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April 5, 2012

One-sided relationship may create earnings risk for Clear Channel Outdoor

by Sridharan Raman.

Highway billboards have become so ubiquitous that most of us would probably only notice them if they vanished overnight. Many of these giant signs – advertising everything from high-end smartphones to neighborhood moving companies – are owned and operated by Clear Channel Outdoor Holdings Inc (CCO.N), which is 89% owned by CC Media Holdings, Inc. (CCMO.PK). That relationship has created some new risks for Clear Channel Outdoors of late, as its parent (which controls 99% of the voting rights in the billboard company) relied on the subsidiary’s financial strength to pay off its own debts; the subsidiary took on additional debt of $2.2 billion in order to pay a special dividend of $6.08 per share, or a total of $2.17 billion, to CC Media Holdings, announced in early March. The latter then used that that payout to pay down $2.1 billion of its own debt that was due by 2014, raising more than a few eyebrows among analysts and corporate governance experts.

Unsurprisingly, this sequence of events also has created some uncertainty about what lies ahead for Clear Channel Outdoor if its parent company continues to rely on it for financial assistance. It has also left analysts concerned about the impact of this new debt load on the business’s profit margins. In the wake of that event, several analysts with high StarMine ratings lowered their earnings estimates for Clear Channel Outdoor, one reason why Clear Channel Outdoor is the next in a series of ten companies selected by the research team at StarMine as being likely to beat or miss analysts’ earnings estimates when it reports its quarterly results on May 8, 2012. While according to the I/B/E/S consensus, analysts still expect the company to report a loss of 8 cents a share, the Predicted Surprise figure of -13%, a large negative number, warns us that the actual loss could be much greater.

Clear Channel outdoor has seen strong positive cash flows (both free cash flows and cash flow from operations) every quarter for the last three years. In the eyes of analysts, however, the recent special dividend payment – and the company’s increased debt load – seems to tip the balance toward being more bearish. As a result of the recent downward estimate revisions, the SmartEstimate (represented by the blue line in the chart below) has fallen to a level signaling that those analysts with a track record for being most timely and accurate now expect the company to report a loss of 9 cents a share. The fact that the SmartEstimate falls below the consensus indicates that other analysts may cut estimates on the coming weeks or the company is likely to miss estimates when it reports earnings.

Clear Channel Outdoor already had been directing a large part of its operating income to interest payments even before it took on this additional debt load, as the chart below shows. Taking on almost $2 billion more of debt means the company is likely to see those interest payments double and its leverage increase. Unless the company can find a way to increase operating income (hard to do without capital expenditures), Clear Channel Outdoor may see its string of four profitable quarters give way to a series of quarterly losses in the coming months.

Only about 11% of Clear Channel Outdoor’s shares are widely held by outside investors, with CC Media Holdings owning the balance. That ownership structure, along with the skewed voting structure that gives outside investors 11% of the stock but only 1% of the votes, increase the risk of the parent company continuing to view Clear Channel Outdoor as a kind of corporate piggybank. The StarMine SmartHoldings gives Clear Channel Outdoor a rank of only 14 of a possible 100, an indicator signaling that it is unlikely to be a stock that institutional investors will seek to add to their portfolios. That removes one source of additional potential buying from the mix. These investors may be even more reluctant buyers if the large negative Predicted Surprise proves to be an accurate indicator and the company reports a larger-than-expected loss for the quarter.

SMARTESTIMATES AND THE PREDICTED SURPRISE %
SmartEstimates: StarMine Professional quantitatively analyzes the earnings estimate accuracy of sell-side analysts and uses this information to create proprietary SmartEstimates®. SmartEstimates help you better predict future earnings and analyst revisions with estimates that place more weight on recent forecasts by top-rated analysts.
Predicted Surprise %: The Predicted Surprise% is the percentage difference between the SmartEstimate and the I/B/E/S consensus estimate. When SmartEstimates diverge significantly from consensus, it serves as a leading indicator of the direction of future revisions and/or surprises. In aggregate, this indicator gets earnings surprises directionally correct 70% of the time.

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