Description

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Lamar Advertising (LAMR) – Long, $68 7-mo target: “No ability to Fast Forward, Lamar is Unskippable”

Mkt Cap: $4.7B

EV: $6.7B (Debt: $2.1B | Cash: $183MM)

ADV: $65MM (1.3MM shrs)

Shrs o/s | Float: 94.1MM / 80MM

Upside: ~$68/shr

Bull Upside: ~$100/shr

Downside: $56/shr

Risk/Reward: +$18 upside / +$6 downside 

Event Type: REIT Conversion

Situation Overview / Entry Catalyst:

Lamar Advertising is a billboard owner/operator that is awaiting a PLR from the IRS.  A PLR will allow Lamar to effectuate the conversion of its billboard assets into a Qualifying REIT Subsidiary (QRS).  Assuming the issuance of a PLR, Lamar (at $49.50) is only trading at 11x ‘14 AFFO vs. REIT peers at an average 17x ’14 AFFO. Each turn (1x) of LAMR’s AFFO = $4.35 (+9%) to its shr price.  LAMR will also be able to pursue low-interest cost of capital acquisitions post-conversion that will be AFFO-accretive and drive its P/AFFO multiple higher.   At a minimum LAMR should trade at 14-15x ’14 AFFO which offers ~30% further upside over the next 7 months (not including the 6% initial dividend payout).

Event Path:

Description:

Lamar operates both digital and analog billboards and advertising logos – in this industry two other larger players exist (Clear Channel Outdoor & CBS Outdoor) along with a long tail of various-sized owners.   The value of billboards rests in their being nearly impossible to compete against on a greenfield basis – most are either nonconforming legal structures (i.e. – legal when built but in violation of current zoning laws) or specifically allowed for under the 1965 Highway Beautification Act, which sought to curb the proliferation of highway roadsigns along US interstates.  Lamar owns or operates >144k billboard advertising displays within 44 states, 115k logo advertising displays in 22 states and 34k transit displays in 15 states – 1,700 displays are currently digital.

Industry dynamics:

-          >500k total billboards within the US (fewer than 5k digital)

-          $7.6B out-of-home ad spending ’12 (4.7% of total $161.2B major media spend ’12)

            - 1980-2012: 8.4% CAGR for outdoor spending

-          CBS (45.6k billboard displays, 287k transit & other displays) / Clear Channel Outdoor (108k display structures in 48 states)

Variant View:

• Street mis-modeling LAMR’s EBITDA-to-AFFO bridge & REIT QRS/TRS tax impact. Analysts estimates vary widely for 2014 AFFO from $3.00-$4.35. Management has recently indicate a 2014 AFFO of ~$4.35.This mis-modeling creates a potential valuation upside from analyst estimates of $20-$22.50/share (at 13-15x mult). An example of this mis-modeling is Evercore Partners’ EBITDA of $531MM bridging to $3.30 ’14 AFFO due to a ‘plug’ 20% tax rate.

•  Potential bolt-on acquisitions using higher leverage (at lower rates) – could be ~$0.20 of AFFO using all debt at 13-15x AFFO mult = $2.60-$3.00/shr additional value.

•  Potential for transformational acquisition (CBS Outdoor) in 2015-2016, could be ~$70-100MM of synergies ($0.75-$1.06/AFFO x 13-15x mult = $9.50-$16/shr value).

• Lamar’s current status as a more risky REIT structure – this perception should change over time as LAMR pays steadily increasing dividends while growing both organically and via acquisitions. 

• Interest cost reduction from $107MM+- rate towards $80-85MM/yr without any reduction of current leverage levels.

• LAMR’s sensitivity to the 10-yr Treasury Rate should be lower than the average REIT given their average tenancy is under 3 months – as rates rise, Lamar should be able to recapture inflation faster than REIT peers.

An investor in Lamar is underwriting downside to $56 (+6 – 13x AFFO), base upside to $68 (+18 – 14x AFFO) and bull upside of $75-100 (+25-50 – 15x 2015 AFFO/M&A outcome) – this assumes the ultimate exit catalyst such as a merger w/CBS Outdoor).

REIT Situation:

IRM’s REIT election caused the IRS to halt all PLRs and create an internal working group specifically to streamline/codify (but not change) current REIT definitions.  The IRS did this in July due to a large influx of PLR requests from non-traditional potential REITs (such as Iron Mountain) but also shut off what would have been routine PLR issuances from requests such as Lamar’s (requested 11/16/2012).  In the meantime investors have become skeptical, offering what is a great opportunity at low risk to play the conversion of LAMR into REIT-space as its likely that LAMR would have been seen as a ‘plain vanilla’ request in any other filing period but was caught up in the working group halting all further PLR issuances.  Now that the Group has issued its findings/standards the IRS has now stated (on 11/15/2013) its readiness to begin issuing rulings imminently (as per LAMR/IRM/EQIX recent 8-Ks disclosing solely this transmission from the IRS – SEC link).

Separately, there is skepticism as to whether LAMR’s digital billboards (which represent $100MM+ of their EBITDA and growing) will be included within their QRS - however there is a legal framework for supporting Lamar's REIT petition (below).

Precedents supporting LAMR receiving a digital-QRS allowance PLR:

• Whiteco Industries vs. Commissioner of IRS (1975) – billboard structures (link)

•  American Tower Corp PLR (1975 - microwave towers) – poles/supports of billboards (link to IRS ruling w/1975 ruling cited)

•  SL Green (2010 - digital billboard allowed on side of building within QRS)

And a link to IRS’ recent PLRs (here).

REIT qualifications:

• Must pay out 90% of qualifying income (FFO is not qualifying income, D&A is counted against FFO)

• In any REIT, QRS income/assets must be > than 25%, 20% (respectively) of qualifying income/equity

• Example: a TRS cannot be $50 and the QRS $100 of income

A good overview on REIT qualification/characteristics can be found (here).

LAMR REIT Economics:

All qualifying income is included within Lamar's QRS (traditional/digital billboard income) alongside TRS income (services such as digital graphics & transit income such as bus shelters/benches/etc,) - walk below assumes paying off of debt maturities into 2014 (note that these could be rolled into a combination of HY + Term-B maturities to maintain leverage).

Below is the EBIDA to AFFO walk of Lamar's cashflows upon converting to a REIT:

Valuation:

• 12/2013 -1/14: Receive PLR: ~$56/shr (13x ’14 AFFO)

•  3/2014: Post-acquisition: ~$68/shr (14x ’15 AFFO)

• 6/2014: Sell-side REIT initiations, defensive EBITDA, accretive levered acquisitions in the future, potential index addition: ~$75 (15x AFFO w/2014 $3 dividend)

LAMR P/AFFO  Sensitivity Table:

 REIT Comps:

 Survey of REIT comps are below, with average P/AFFO of 19/17/16x over FY 1/2/3.

Supporting Quotes:

On ability to convert into a REIT:

“We're going to assume the request absent anything else to build upon. So what does that mean?

We are going to put everything in the qualified REITs that we asked for in the PLR, and we're going to put in the

taxable REIT subsidiary those things that we already know are not income from real property."

 – CEO Sean Reilly, Wells Fargo TMT Conference, 11/12/2013

“What I've learned about REITs and in particular non-traditional REITs is that you can structure

around virtually anything. The question is how much tax leakage is there, and so, you just have to calculate whether it's

worth the effort. We have been doing all those things you would expect us to do in preparation for a conversion. We're

running all the transfer pricing from the TRS up to the parent. We've got our accountants in there helping us understand

all that. And so assuming we get the answer that's a good answer, it's minimal. There's minimal tax leakage."  

– CEO Sean Reilly, Goldman Sachs Communicopia Conference, 9/25/2013

PLR timing for 2014 REIT Election:

“The short answer is – if we get the right answer from the IRS really up until the third quarter of next year, you can do a

retroactive."

– CEO Sean Reilly, Goldman Sachs Communicopia Conference, 9/25/2013

AFFO/EBITDA math:

“I think since – I'm getting ahead of myself here but the math is pretty easy, all right? So, I mean, you've got us in 2014

doing $570 million or thereabouts, right, in EBITDA. Subtract $100 million in interest. Subtract $50 million in maintenance CapEx. You're there. [foots to ’14 AFFO +$4.30]"

– CEO Sean Reilly, Wells Fargo TMT Conference, 11/12/2013

Exit Catalysts/Margin of Safety:

Margin of safety exists as there is a high probability (>95%) that Lamar will receive a favorable ruling from the IRS.  The bear ($56, +6), base ($68, +18) and bull ($100, +50) scenarios skew positively.

Multiple exit catalysts exist into 2016, each of which also create a new entry catalyst for new investors as Lamar both becomes a ‘safer’ REIT and its narrative comes further into focus:

1. PLR ruling ($56/shr value) - near term
2. M&A (+3/shr incremental) – First Half ‘14
3. Sell-side REIT team initiation ($68/shr) – Feb-June ’14
4. Re-rating ($75/shr) – YE ‘14
5. CBS Outdoor merger ($100/shr) – YE ‘15/early ‘16

Risks/Potential Hedges:

Lamar’s risks reside in (order of magnitude):

1.)   Full rejection of REIT eligibility (i.e. – negative PLR)

2.)   10yr UST yield risk (particularly given convexity at low rate) – REITs typically key off of the 10yr yield, both P/AFFO compression and higher dividend yields would result

3.)   Local advertising conditions (Lamar is 80/20% local/national accounts)

5.)   Esoteric nature of Lamar’s business as a public REIT (similar to investor comfort needed to grow with prison REITs)

5.)   Lack of sell-side coverage post REIT conversion (potential transition period as broker REIT teams assume coverage from media analysts)

Of these risks only the 10yr yield is readily hedged, and within this trade it would be wise to short a basket of REITs sufficiently diverse (and liquid) to match the average P/AFFO of the REIT universe (but avoiding a concentration within mall/residential/exotic/et al classes).  For PLR risk there is the potential to hedge other companies awaiting an IRS ruling, such as CBS (for CBS Outdoor), Equinix (EQIX) or Iron Mountain (IRM).

Catalyst