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Lamar Advertising Company: Expansion At All Costs Creates Unnecessary Risks ($LAMR)

October 05, 2011 | About:
Lamar Advertising Company (NASDAQ: LAMR) is an outdoor advertising company with a network of approximately 146,000 billboards, 108,000 logo advertising displays and 30,000 transit displays. I have always been fond of businesses like this, which entail a single up-front payment in return for years of income with nearly nonexistent capital demands. I thought I would take a closer look.

The first thing notable about LAMR is that it has has only a passing relationship with profitability (note how the net margin line in the following graph only infrequently moves above 0% on the right scale).

LAMR-revenues-1024x608.pngLamar Advertising Company - Revenues and Margins, 1997 - 2010

Though it is distressing to find a company that is only rarely profitable, it is not always negative. In some cases, a company has non-cash expenses (such as depreciation) that are disproportionately large and understate the true economic life of the underlying assets, thus masking the true cash flow generating capabilities of the company. This is most common in growing companies that require large capital expenditures for growth. This is exactly what LAMR is, so let’s look at its cash flows.

LAMR-Cash-Flows-1024x600.pngLamar Advertising Company - Free Cash Flows, 1997 - 2010

Here we get a much different picture of the company. Rather than barely keeping its head above water, we see a company that generates consistently strong cash flows from operations which generally has translated into nearly equivalent free cash flows. The company trades for about $1.65 billion, yet has produced approximately $200 million of free cash flow on average for the last nine years, for a yield of 12%. Not bad, but not much to get excited about either. This isn’t the whole story.

Note from the chart is that the company’s capital expenditures increased dramatically from 2006 – 2008. Checking the company’s 10-Ks from this period, it appears that the jump in capex was related to growth in the company’s use of digital billboards. This is a good thing, because this signifies that the company’s capital demands have been related largely to growth (i.e. constructing new billboards), rather than maintenance. In a jam, companies can stop growing and redirect discretionary uses of cash (e.g. growth capex) toward more pressing needs. Companies that have high maintenance capex demands lack this flexibility.

I soon learned that this really is the story of LAMR. Growth has been the company’s top priority for more than the last decade. Let’s look at the above graph again, but this time adjusted to show free cash flows after acquisitions.

LAMR-FCFA-1024x614.pngLamar Advertising Company - Free Cash Flows After Acquisitions, 1997 - 2010

Here we note that the company’s free cash flows after acquisitions have frequently been negative. In other words, the company has been using massive amounts of capital in order to expand its network of billboards. But if the company is consistently spending far more than the cash flows from its operations, where is this capital coming from? Let’s check its capital structure.

LAMR-Capital-Structure-1024x622.pngLamar Advertising Company - Capital Structure, 1997 - 2010

The company has been funding its growth with increasing amounts of debt. This adds significant risk to the organization, though there are situations where a high debt load can be acceptable. For example, where a company has exceptionally stable operations (in that free cash flows are consistently greater than financing demands) and management is committed to and indeed actively paying down the debt, investors may be able to get comfortable in the short term with high (but declining) debt levels. Unfortunately, LAMR does not appear to fall into this category. Though operations are somewhat stable, management does not appear to be committed to reducing the company’s debt load anytime soon, rather choosing to focus on growth.

One negative aspect of the company’s debt-fueled growth by acquisition is that it has negative tangible equity. Though book value frequently understates the value of real estate based assets, note that the bulk of LAMR’s assets were purchased recently, and just prior to the recent recession, during a bubble period in the prices of real estate, residential and commercial alike. Consequently, I would have little confidence in asserting that LAMR’s book value is understated (and certainly not to such a degree as to outweigh its negative tangible equity). On an asset basis, I do not see value.

To find value on an earnings (really, free cash flow) basis, there would have to be a complete reversal in the company’s focus toward a more conservative strategy that focuses on strengthening the company’s foundation before further growth is attempted. I think the fundamentals of this industry can be quite strong, and LAMR’s massive network could be a free cash flow generating machine. In the meantime, the company is far too risky for me.

I should note that the company is controlled by the Reilly family, which holds a majority of Class B shares which have 10 votes each, as compared to Class A shares which have just one vote each. Thus, the Reilly family controls the company and it is up to them to decide the company’s focus.

What do you think of LAMR?

Author Disclosure: No position.

About the author:

Frank Voisin
Frank is an entrepreneur who owned four restaurants by the time he was twenty. He sold his businesses and returned to school, completing a concurrent Law / MBA degree. At the same time, he successfully completed all three levels of the CFA exams. He now invests full time with a focus on value investing. Frank Voisin writes about value investing topics at http://www.frankvoisin.com.

Visit Frank Voisin's Website


Rating: 2.5/5 (14 votes)

Comments

cm1750
Cm1750 premium member - 2 years ago


I own a cell tower company (CCI) and have been somewhat interested in LAMR as it shares the same basic model (recurring revs with high upfront costs), although tower owners can add more tenants on existing towers (high incremental FCF) and have longer contracts with cell companies (VZ, T etc.).

From my casual understanding, LAMR has a lot of local billboards and that market is getting hurt by the recession as evidenced by LAMR's poor revenue growth and reduced guidance.

Using a back-of-the-envelope approach using historical numbers and assuming LAMR milks it's current assets without significant incremental growth capex, it seems they should be able to maintain FCF of roughly $250-$280MM/year in a decent economy, or $2.69-$3.01 FCF/share.

Assuming zero FCF growth and a 11% required IRR (Ke), LAMR should be worth 9.1x FCF using the perpetual FCF growth formula of FCF/(r-g). Using the lower $250M FCF number, that yields a $24.50/share equity value. I would consider buying at a Graham 40% discount, or $14.50/share (currently $17.80). With the horrible stock momentum, it could easily get there. Furthermore, the sell side hates the stock and dramatically reduced targets in September.

Given the Reilly family has a large voting and economic interest, I would have to understand how they look at capital allocation. If it seems they are earning decent incremental returns on capex vs. paying down debt or buying back shares, it might be a decent investment for a 5 year horizon (20% IRR at $14.50/share).

Interestingly, concentrated investor Abrams Capital (formerly at Baupost and a LAMR board member) bought 2.8M shares in Q2 at about $27/share and another 1M shares last week at $18.40. Since Abrams is on the board, I am quite sure he knows the likely ROIC on future capex so my no growth base case valuation may be conservative.

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