- Many of Clear Channel's largest expenses are fixed costs which are locked in for years.
- The company has been upgrading to digital billboard faces which require less labor and can be operated remotely.
- Management has discussed that they could look at tuck-in or bolt-on acquisitions, which could result in significant cost savings on acquired assets.
- The company's board might decide to divest the European assets, which could deleverage the balance sheet and make Clear Channel an even more attractive takeover target.
One of the biggest winners we had in our speculative and special situation portfolios coming out of the pandemic was Clear Channel Outdoor (NYSE:CCO). Many investors were worried about the company's prospects during the pandemic as they are asset heavy in many large, urban areas and carry a heavy debt burden resulting from their days of being the piggy bank for their former parent company. While the debt load has been an issue, we really do like the debt market transactions the company has done and think management has positioned the company to be able to dig their way out from under their debt load in the next few years.
While we could have walked away from this name after some of our spectacular gains, we have elected to stay put. We have taken steps to generate some income, such as selling calls from time to time, but our propensity here is to stay long because we think that the billboard business continues to improve, the company has positioned itself to have a chance at paying down debt and over the next few years we could see the stock outperform in either a high inflation environment or an environment with higher interest rates.
Why Inflation Could Have Less Of A Bite
Clear Channel focuses on urban areas and has their real estate portfolio structured so that most of their leases are fixed cost and not the variable rate leases that require revenue sharing. This allows the company to go into each year with a pretty good idea of exactly what they are spending on their ground leases and structure their capital expenditures and/or M&A with pretty good accuracy (the company has mostly been focused on CapEx in recent years, but has indicated that they are interested in small tuck-in or bolt-on acquisitions moving forward as well) so long as their revenue estimates are in-line. We have really liked the CapEx focus in recent years because management has focused on adding to their digital billboard inventory by building new locations and converting older, high traffic areas to digital faces in order to increase ad inventory, increase revenues at those locations and lower labor costs by making those locations more efficient and less labor intensive (as they are controlled remotely).
While management has done a very good job restructuring the company's debt by refinancing with longer final maturities and lower rates, the company is going to have to make hard decisions in the next few years based on what the market encounters. If rates tick higher to fight inflation and tamp it down, then they will most likely have to decide how much they want to improve their credit quality and the impact that will have on annual interest costs. Our guess is that the company would want to lower interest costs on an annual basis by paying down some principal on their debt issuances, but the math behind this all depends on where the Federal Reserve goes from here and where Clear Channel's credit rating ends up.
If inflation heats up and the Federal Reserve has an issue fighting it, then the company might find it more advantageous to repurchase their debt for pennies on the dollar rather than building new locations. We do not see inflation becoming this bad, but it is a scenario to be aware of because the company could find it more beneficial to earn a spread on cash holdings vs debt issuance and to buy certain fixed coupon issuances as they roll down the curve at discounts to par. As we stated, this is not highly likely.
Author's Note: The fixed ground leases and fixed debt payments are two huge expenses that the company has locked in for a few years (they also have floating rate debt, but this is mostly bank loans and the such). This gives the company flexibility in adjusting their second largest expense of labor higher without having to worry if they can pass on all inflation to customers in the current year; which is the main problem many companies facing inflationary input costs run into. So if inflation is up by 10% this year, the company does not necessarily experience across the board increases to costs of 10% (on a cash basis because they have a lot of fixed costs locked in for years) and can actually still see improvement in results even if they increase their rents charged to customers at a lower rate (assuming it would cover their increased labor and a little extra). That is the benefit of leasing long-term and renting short-term in an inflationary environment.
Management has tried not to address it (on the most recent conference call they did a very good job avoiding giving any insight really), but the company released a press release (located here) stating that the board is reviewing strategic alternatives for the European business and potentially looking at divesting it. Clear Channel already sold their business in China, which was very helpful during the pandemic, but now is eyeing a potential exit from Europe which would make it much more similar to Lamar Advertising (LAMR) and Outfront Media (OUT). How any deal is structured would be key, especially when looking at the debt because most of the debt is under the parent company's name. So, any deal would have to generate either significant cash proceeds to repurchase that debt, or have a spin-out assume debt (which might not be possible based off of debt covenants).
The good news with any deal is it would allow the company to sell near what are still pretty historic highs for asset prices and use the proceeds to pay down a significant portion of the debt. While the fixed coupon debt might get cheaper in years ahead with higher inflation and/or higher rates, we like this scenario best because it frees up cash flow now to be redeployed into the more attractive US market and for potentially buying back that cheaper debt down the road. Essentially, a divestiture now allows the company to take advantage of high prices, lower their annual interest expense and hasten their positioning of the company to better withstand future storms.
If Clear Channel can exit the European business at a respectable price, retire enough debt after taxes and other deal expenses to increase cash flow and continue to benefit from strong ad sales, we believe that the company could look similar to Outfront Media in size (as measured by revenues). We could see shares double from current levels as investors revalue the company based on exposure to the US market and looking more like a domestic pureplay billboard company which should fetch a higher valuation over the long-term. The key is all about what price the company's European division could ultimately deliver.
Continued Portfolio Optimization
As management continues to focus on lowering debt outstanding, modernizing their billboard portfolio to include more digital faces, and looks at either building new sites or M&A focused on tuck-in/bolt-on locations that add to current markets, we see the ability to further economies of scale and make the current workforce of roughly 4,800 much more efficient. The digital boards that the industry has rolled out in recent years are all controlled remotely and have enabled some companies to further consolidate divisions (such as their art and design departments) that were once spread out across their geographic operating areas.
While we hate job cuts related to M&A activity, the reality in this business is that you can buy decent sized billboard portfolios in an area and really only require very little additional help on the installing side; management, administration/support and sales departments are usually gutted. So, tuck-in acquisitions see a lot of the gross profit flow down to the net income line of the income statement and see a nice increase to free cash flow for the acquirer.
Potential Acquisition Target
Clear Channel itself could become an acquisition target, and could look even more attractive to a purchaser with a lot of cash that was looking to bulk up on assets. Regardless of whether inflation becomes a problem or not, if the company can rid itself of its overseas exposure we do think that it would make an attractive acquisition target for a number of industry players and/or private equity names. This has been rumored before (JCDecaux has been rumored as an interested party multiple times, see most recently here), but at certain times the European assets were seen as a barrier, so moving forward without the overseas exposure might be the icing on the cake for shareholders hoping for a takeover.
While inflation has a tendency to wreck havoc on equity and bond portfolios alike, we do like Clear Channel Outdoor as a potential play to insulate portfolios against some of those risks. Without a divestment of European assets, we think this is a good play; with a divestment of the European assets we think this is an even better play as it would enable the company to move more quickly towards their goals of creating more free cash flow and simplifying the business. Each step management takes towards improving the company's performance unlocks value for shareholders and makes the company a much more attractive target for M&A activity.
This article was written by
Analyst’s Disclosure: I/we have a beneficial long position in the shares of CCO either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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