Description

Overview

Clear Media is a leading out-of-home (OOH) advertising firm in China. This is likely a PA idea, not least because the market cap is ~US$300m and the float is 50% (more realistically 25%).

The company was written up earlier this year by mimval, who is a filing shareholder, but I believe enough has changed since then to warrant continued discussion from a slightly different angle. I encourage you to read that note. The share price is (35)% since it was written, largely on the back of the trade war and fears over weak Chinese consumer health, which I argue are not a threat to the long-term value proposition of this company.  Meanwhile, the possibility of a sale by 50% owner Clear Channel Outdoor has increased materially.

The business model has proven to be cash generative in even the worst market cycles of the last 15 years and the balance sheet has net cash approaching 20% of the market cap.

At HKD 4.22/share the company is trading at 2.9x depressed 2021 EV/EBITDA, 50% below its trailing 5-yr history and >75% discount to global peers. All this despite having net cash, a 20% operating FCF yield (pre growth capex) and an established position in the largest long-term growth economy in the world.

Business and Market

Clear Media manages 54,000 outdoor street furniture (bus shelter) advertising panels in 24 cities across China. 62% of sales come from Beijing, Shanghai and Guangzhou, where Clear Media has >70% market share. The company earns RMB 55k/panel in these three cities vs. 28k/panel in its Tier-2 cities.

Almost all of its panels are static (analog), with just 264 digital panels generating only 0.5% of group sales. Long-term there is a growth opportunity from converting analog to digital, as has been seen at JCDecaux, Stroeer and the US outdoor advertisers.

There is clear customer concentration risk. 30% of sales come from domestic e-commerce clients (Alibaba, JD.com, etc.) and 17% come from hardware & software IT firms. Management is actively trying to diversify away from this and did grow their number of customers to 440 at 1H19 from 405 last year.

COGS are 60% of sales in the form of rent to municipalities, electricity and labor. There is risk of perpetual cost inflation as contracts are renewed, as well as of low-level corruption as deals are struck with local authorities. Clear Media has a JV affiliate, White Horse, which is responsible for some of the sales and maintenance duties. The CEO and his brother have economic stakes in White Horse and the relationship is optically concerning, even if not unusual.

SG&A of ~20% of sales leaves 20% operating margins, which flows cleanly into PBT. 30% tax leads to a historic average 14% net income margin.

Yes this is a cyclical business and sales can evaporate quickly, as is currently the case. But there is a mountain of evidence suggesting that the Chinese economy and consumer spending has years of above-average growth as household wealth continues to close the gap with western economies. Ad spending follows consumer spending, and the current trade war has only expedited the Chinese government’s priority of promoting domestic spending. Clear Media is well positioned to participate in this trend.

This slide from JCDecaux makes the point well:

Source: JCDecaux 2018 Presentation

Recent Events

So first, the quick summary to present:

1. Mysterious death of CFO in March 2018
2. Trading was halted for 8 months (March-November) on now-resolved small fraud
3. Clear Channel Outdoor (CCO) remains a 50.4% shareholder with 2 key executives on the board and is likely a motivated seller at the right price

The fraud involved $10m of stolen funds over a period of many years. Much of the money was recovered and the offending employee is still at large. Meanwhile an independent forensic audit and police investigation give me comfort that there aren’t any further hidden surprises.

Aside from the CEO and CFO the board is entirely comprised of Western and Hong Kong members, including Bill Eccleshare (Clear Channel Worldwide CEO) and Michael Saunter (Clear Channel International CFO), and Zhu Jia, an MD at Bain Capital and former CEO of Morgan Stanley Hong Kong. Yes they missed a low-level fraud for years, but the board is experienced and is now extremely motivated. 

The CEO and CFO’s current options plan has exercise prices of HKD 8.99-9.54.

Operating Performance

2019 will be a trough earnings year. The Chinese economy is suffering as a result of the US-China trade war, leading advertisers to limit spending. 1Q19 was flat yoy but 1H19 was  -13% and recorded a net loss of RMB 58m. Seasonality means 1H is always weaker than 2H with ~45% of FY sales and 30%-40% of FY net income.

Until 1H19 the company hadn’t recorded a net loss in any semi-annual period since at least 2003. The 2H of 2009 was the closest, with 0.5% net profits as COGS inflated to 62% of sales and SG&A was 21%.

Let’s assume a 2019 that is worse than 2009. It might look like this (figures in RMB, mn):

In this scenario, sales are -20%, COGS are 75% of sales and SG&A inflates 12.5% yoy to 28% of sales (vs. 2009 when SG&A declined 9% on cost-cutting initiatives). On these figures the company would report its first ever full-year net loss. This compares with its 15-year net profit margin average of 13.5%, of which every single year was >12% except 2009.

Cash flows are similarly resilient. Even in the above scenario Clear Media can convert 25% of its revenues into operating FCF, which reflects a 17% FCF yield on today’s share price. How much of that is then spent on growth capex is up to management, who require a 15% ROIC and have guided that 2019 should be similar to 2018’s RMB 363mn. This conveniently equates to exactly 25% of my (depressed) 2019 sales estimate, suggesting the firm will be cash break even this year, depending on the dividend.

The below chart summarizes COGS, SG&A, EBITDA and FCF over the last 15 years. The take-aways are (1) these figures are fairly resilient to cyclical pressures, (2) stable margins don’t reflect much operating leverage as sales have grown 3.5x, and (3) operating FCF is always >25% of revenues:

Sales have grown at an 8.7% CAGR since 2003. This is largely a function of purchasing new advertising rights, which involved higher up-front expenditures and is why capex has averaged 26% of sales during the same period. Other than 2009, there is a downward trending 0.4x correlation between capex spend and incremental revenue growth (not strictly accurate as organic growth is included in this figure). Given that contracts are typically 10 years, an average 2.5yr payback seems attractive.

Valuation

Putting this all together, I assume a terrible 2019 with sales -20% and modest net loss for the year. Management may choose to pull back on capex in order to support the dividend, draw down cash or suspend payment (the policy has been to dividend out all “excess” cash flows). In any case net cash should end the year around 20% of the current market cap.

Unlike 2010-11 when sales rebounded 25% from the trough, I assume mid single-digit sales growth and margins returning to their historic averages over the next two years as management right-size the cost structure (â…” of staff are in sales).

On these assumptions, on 2021 figures Clear Media is trading at 11x earnings, 2.9x EBITDA and a 21% operating FCF yield (7% yield if you assume continued growth capex, but then topline would be higher…). Cash will be 23% of the market cap and would grow to 40% if growth capex was dramatically cut back (unlikely).

If this happens, somebody will take it out. JCDecaux paid 12x pre-synergies EBITDA for APN Outdoor in Australia last year. JCDecaux itself trades at 20x earnings and 16x EBITDA, with 1.5x turns of debt. Yes JCDecaux is a globally diversified business, but I’ll point out that China is its single largest market. At 8x 2021 EBITDA Clear Media’s equity is worth HKD 9.60/share, 2.3x today’s price and reflecting an 11% operating FCF yield (vs 13% 5-yr average).

For what it’s worth, Clear Media has underperformed both the Shanghai and Hong Kong indices over the last 5 years, 2 years, and YTD (-30% YTD vs +16% and +1%, respectively):

Catalyst - a sale by Clear Channel Outdoor

Finally, Clear Channel is a motivated seller that, until May of this year, was unable to execute any M&A transactions.

iHeartMedia emerged from bankruptcy on May 1st, triggering a debt-to-equity swap with creditors of its 61% stake in Clear Channel Outdoor. The separation is now complete and PIMCO is CCO’s largest shareholder with 22% of the equity. 

CCO has 450k displays in 31 countries. It is 8x levered with $600m of EBITDA against $4.8bn of net debt with a weighted average cost of 7.9% leading to interest payments of >$350m/yr. Earlier this year the company was compelled to issue 100m shares of equity at $3.50/share to pay down some of its more expensive borrowings (the share price began 2019 at $5.20 and is $2.60 today). Reducing debt is management’s stated top priority, and they acknowledge that equity raises and refinancings alone are insufficient.

Management held their first analyst call as an independent company on August 1st. During the call, William Eccleshare the CEO (and Clear Media director) said the following:

1. As an independent company, we can now fully chart our own course as we seek to build on our momentum, fulfill our ambition and pursue the opportunities in front of us.

2. Our new Board of Directors has made it a priority to address the capital structure including reducing leverage

3. In China, we own just over 50% of the publicly listed company, Clear Media Limited. The business has delivered exceptional results for a number of years. However, starting with the fourth quarter of last year, they have experienced flat to declining revenues due to the slower economy and their e-commerce and IT industry customers remaining cautious with their spending. Clear Media has put in place a plan to broaden their customer base and reduce their dependence on large customers from the tech sector. In addition, they are also realigning their sales organization and implementing cost-saving initiatives to address the shortfall in revenue and higher rental payments. It's still early in the process, but we believe they are moving in the right direction.

4. So I think we're seeing a cyclical issue, not a structural issue for the Clear Media business. But I don't really want to say more than that until the Clear Media announces its results later this month.

And the CFO Brian Coleman said:

1. Your question really is, though, after [the equity raise], what comes next? And look, I think the -- we've done a great start. We've issued equity, we put ourselves in a position to take advantage of opportunities in the high-yield marketplace, do some significant refinancing, dramatically increase our free cash flow by interest cash reduction, strengthen our strategic flexibility. So I think that puts us in a pretty good place. And I think that will help with further steps that we can take to delever. Because ultimately, that's the goal here. The company, upon separation, had too much leverage, it was a goal of the board and senior management to reduce leverage, but there's still significant amount of leverage even after we do this. … [the equity raise alone] didn’t fix the balance sheet.

2. We talked about equity as one of the levers that we have, asset monetization as being another lever, addressing our capital structure or our debt and the financial markets as being another … There had to be a combination of these different levers to really address where we wanted to go.

So far, Clear Channel has pulled the equity-raise and refinancing levers, but is yet to execute any M&A.

On August 13th the CFO in a press release added: “"As we focus on operational efficiencies that drive greater margin and cash flow, the Company will continue to review and consider opportunities to unlock shareholder value, which may include, among other things, a review of potential asset or operational divestitures intended to accelerate deleveraging and growth in free cash flow.”

And in April he said: “as fiduciaries of the company we will look at opportunities to monetize assets if there are potential buyers out there that are willing to offer more than we think the assets are worth.”

If a buyer offers 10x a depressed NTM EBITDA estimate of RMB 500mn that would provide CCO with US$320m (RMB 5bn EV less RMB 470m net cash = RMB 4.5bn equity value or HKD 9.12/share). The cash on the balance sheet is worth an additional $33m to CCO. Reducing debt by ~$350m is 0.6x turns of debt and $28m/yr of interest payment savings, which capitalized at whatever rate you want is worth a material amount to management.

Distress within the HK stock market and Chinese economy mean low-ball offers are a risk, but CCO management have repeatedly emphasized price discipline in any potential sale. Acquiring a leading OOH advertiser in China for $700m EV on below global-comp valuation metrics is a check numerous international buyers could write, as well as, I assume (but have no insight into), Chinese domestic buyers.

Conclusion

If no transaction occurs, Clear Media remains a net cash company that has paid out 82% of its current market cap since initiating dividends 6 years ago and that will continue to return capital so long as CCO remains a controlling shareholder. It has the balance sheet to withstand short/mid-term macro weakness and long-term is positioned to gain from the ongoing trend of rising consumer spending (and subsequent ad spending) that will continue in China. There is a quick win here if CCO executes a sale, or a long-term win by owning a leading provider of a structurally growing sector (OOH) for a 75% discount to global peers and 50% discount to its own history.

Risks certainly exist. Clear Media has traded cheaper than its current valuation metrics in the past and FY19 figures could disappoint, making now the wrong time to establish a position. Additionally the normal rule-of-law concerns around China are particularly relevant here as the business relies on access to public spaces. Ongoing political unrest in Hong Kong could lead to a broader China-HK conflict and of course the US-China trade war could have a prolonged and deeper impact on Chinese consumer health.

Catalyst

Sale by Clear Channel Outdoor.