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February 27, 2006

Clear Channel: Outlook Improving

Clear Channel (CCU) reported slightly worse than expected 4Q05 earnings with EPS and revenues just short of estimates. However, everyone was expecting a weak 4Q05 so that is not news. The real news is that the company confirmed 1Q06 pacings at 2.9%, better than feared following recent revelations by other operators about 1Q06 guidance. The shares are responding positively but would be trading up more if not for an unexpected increase in expense growth at the Radio division. In 4Q05, radio expenses rose 4% vs. expectations for flat growth. On the call, management explained that the expense increases were related to programming, talent, HD radio, and internet initiatives. Overall, radio expenses are now projected to rise 3-3.5% for the year with 1Q06 above that range. In 4Q05, revenues fell 6% which coupled with the 4% expenses growth led to a sharp margin contraction in radio from 42% to 37.8%. In 1Q06, revenue and expense growth should be about equal so margins should stabilize.

Overall, I think the earnings report and conference call will stabilize CCU shares and create the potential for a modest rebound in the shares. The company's Less Is More initiative has been in place for a year and it appears that the financial penalty has ended. 2006 should be a decent year as the company has easy comparisons. However, it is not clear to me at what level revenue growth in radio can be sustained beyond 2006. Additionally, it is not clear if expense growth will moderate beyond 2006. Radio faces some tough challenges as advertising growth is inhibited by market share loss to the internet, growth in satellite radio, and continued growth in people listening to iPods. Given these challenges, I still don’t believe that CCU and other radio stocks can sustain a premium EBITDA valuation to other traditional media sectors. Granted, the low capital spending requirements create a favorable free cash flow profile. However, without sustained advertising growth of at least mid-single digits, I don’t think the street will pay up for radio stocks. Consequently, a relief rally in CCU shares is likely but will be limited.

Other highlights on the call included:

• January was up 5-6%, an excellent performance well ahead of radio peers. 1Q06 pacings for 2.9% do suggest that February and March are weaker, however.
• CCU is outperforming the radio industry in 1Q06. This is a switch from 2005 when LIM severely penalized results. As mentioned, comps are easy for CCU this year. The question is what happens in 2007 when LIM comps are apples to apples.
• Ratings and time spent listening have risen for several consecutive quarters. SO far, the ratings increase is ahead of any revenue gains. Will the revenue gain catch up to 5-6% ratings increases?
• So far, the industry has not followed the LIM initiative. CCU is now showing some success, possibly proving that less inventory and more 30 second spots can lead to revenue gains. This prompted several questions form analysts wondering if other radio companies were beginning to cut back ad inventory. If so, this would be good news for CCU. Management wouldn’t offer much commentary about other companies.
• Outdoor continues to be a strong business for CCU. Revenue growth has decelerated but remains healthy at 7% with the U.S easily outperforming international markets. Outdoor had EBITDA of $250 million in the latest quarter against $329 for Radio.
• The company has restarted discussed about a special dividend while also maintaining its share repurchase program and recurring dividend. This is a small positive although I would be in favor of raising the regular dividend further. The 2.7% current yield is healthy but bumping the dividend further would create great support for the shares.
• The balance sheet is fine at $7 billion in debt and debt to trailing 12 month EBITDA at 3.4 times.

Posted by Steve Birenberg at February 27, 2006 08:25 AM in CCU