Clear Channel: Better Quarter Will Help Short-Term

Clear Channel (CCU) reported better than expected 1Q06 results led by a positive surprise in radio and continued strong growth in outdoor. CCU has easy comps in radio in 2006 and management seemed confident that current trends would hold. Consequently, I think the shares can trade moderately higher in the near-term and will continue to show good relative performance compared to other radio stocks. I don’t find the shares cheap versus the broader media universe and I remain concerned that radio is a market share loser in listening time and advertising revenue. Therefore, I don’t see much long-term upside for CCU.

The shares are responding well to the earnings because of better than expected results in radio. Revenues rose 5% in the quarter against expectations for 3% growth. Revenues were ahead of pacings announced during the quarter. EBITDA also exceeded expectations, growing 3% against expectations of 0-1% growth. The margin compression is the result of continued heavy investment in programming and station promotions. Management indicated trends for 2Q were similarly sold. I think investors will take away that the "Less Is More" initiative is having some positive impact and that growth is not solely the result of easy comparisons.

Outdoor continued its strong performance. Revenues were up just 3%, penalized by adverse currency movements but EBITDA rose a better than expected 14%. Outdoor remains the star of traditional media and there is no sign of a slowdown.

Short-term traders might consider getting long CCU but I don’t think there is more than 10% upside given the long-term challenges from the internet, satellite radio, and iPods.

Radio Industry Outlook Hurts Clear Channel

Clear Channel (CCU) shares have given back most the gains which followed the solid 1Q06 guidance the company provided with its 4Q05 earnings report. In my summary of the earnings, I said a brief rally in CCU shares could occur. I didn't think it would quite this brief. Three issues continue to trouble the shares. First, competing radio companies are consistently reporting weak pacings and guidance for 1Q06. Second, if you look at the details of CCU's 1Q06 commentary, despite the 6% gain in January radio pacings, February and March could be negative. Third, radio stocks are still at a significant premium to other traditional media sectors with no signs that the short or long term challenges the industry faces are moderating.

Since CCU reported, competitors Entercom (ETM), Cox Radio (CXR) and Radio One (ROIAK) have announced results. Each company reported subdued numbers for 4Q and provided worse than expected commentary on 1Q06 trends. As noted in the earnings coverage, last year CCU dramatically underperformed industry advertising trends by around 500 basis points as it cut back inventory and moved to 30 seconds spots in its "Less Is More" strategy. January pacings and 1Q guidance showed that LIM might be working as CCU is now outperforming the industry. At a minimum, the easy comps set up by implementation of LIM suggest CCU should easily outgrow the industry in 2006.

However, if the radio advertising growth takes another step down, CCU is unlikely to outperform enough to meet current estimates. I think this fear has led to the CCU pullback as competitors' results did not provide much confidence for the industry. CCU said its pacings in January were 6% yet only forecast a 2.9% gain in advertising for 1Q06. January is the smallest month in the quarter, although February could be negatively impacted the Olympics. Regardless, the much slower 1Q guidance compared to January results suggests that CCU is experiencing flat or even negative growth in pacings for February and March. This may still outperform the industry but it will likely not give the street much confidence in 2006 estimates.

All of this would be less concerning if radio shares were cheaper. However, the industry still trades at more than 10 times 2006 estimated EBITDA vs. less than 7 times for cable and less than 9 times for the entertainment conglomerates and newspapers. Radio does have a free cash flow advantage since there is virtually no capital spending required in the industry. However, investors are concerned about growth in traditional media and given the challenges poised by satellite radio, internet radio, and iPods, I don’t think the free cash flow advantage is enough to support a big multiple premium for radio. CCU trades at a discount to the radio group but not large enough to make it unusually attractive relative to other media stocks.

The bottom line is that with 4Q05 results and 1Q06 guidance in the mirror for the radio industry, I see no reason to be involved in CCU or other radio stocks.

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.