CCO - Clear Channel Outdoor: Debt Is A Massive Risk

2023-07-11 07:30:20 ET

Summary

• I recommend a hold rating due to significant balance sheet risk and the decline of the outdoor advertising industry due to digital advertising.
• CCO's financials show a history of negative net income and high debt, with a net debt of $6.8 billion, posing a major risk in a rising interest rate environment.
• Despite potential recovery in airport revenue and favorable foreign exchange rates in Europe, the balance sheet risk and challenging industry dynamics make a higher valuation for CCO difficult to justify.

Summary

My recommendation is a hold rating for Clear Channel Outdoor ( CCO ) as the industry it operates continues to face share loss to digital advertising and the business has a major balance sheet risk.

Note that I previously rated hold rating for CCO stock due to the uncertain near-term outlook, and I am reiterating it.

What does the company do?

Clear Channel Outdoor provides out-of-home display advertising such as digital billboards, posters, panels, wallscapes, and mobile advertising services.

Industry overview and growth

CCO competes in the outdoor advertising industry. Outdoor advertising, also known as out-of-home (OOH) advertising, is used by enterprises to promote products or services and spread business-related information among the masses. It provides a cost-efficient and long-lasting solution with wide coverage compared to other forms of advertising.

According to IBISWorld , the US market size is $9.5 billion in 2022, which experienced 2.1% decline a year since 2017. I expect this decline to continue moving forward due to the rising internet penetration, rapid digitization, and the increasing focus on targeted marketing are among the key factors strengthening the growth of the market across the globe. Given the similarity in dynamics, I expect CCO Europe to face a similar situation as the US

My thoughts on the business

CCO's poor performance in 1Q23 is not surprising given the sluggish macro environment and structural headwinds such as declining share due to the rise of digital advertising. Specifically, the business saw 1.3% y/y revenue decline in America and Airport revenue decline of 3.7% y/y. Airport revenue should continue to rise in the second quarter as a result of revived advertising efforts, but I worry that the upcoming months won't be enough to catch up to last year's stellar expansion. In particular, a look at the underlying regions reveals that San Francisco's travel remains weak, likely due to low consumer confidence. As a result, I do not believe that the American segment will experience a significant upswing anytime soon.

For Europe, the segment should benefit from the recovery in FX against the US. While the $75 million in revenue and $15 million in EBITDA guidance reduction may seem low, I'd like to point out that almost all of it is due to the sale of the Switzerland business.

My thoughts on the financials

CCO has suffered from the industry share loss to digital advertising over the years but saw a strong uptick in growth in FY21/22 due to the Covid situation – which led to advertisers spending across all channels to capture demand. I believe this positive trend is over and CCO is likely to recover back to flattish to low-single digits growth as it grows with GDP levels.

As one of the incumbents, CCO has stable margins on all levels (gross, EBITDA, and EBIT), which is a healthy indicator of the business as it shows good cost management and ability to price its product to match inflation. However, the problem comes when we look at the net income line, which has been negative for the past 10 years. I see this as a major red flag to the business as it means they are not able to manage the non-operating expenses, such as interest expense.

The problem with CCO is its balance sheet. CCO has $340 million cash as of 1Q23 and $7.1 billion in debt, translating to a net debt of $6.8 billion, or near 11x net-debt to EBITDA ratio. This is a stark increase from its historical levels of 7x to 8x. I see major balance sheet risk as the rising interest rate environment will put further pressure on CCO net income. Note that this is not reflected in CCO EBIT line, as such some investors might miss this headwind.

Valuation

Based on CCO capitalization, I believe the balance sheet risk is too big to ignore. For instance, using consensus estimates that CCO should achieve $644 million EBITDA in FY25. If we apply the current forward EBITDA multiple to it, it suggests an EV of $6.7 billion, which is less than the total net debt of $6.8 billion, making the equity value worth less than 0. I am not suggesting that CCO is worth 0 at this point as consensus estimate might be wrong. However, to achieve any upside from current share price would mean that CCO needs to trade at a much higher multiple (note that 10.5x is already above historical average), or earnings need to inflect (which is tough as I mentioned above).

It is interesting to see CCO trading at a premium to peers given its weak balance sheet and years of not generating positive net income. I believe there will come a tipping point where the market focuses on this risk, which would put further pressure on the stock. CCO might need to raise capital to strengthen its balance sheet at some point, thereby diluting existing shareholders.

Risk

CCO has accumulated substantial debt and, should the current environment worsen, may need to explore liquidity alternatives. In addition, the increased leverage restricts the company's acquisition targets to more modest deals, which can be used to further boost growth.

Conclusion

I recommend a hold rating for CCO due to the significant balance sheet risk the company faces. CCO operates in the outdoor advertising industry, which is experiencing a decline in market size due to the rise of digital advertising and changing consumer behavior. While CCO's performance has been negatively impacted by these structural headwinds, there are some positive factors such as the potential recovery in airport revenue and the European segment benefiting from favorable foreign exchange rates. However, the company's financials raise concerns, with a history of negative net income and a high level of debt. The balance sheet risk, coupled with the challenging industry dynamics, makes it difficult to justify a higher valuation for CCO. Investors should closely monitor the company's ability to manage its debt and navigate the changing advertising landscape.

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