Description

The Clear Channel Radio stub will be trading at 5.8x my estimate of EBITDA- Maintenance Capex by the end of 2007, with two potential catalysts on the horizon and a couple of free options. Target upside is 40% given an 8x target multiple. CCU has cut their inventory nearly 20% below the industry average in Q1 2005, and a historic review of radio same-station inventory and pricing since 1983 shows a 1-1.5 year delay between inventory cuts and much improved revenue. Also, inventory cuts have a near 1-to-1 relationship with ad effectiveness and hence price per ad, which again has a time lag. The 2H of 2006 should see these efforts bear fruit.

The trade is to short .6 shares of Clear Channel Outdoor (CCO) for each share of CCU. With the short ratio < 1%, I doubt the borrow will be tough. Radio should need no introduction, so I’ll get right to numbers and the analysis I use.

Proper Multiple:
I believe 8x EBITDA-Maintenance Capex is right for a good quality/fairly stable cash-flow stream that will likely have flattish profits over time, but which also has some real option value. Management has returned nearly $4.5B to shareholders over the last nine quarters years (buybacks + dividends) and is committed to doing so going forward, and proper capital allocation is key in a slow growth business.

Potential Catalysts:
1. Spinoff/offering of more/all of Clear Channel Outdoor. CCU management told me they view the IPO as an experiment and if it went well they would spin more out, or if it failed they would take it back in. I tend to believe them, as the Mays family is known much more for financial engineering than for operating prowess. 2005 saw several attempts to unlock value via financial means (spinoff of Live Nation, IPO of part of CCO, share buybacks, talk of a large dividend). In addition, throughout the 1990s CCU was much more about rolling up stations and cutting costs than about running them and I don’t put it past the Mays to try anything if it helps their share price, of which they are large owners. Finally, in my conversation with them they also seemed quite frustrated with the current price so I tend any large discrepancy in the value of radio would be remedied through the above action – although they are big fans of outdoor so I wouldn’t expect them to lose control (???? Would they still own?).
2. Radio improving to beat street estimates – should be apparent by Q4 results


Sum of parts ($B):
EV of Clear Channel: 22.1

Minus:
90% of CCO: -9.8
Radio FCF ’06-’07: -1.9
Investments/TV: -0.9
PV of Tax Shield ‘08+: -1.0
Tax refund from LYV -0.3
Equals:
Radio stub by YE ‘07: =8.25 / 1.43 = 5.8x multiple


2007 Radio estimates
Revenue: 3.9
EBITDA: =1.6
Corp OH allocation: -0.1
Capex: -0.1
Radio EBITDA-Maint Capex= =1.43


Q3 ’06 – Q2’ 07 CCU radio revenue growth buildup

Industry Components:
GDP: 5.5%
Industry share loss: -5.0%
CCU Specific:
Ratings*: +3%
Price/CPM**: +3%
Inventory change: 0%
Mix change: +.5%
Net growth: 6.1%

*Listeners: CCU has been gaining listeners with its 8.5 minutes/hr vs. its major competitors in the 11-13 minute range. Ratings have increased an average of ~3% since then.
**CPM: Based on how effective the ad is, there should be a direct inverse correlation with less commercials (leading to less channel switching and higher attention) and higher. Some trial data has shown a 1 to 1 relationship between ad effectiveness and inventory levels (roughly 60% due to channel flipping, and 40% due to customers being “zoned out”). This also makes intuitive sense and estimating +3% pricing for a 20% inventory cut seems quite fair.

***A key to gaining comfort with the price/inventory inverse relationship is reviewing the industry history section below.

When should the inventory cuts hit?:
Because higher CPM rates must be driven by local advertiser’s perception of radio effectiveness, this necessarily has a lag effect as Harry’s Ford dealership takes time to notice the difference. My best guess is that prices lag inventory by 1-1.5 years, using some triangulation, but in reality it’s unknown and since local is 80% of radio ad revenue there is no central source for future local spend. Most analysts talk to the other 20% - national advertisers, who still dislikes radio in general, (although they believe CCU’s inventory cuts are a good thing), but its the 80% local who drive the bus, and they purchase ads based on their feeling of effectivness instead of based on numbers like national.


Industry history:
Short –term: The industry can game commercial loads for short-term gains, and when they add too many commercials or raise price too much, the market is sluggish until it can be absorbed.

When times were good, stations add commercial inventory (never tracked until recently), which destroyes the value of each commercial, and subsequent pricing would plunge as advertisers realized their value received was low. The late 1990s was a textbook example of inventory increase, and its delayed effect on pricing (see chart below). The industry also would rarely if ever tell customers what slot their commercial was played, which made it easier to add more slots and degrade their value, and not have an immediate effect on pricing, and thus the hangover was long. This also explains why some other players bitterly fought the recent move toward better radio commercial and listener measurement as they were notorious for abusing the system.

Previous peaks in pricing/inventory include 1989 and 2000, when radio revenues surpassed GDP, and thus was unsustainable if one believes total ad spend = GDP given constant share of media. Valuation multiples also followed these peaks. Radio stock price/sales ratios went from near 2 in mid 1987, to below .9 in early 1991, to 2 by mid 1992 and 4.5x in 1994.


Year Inventory Price/unit Same-station US GDP
revenue
1983=100 1983=100 1983=100

1983 7.8 100% 100% 100%
1984 8.3 109% 117% 111%
1985 8.6 116% 130% 119%
1986 8.7 122% 138% 126%
1987 8.6 127% 142% 134%
1988 8.7 135% 152% 144%
1989 10.0 125% 161% 155%
1990 10.1 129% 168% 164%
1991 9.9 125% 160% 170%
1992 10.3 120% 160% 179%
1993 10.4 128% 172% 188%
1994 10.7 136% 189% 200%
1995 11.0 141% 200% 209%
1996 11.3 148% 215% 221%
1997 11.4 161% 238% 235%
1998 11.6 175% 263% 247%
1999 12.3 188% 298% 262%
2000 12.3 210% 334% 278%
2001 12.2 191% 301% 286%
2002 12.5 195% 315% 297%
2003 12.8 191% 317% 311%
2004 13.2 186% 317% 332%
2005 11.0 317% 352%


The key is that, even accounting for share loss, CCU's same-station revenues are below the equivalent GDP growth, which last happened industry wide in 1996.

Long-term growth rates:
1) Advertising spend roughly follows GDP, and radio’s share of America’s attention should = its share of advertising dollars. As mediums gain or lose share, their dollars should adjust accordingly.
2) The demise of radio as a distribution bottleneck is becoming well known, and therefore long-term industry growth will be much less than GDP. There are several guesses as to this rate of share loss:
A) 5-6% - in line with satellite radio share estimates (which themselves vary greatly)
B) 2% - in line historical share loss from disruptive media. Looking at disruptive media since 1950, an average yearly loss is 2%, with the worse being radio when TV came on, with radio losing 45% from 1950-1960. Radio gained 20% back when the transistor radio came out (1960-1970). Cable and the Internet were far less brutal – although not kind to incumbents who never saw the writing on the wall.

The bulls also point to two more arguments (among others):
A) Car listening time is going up .5%/yr with longer commute times, however perhaps higher gas prices cities will become more compact like European cities
B) Much of listening done at home, which will be upgraded much slower than cars with OEM satellite radios installed.
However, new un-known technologies will surely come on, so I assume a 5% share loss/year, base case.



Option #1: HD
I do not give CCU credit for HD – but this surely has some option value as a successful offering could stem the flow of listeners to other mediums since it offers:
1) more stations (HD can multiplex several stations into one “setting”, say 101.1)
2) unique content: (CCU could offer any content to any market at minimal cost via servers since HD is digital)
3) better sound quality (FM sounds like CD – at least in theory, although there is some debate here), etc.
A JP Morgan study of satellite radio purchasers showed that 40-60% of them named these three reasons for switching (the biggest reason cited was no commercials – something HD likely never will be due to FCC regs prohibiting paying for radio). Obviously, retaining half of listeners going to satellite or other mediums would be quite valuable – but not assumed here.

Currently HD receivers are quite pricey, but assuming normal experience curves one might assume the incremental cost to equip OEM radios with HD to be ~$15 in 2009. By then, an estimated 60% of stations (80% of urban ones) will be equipped to handle HD.

Assuming 18M cars/year, at $20 each car, realistically the radio industry could subsidize that and get a very quick payback on investment if one makes realistic assumptions on how many future satellite consumers terrestrial radio recaptures. I shared a much more detailed analysis with CCU management and so I know they are aware of the potential, but they are keeping their cards close to their chest.

There are multiple barriers to market acceptance though. First, satellite radio providers could up their current subsidies to car manufacturers to make sure that HD in OEM cars never happens. Second, new technology could come around by 2009 to make HD obsolete. Third, a true working version of HD, while very near, isn’t quite here yet, so whether consumers buy HD over sat. remains to be seen.

Option #2:
The drop of 20% in inventory has more than a 3% change in pricing. As stated before, I believe the relationship between ad effectiveness and commercial load is close to 1, but I don’t think CCU can pull of anything close to that if the industry is still keeping higher commercial loads and keeping most advertisers at bay.

Option #3:
The introduction of better listener measurement (the PPM – Portable People Meter by Arbitron – top 25 markets rolled out by mid 2009) will show listeners flipping away during very long commercial breaks by CCU competitors, which will cause the competitors to also lower their commercial loads, which should drive up pricing for everyone. This might be a stretch.


Outdoor business side note:
One can make current valuations make sense using a DCF and some realistic assumptions (tv r = 9%, g = 6%). I do believe that one day electronic bulletin boards will raise the profitability the costs of existing billboards in high-traffic areas, potentially by 2x in the limited locations they are rolled out in, so investing in the whole of CCU (and therefore being long CCO) might make sense, although I think these boards might take longer to roll out that many believe.



Final note: I have no sense on earnings tomorrow, and the timing of this write-up is mere coincidence.

Catalyst

Better radio earnings 2H 2006
Spin off of rest of Clear Channel Outdoor