Quick Summary:  Clear Media (100:HK) is a HK-listed majority-owned subsidiary of Clear Channel Outdoor (CCO:US) that operates the largest bus shelter advertising network in mainland China.  The Company is well positioned to be a beneficiary of long-term consumption and advertising growth in China.  Despite the 40% run-up in the share price over the past three months on the back of record financial results and an increased dividend payout, the shares are still reasonably priced at less than 6x EV/FCF for a high quality business consistently growing revenues at rates in the low teens.  The Company currently has over 40% of its market cap in net cash, providing significant downside protection.

Wait a second, not another Chinese outdoor advertising fraud! 

It’s true; this space in particular has been plagued with poor corporate governance and outright fraudulent activity, which has been well documented on VIC and in the major financial press, and this is undoubtedly weighing on the share price.  Before we go further into analyzing the business, we should first address why we believe Clear Media does not deserve to be tarred with the same brush as the troubled FMCN and confirmed fraud CCME.

• Clear Media is a legal Wholly-Owned Foreign Enterprise, with no Variable Interest Entity in the corporate structure, and as such shareholders have direct legal ownership in the assets of the operating subsidiary in China. 
• Apart from Clear Channel’s initial acquisition of the bus shelter business and subsequent capital injection into the White Horse Advertising Joint Venture (operating subsidiary in China) in 1998, growth has been entirely organic.  There have been no dilutive capital raises over the Company’s 11 year public history, and the Company recently increased the dividend payout to 36% of net income with the stated intention of growing the dividend over time.
• Clear Channel has executive representation on the board of directors, setting the Company apart from the rest of the space in terms of corporate governance.  The new Executive Chairman, Mark Thewlis, was formerly the Director of Finance for Clear Channel International and previously represented Clear Channel on the board of directors.  The original founders are also still on the board of directors.  One of the founders is currently the CEO and is still involved with day-to-day operations in Guangzhou.  If there was a problem with the accounts, it’s highly likely that Clear Channel would have discovered it by now.

A Decade of Growth

Clear Media’s bus shelter business was originally founded by two brothers in Guangzhou in order to complement an advertising agency, which they also founded (One of the brothers, Han Zi Dian, still manages this agency).  Realizing the importance of a first mover advantage and the capex-intensive nature of the business, the brothers went looking for investors and were introduced to Clear Channel, which pumped in cash and became the largest shareholder in 1998.

Clear Media operates bus shelters on long-term contracts with various municipalities in Mainland China.  The Company does not actually own the physical shelter, only the right to advertise on that shelter over a given period of time.  During this time, the Company is responsible for maintenance, including cleaning, repairs, and lighting.  Contracts typically last 10-15 years, and are typically secured with an upfront lump sum followed by a fixed annual rent per shelter.  Over the life of the contract, Clear Media will work with the municipality to construct new shelters as the municipality grows and adds new bus routes.  In the past, the local governments have typically been willing to renew contracts 2-3 years prior to expiry so that Clear Media will continue to build shelters.

Over the past decade, the Company has grown its network from 15,000 to 37,000 shelters in 28 cities, which puts it well ahead of its nearest competitor (P.E.-run Long Fan with 8,000 shelters).  This allows the Company to benefit from economies of scale both in the form of lower operating costs and a more attractive offering to customers that demand national coverage for advertising campaigns.  As a result, the Company claims to generate as much as 50% more revenue per shelter than its competitors at attractive margins.  This enables the Company to outbid competitors on new concessions and creates the possibility for value-adding acquisitions.

Recent Developments

In recent years, the Company has generated significant free cash flow while continuing to grow its bus shelter revenues at low-teen annual rates.  Capex/Revenue has dropped as panel growth has slowed in conjunction with an increasing average selling price (ASP) and relatively stable utilization rates.  There are two key factors that have to be taken into account when analyzing the Company’s financial performance over the last five years:

• Shenzhen Bus Body Business – This non-core concession was acquired in 2007 and disposed at the end of 2011.  The business never achieved the necessary scale to become profitable, and as a result the consolidated financials mask the true profitability of the core bus shelter business.  From 2007 to 2011, the bus body business generated average annual revenue of HK86m and roughly broke even over that time frame.
• Shanghai World Expo Format Change – In preparation for the 2010 World Expo, the Shanghai government requested that approximately 2,900 old shelters be removed and replaced with a newly designed format.  The Company had to take a one-off noncash charge, which adversely affected reported EBITDA and earnings.

As a result of the growing free cash flow generation, a significant amount of cash has been piling up on the balance sheet.  The Board has taken the first steps towards returning this excess cash to shareholders by initiating a dividend in 2011 and increasing the payout to 36% of net income for 2012.

Future Prospects

While we have long been wary of the impact of the internet on traditional media advertising revenues, we believe that outdoor advertising is relatively sheltered from this trend, as it provides one of the few remaining opportunities for mass brand marketing.  Clear Media’s shelter network is one of the only mediums available to advertisers who wish to run a national campaign in China (Coke or P&G). Clear Media appears to have significant room for growth in its existing network and through securing additional concessions via bids or acquisitions.  Revenue growth will be driven by the following factors:

• Panel Growth – This factor will be driven by continued urbanization in municipalities where Clear Media already operates, as well as potential acquisitions of competitors or new concessions.  Acquisitions have the potential to be quite accretive to earnings, as the Company is able to generate much higher revenue per panel than its smaller competitors.  Mark Thewlis recently stated in the annual results presentation that the Board feels the market is ready for consolidation.
• Utilization Rates – In developed markets, utilization rates normally run at 75-85%.  There is significant room for improvement in Clear Media’s overall utilization rate of 59%.  The lower rate is mainly a function of the physical growth of Chinese cities and the Company securing concessions when they become available ahead of demand.  The utilization rate is only 50% in Shanghai due to the Expo format change, but this number is now improving.  In certain Tier-2 cities where the shelter networks are not growing as fast, utilization rates have approached 90%.  Any improvement in utilization will result in increased profit margins, as the Company’s cost base is largely fixed.
• Average Selling Price – The Company was able to increase ASP by 14% in 2012 and has increased ASP by an average compound rate of 6.9% over the past five years.  The Company is planning another increase in ASP by 5-8% in 2013.
• Digitization – One of the reasons Mark Thewlis was recently appointed as the Executive Chairman is that he has personal experience building a digital bus shelter network in Singapore.  This network consists of 30 high-traffic, premium locations and was able to attract premium advertisers that would not normally advertise on bus shelters, such as luxury brands.  The payback period is slightly shorter than a traditional shelter, and a digital shelter can generate four to five times more revenue than a traditional shelter.  Capex requirements are significantly higher than traditional shelters, but the technology costs are constantly dropping and the initial rollout will be relatively small.  Although we have yet to see the economics of digital in China proven, we take some comfort in the fact that the Company can apply lessons learned in other markets and has historically been a good steward of capital.

Risks

Clearly, the main risk here is that all operations are located in Mainland China, which is cause for a number of concerns:

• Weak rule of law and corruption could adversely affect Clear Media’s ability to bid on and renew concessions.  The worst outcome would be the loss of a major concession in one of the Tier 1 cities, which would hit revenues significantly. The three biggest cities account for 56% of total revenues.  On average, these concessions do not come up for renewal for another 6 years.  We do not see this as a likely outcome, given Clear Media’s scale advantage over local operators and good working relationship with the local government authorities.
• Economic hard landing results in a significant drop in advertising spending.  For now, China appears to be avoiding the hard landing scenario, but we would not rule out the possibility.  In 2009, the Company did record a drop in revenues; however, this was partly due to the Shanghai Expo format change.  The Company continued to generate satisfactory free cash flow during the downturn.  The large contribution from less cyclical sectors such as Food & Beverage and Telecom should also mitigate revenue declines in the event of a prolonged recession.
• Poor capital allocation.  There is a risk that the Company will overpay for acquisitions.  In the past, the capex committee has maintained a 15% DCF threshold for any major expenditure.
• Fraudulent accounts.  All cash is held in RMB in Chinese banks.  We are told that the cash balances are regularly checked at the regional branch level (the smoking gun for CCME).  The controlling shareholder, Clear Channel, implements regular training programs to strengthen internal controls.

Model and Valuation

As the core shelter business now accounts for 100% of Clear Media’s revenues, I have adjusted the last five years of financials to reflect this change.  I have also added back the one-time charge for the Shanghai Expo format change.  The following model presents the normalized financial results for the core bus shelter network:

The following table shows the underlying panel growth, ASP and utilization rates:

Assuming below-average panel growth of 4%, ASP growth of 5%, and a flat utilization rate of 59%, revenue growth will average 9.2% annually. 

This model will result in the following forward valuations, based on the current stock price of HK$5.75:

Despite strong financial performance and growth potential, Clear Media is trading at a significant discount to its listed peers:

If we assume an exit valuation of 10x EV/FCF (about 5x EV/EBITDA) at some point within 5 years, we get the following annualized returns:

The efficient use of excess cash for acquisitions, digital panels, or share repurchases could generate additional upside to our model.

Continued revenue growth in core bus shelter business, driven by higher utilization, ASP and panel growth as the Chinese economy rebalances towards domestic consumption

Cash flow generation that will exceed the current enterprise value within five years

Increased dividend (Possibly due to the heavily indebted parent company’s capital needs)

Accretive acquisition

Successful execution of digital strategy