at $65.03 at the time of the interview (current price here):
Tell us more about one of your specific ideas, Lamar Advertising (LAMR).
Paul Klibanow: Lamar is the country’s only pure-play outdoor-advertising company. The market is dominated by three big players – Lamar, Clear Channel and CBS – which are of roughly equal size and control about 85% of all billboards in the U.S. While CBS and Clear Channel go more head-to-head for national advertising dollars in bigger markets, Lamar is focused more on local advertising and smaller markets, like Baton Rouge or Louisville. Within each of its markets, Lamar typically owns about 80% of the billboard faces.
At the same time the market has consolidated, federal and local regulation make it very difficult to put up new billboards. Constrained supply is usually quite a good thing if you’re a market leader – which Lamar is in almost all of its markets – and inflation-adjusted pricing has been rising steadily.
RJ: An important part of the thesis here is what’s going on in the traditional advertising business, where it’s getting harder and harder to get your message out. If you advertise on the radio, you’re competing with people talking on their cell phones or listening to their iPods. With newspapers, you’re seeing sharp declines in readership by people 18 to 30 years old, so you’re missing out on a very important demographic. And television advertising is getting killed by Tivo. But if my ad is on a billboard, there’s little doubt in my mind that the consumer is going to see it and I can be more confident I’m getting what I pay for. So far at least, people still have to look out of their front windshield to drive a car.
What is the “transforming” industry event you alluded to earlier?
RJ: The changeover of the company’s billboards from analog to digital is a massive opportunity. Think about the opportunity digital billboards provide: For national advertisers, McDonald’s can now buy the 4 a.m. to 7 a.m. slot to promote breakfast or Anheuser-Busch can advertise Budweiser during the evening rush hour. For local advertisers, banks can market their current interest rates, grocery stores can promote their latest sale on chicken, or the gas station down the road can offer up their latest gas prices. The economics of the transformation to digital can be remarkable. It costs $300,000 or so to transform a board and based on the work we’ve done and the industry experience to date, we believe that per-board revenues will rise by as much as 10-12 times after the switch to digital. With margins on that incremental revenue as high as 80%, you can pay back the costs to switch in as little as a year.
PK: Lamar currently has more than 150,000 billboard faces and only about 300 of them are digital. Because 80% of the revenues come from 20% of the boards, you certainly won’t see all the billboards switched to digital anytime soon, but it does mean there’s a lot of leverage from the 20% or so of the boards we eventually expect to get upgraded. This is a multi-year process.
How does this translate into share upside from the current price of around $65?
RJ: There are three main elements to the story here: First, we believe there’s a significant opportunity to re-capitalize the company, given its strong cash flow and attractive prospects. If they borrowed enough to return to the highest amount of leverage they’ve had in the past five or six years, they could buy back $3 billion worth of stock, out of a current $6.4 billion market cap.
The second element is the growth from the digital conversion. To simplify the upside we expect, we’re assuming up to 80% of their current revenues can be magnified by 10x, at an incremental EBITDA margin of 80%. That translates into annual EBITDA growth of more than 20% over the next five years. Just from that, we come up with net present values for the company of between $130 and $200 per share, depending on how quickly the conversion ramps up.
The third element is further down the road, which is that we believe they could eventually convert to a tax-advantaged REIT structure. They’ll tell you they don’t pass all the tests for conversion, but we have legal opinions saying they do.
So for us, this has all the makings of a great investment: an immediate capitalallocation decision that would create value, a fundamental change in the business that provides big upside and an eventual business-structure change that would deliver added permanent benefit.