I want to believe that online music streaming services are a viable model. The recent acquisition of Beats Audio by Apple (AAPL) continues to encourage me about this industry in the long-run, but I remain a little skeptical about its ability to be successful in the short term. If I am right about that, it will likely contribute to the bearish case I’ll lay out for you.
Even the dominant player in the online music industry, Pandora (P), has been unable to turn cash flow positive. In fact, P isn’t even operationally profitable. As I saw following the dot-com boom, development in technology and media streaming provides a lot of value for consumers, but not as much for the companies providing the service.
P could be an interesting short in the future; however, I think the best bearish bet in the online music industry is Clear Channel Outdoor Holdings (CCO). It may surprise some of you to find out that CCO not only owns billboard networks and radio stations but it also owns the second-largest streaming media service called “iHeartRadio”. It is ahead of AAPL’s online music service and just behind P.
Like many traditional firms during the dot-com boom, CCO’s core business was not growing so it moved into online music streaming a few years ago. It does break out iHeartRadio’s costs and revenue in its filings with enough detail, but management will say that the division drives a lot of growth in the expense side of the Clear Channel Media and Entertainment (CCME) side of the company’s operations.
I also can’t say for sure how much investment has gone into the product but I know that during the last few years, CCO has been accumulating debt like it was going out of style. The debt has been used to fund acquisitions, attempt expansion across the organization, and to pay the expenses for iHeartRadio without much of a return in the form of growth.
This is a company that is actually profitable operationally but pays it all back out as interest expense – plus a lot more. This should sound familiar to many of you who were trading through the early days of the dot-com boom. Everything old is new again as unprofitable (or just stagnant) companies try to make up for the lack of growth by buying or building a dot-coms of their own. This was quite the fad for a while in the early 2000s.
The bottom line is that CCO made slightly more than $1 billion in 2013 at the operational level but then turned around and paid $1.65 billion in interest expense. It’s true that some of the debt is between related parties, but net-cash is flowing out of the company very quickly. You would have a hard time even calculating a debt to equity ratio because losses have turned equity negative on the balance sheet.
Here Comes the Wall
“Interest never sleeps nor sickens nor dies; it never goes to the hospital; it works on Sundays and holidays; it never takes a vacation; it never visits nor travels; it takes no pleasure; it is never laid off work nor discharged from employment; it never works on reduced hours”. — J. Reuben Clark
I think most reasonable investors feel that the optimal capital structure for almost any company includes debt. However, excess debt combined with losses can lead to a death spiral. CCO needs to refinance $400-plus million in 2014, $240-plus million in 2015 and $2.4 billion in 2016, or find other sources of capital. During the past few years, it has been rolling debt over into higher interest rate facilities, which is likely to continue.
Having so much debt all come due at one time is called a “maturity wall.” What will it cost to roll that much low-quality debt over at that time? The amount CCO will have to pay is a function of average interest rates as well as a decline in their own credit rating. Neither of these trends are currently going in CCO’s favor.
The bottom line is that CCO is running full speed into a maturity wall without operating cash flows to get over the hurdle. Although the collision is two years from now, investors should be pricing it into the stock now. From a technical perspective, I think this presents an interesting opportunity for a short position to be opened on a break below support at $7.75 per share.
Clear Channel (CCO): Chart Courtesy of MetaStock Professional
In this article, I focused on the debt problems CCO faces with its online music offerings without a deeper dive into its operations. I would recommend any traders continue the investigation of the company to see if they agree with my conclusions. I wanted to emphasize this particular issue because so many “junk” rated companies are getting closer to their walls in the next year or two. This is a problem traders should become familiar with if they want to avoid surprises during the next 24-36 months.
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