Boston Omaha (BOMN) is a young holding company with about 50% of its capital invested in the static billboard industry. After a relatively quiet IPO in 2017, the company has been issuing shares and using the funds primarily to acquire billboards in secondary markets such as Wisconsin and other Mid-Western as well as South-Eastern states. As of right now, around 30% of its capital is in cash, 10% in a wholly owned surety-line provider, and the remaining 10% in miscellaneous private investments such as construction and banking.
The company seems to have created some interest among retail investors due to one of the co-CEO’s familial relation to a certain famous investor from Omaha, and on the surface BOMN’s letters are similar in style and format to those of the early Berkshire. The combination of these elements creates an interesting story and a stock valuation that applies a fair amount of belief as well as a willingness to look beyond the basic economics of their primary operating business.
Given that their primary business is billboards and that the rest is but a fraction of their invested capital, that’s what I will focus on here. I believe as a result of their current position, it will be difficult for them to stop acquiring billboards in an attempt to improve profitability, so I expect this to remain their biggest focus in the near future.
The billboard industry is relatively fragmented with many smaller players nationwide, but the three largest firms- Lamar, Clear Channel, and Outfront take in over 50% of US billboard revenues at $1.6bn, $1.2bn and $1.6bn respectively. All other firms fight for scraps and tend to occupy secondary markets where competition and potential revenues are both lower, allowing for them to exist to promote ads for local firms. In the US, Lamar has around 154,000 billboards, Outfront has 47,000 and Clear Channel has 79,000 and they each have far more posters and displays in larger cities.
Given that anyone can buy a billboard structure, it may seem odd that three firms have a stranglehold on the majority of industry revenues, but there are some benefits of both scale and density in this business which provide them a significant advantage.
Firstly, the big three can sell to the largest firms worldwide as they have a national/global scale and can roll out nationwide campaigns on a variety of their media, including billboards, posters, and metro displays. Firms such as Verizon or Coca-Cola would likely prefer to work with only a single provider of outdoor ads which can provide them with the number of ads they want at a high budget. Outdoor advertisers usually work with the large ad agencies that represent such firms, and these agencies are unlikely to contact a local advertiser with only 3,000 billboards.
Secondly, the big three are all rolling out digital displays which can automatically switch messages and grab consumer attention with videos. These digital displays cost approximately 2-3x more than the traditional static boards given the higher initial and maintenance costs, but they generate about 4x the revenues. Along with the digital displays, they provide proof of consumer views to their clientele from third-party auditing firms which estimate the reach of an ad based on traffic and other factors. These digital billboards also come with new features such as virtual ads sent directly to the smartphones of consumers within a certain radius of the billboard.
Third, the big three experience both economies of scale and density and as a result have lower costs per view. They have national sales teams by which a single salesperson can sell a campaign across 10,000+ billboards. Since most of their billboards are located in high-population areas, they only need a few locations and local managers to oversee a large number of boards in a small area. This reduces manager costs, local facility costs, and the employee costs of billboard maintenance and ad turnover on a per billboard basis. For static displays, the ad copy is produced then sent to a centralized warehouse to be sorted then sent to each facility and as a result, there are also economies of scale here too, as warehouse overhead and employee costs decrease as a percentage of revenue as the number of ads sent increases. As a result of these factors, they are the only firms that can attract large advertisers and can do so at a lower cost than the smaller players which have static billboards spread out all over secondary markets.
A discussion of billboard valuation by the Appraisal Institute sums it up aptly by saying that as a result of these factors, billboard revenues and costs will vary dramatically by firm and it would be incorrect to think that the value comes from tangible assets. They compare the billboard industry to the hotel industry:
“Clearly, looking at the mix of business and real estate services that are commingled in the revenue generated by a hotel enterprise leads to the conclusion that the fundamental nature of a hotel is a hospitality business whose largest capital asset is an investment in real estate but whose most important operating asset is a collection of intangible business resources and relationships.”
The value of Hilton for example, has much more to do with their ability to provide a great service at premium prices, primarily as a result of their operational experience, culture and brand which have been developed and nurtured over decades. They apply these intangibles across their global hotel network for a business valuation far in excess of the replacement value of their hotels. Anyone can open a hotel, and a few firms could fund global hotel chains, but it would be difficult to match Hilton’s brand and offering. The authors of that piece note that the average billboard firm has a much greater percentage of its assets in intangibles than hoteliers, primarily site location rights, customer contracts, and/or perpetual property easements.
From this discussion, it should be clear that the purchase price or replacement value of the wood and steel billboard structures matters little to the operating results a firm will receive. What drives revenues and profitability is the ability to sell ads at a premium price, experience very high ad turnover and occupancy levels on these fixed assets, manage local teams which oversee operations as well as centralized sales teams, and do all of this in a cost-effective manner.
As I see it, Boston Omaha has little if any competitive advantage in this industry, and as a result I don’t know how they will be able to match the profit margins or return on capital of the big three, or even other larger billboard roll-ups.
BOMN currently has 2,900 billboards across its network and has been growing rapidly as a result of acquisitions. The co-CEOs discuss their views on the industry in a few of their letters, and they find it attractive since it is difficult to create new structures in favorable locations due to regulatory restrictions. They believe demand for billboards will continue to increase (which it likely will), and they believe the maintenance costs are low and as a result they can experience attractive cash flows relative to “tangible invested capital”. They also provide their estimates of the unit economics per billboard they expect to receive in maturity in their 2016 letter as displayed below:
They estimate about a 45% operating margin excluding depreciation and the amortization of intangibles. There are a few problems with this logic and their estimates. Firstly, none of the big three experience either operating income or FFO/AFFO margins of 45%. The average net margins of the big three is about 10% of revenues, and FFO margins around 20%. FFO adds back D&A and a few other costs but doesn’t deduct maintenance capex or stock-based compensation so it is likely higher than real net economic income. Lamar, which seems to be the best run of them, has FFO margins of 30% and operating margins of 41% after adding back D&A as well as interest and taxes, but interest and taxes are real annual expenses and this would exclude necessary capex. In these estimates, BOMN is both excluding real costs and estimating profitability higher than the best-run national player which is able to charge higher revenues per billboard and has lower costs per static billboard.
Lamar and Outfront are also both REITs and as a result experience flow-through taxation and lower taxes to owners than BOMN. The REIT structure works very well for billboards, as the only way to grow is through acquisition or construction and national firms can raise capital to take advantage of the private/public valuation disparity while paying little in taxes.
The main problem I see however, is that the employee expenses will be higher than estimated and it will be difficult for them to generate the desired revenues on their billboards. See below for BOMN’s 2017-2018 billboard results:
It may stand out that of its $14m in 2018 billboard revenues, its highest costs were SG&A and other employee expenses at around 34%. Agency commissions necessary to generate billboard ad sales were around 9%. If we are generous and assume they will never need to spend on maintenance capex (which they will if they require proper lighting and safety structures), adding back D&A would provide about $2.7m in pre-tax earnings on $172m of invested billboard capital. Q4 2018 billboard revenues were around $7m and Q1 2019 was $6.8m. They will experience some organic revenue increases on their current boards, but at the Q1 level of revenues they paid $172m for around $28m in annual billboard revenues and at that price it is going to be quite difficult for this to be a good investment.
BOMN notes that they are simply purchasing boards for the ‘favorable characteristics’ of the industry. From their 2015 letter:
“Any attractive margin we may earn will not be due to Boston Omaha’s brilliance though as these billboards generated attractive margins prior to our purchase, and our hope is to improve on those favorable, preexisting economics. Excluding this last point, many of these general factors benefit all owners of a well located billboard plant over the long term, and our corresponding time horizon will allow us to obtain our share of these favorable dynamics. We are not paying bargain prices but instead are paying fair prices”
As they note and as would be expected, they have no cost or revenue advantage here as all firms compete for the same deals and negotiate structure/land costs at arms-length with lessors. Acquiring other local billboard operators also seems to confer no advantage. They are simply purchasing average billboard companies at average prices. Without a competitive advantage to receive higher margins than incumbents, it is my opinion that they would need bargain purchases to experience high returns on equity (the big three experience ROIC of around 10%). They seem to be betting that the industry as a whole will do better than expected and they are comfortable being one of many other players in it. In Lamar’s most recent report, they note:
“The pool of suitable acquisition candidates is dwindling, and we may have a more difficult time negotiating acquisitions on favorable terms”
Similar to every other fragmented industry with local roll-up potential, private equity and other firms compete away the easy money and acquisition prices are bid up. BOMN will also experience an uphill battle in maintaining and growing same-billboard revenues to the industry average, as they have learned:
“We made an acquisition in early 2017 that came with some national advertising contracts that we expected would cancel and remain with the larger footprint seller once we owned the structures... Revenue dropped quickly while expenses remained… Our sales team is hard at work building back up revenues”
BOMN’s management prefers a few key metrics to judge its results, shown below:
I’m not sure why these metrics were chosen, because frankly they don’t represent the major real costs of the business. They have attempted to purchase underlying land when possible, and as a result have lower than average land costs relative to revenue, but that also comes with significantly higher invested capital. Margins increase as the cost is capitalized and depreciated over a long period of time rather than paying rent, but returns on capital decrease. Their overhead % of revenues figure doesn’t include total billboard employee costs and SG&A which are a large component of industry costs. Further, tangible PP&E is only a fraction of the real invested capital and acquisition costs- $130m of BOMN’s $170m billboard capital is intangible in the form of goodwill paid, customer contracts, and right of use assets. The tangible book value of net PPE is misleading and not representative of what they paid for acquisitions- they aren’t buying net PPE, they are buying operating companies and trying to build a roll-up of them.
The question really comes down to this. If Boston Omaha is paying average prices for billboards just like everyone else, and if they generate lower revenues per board, have higher costs per board, and have a higher tax rate than the big three, how will they experience similar or better returns on capital? In my opinion, BOMN is just another billboard company and will fight for average profitability in this space. For a holding company like this run by professional investors, nearly all the value will come from the performance of their marketable securities portfolio and any low-cost float which can be used to increase the portfolio’s size. Although it is currently experiencing large losses, I have no idea how their surety line will do, but I don’t understand the attraction to billboards and with all due respect to them, I’m unsure if they have properly considered their position in the industry.
For potential investors, BOMN’s market cap is at about $500m, excluding net cash and liquid securities it is around $400m. For this, you get around $36m in total company revenues and $230 in other assets, most of which are billboard intangibles. They will continue to grow as they issue shares and acquire holdings, but unless they are purchasing great companies at reasonable prices or average companies at bargain prices, I don’t know if much value will be added. In order for this to work out well, they are going to have to grow revenues per billboard at a very high pace as well as become much more efficient and I’m doubtful that either will happen.