CBS (NYSE:CBS) is in talks to sell its outdoor advertising business as a result of being approached by some bankers who proposed the idea.^[1] Why would the company want to sell a unit that is profitable? A Business Insider article cites high depreciation and amortization expense as a reason but a better way to look at is through cash profitability, taking into account capital expenditures. Depreciation and amortization results arise due to these capital expenditures.

See our complete analysis for CBS

The Economic Pressure

Compared to 2007 levels, the EBITDA margin (earnings before interest, taxes, depreciation and amortization) has come down significantly as revenues declined. There are high fixed costs associated with billboard (outdoor advertising) business and a decline in revenues hurts profits significantly. Revenues, in turn, are dependent on health of the advertising market and the overall economy. This figure suffered significantly in 2009 as the U.S. economy was in a recession.

The Recovery

However, both the revenues and the EBITDA margins have shown improvement in the past couple of years and with the U.S. economy recovering and political advertising dollars flowing, these figures have the potential for further improvement. Even capital expenditures have been reduced by the company from 9% of revenues to 3.5% of revenues over the course of past three years, in order to reduce the pressure on free cash flows. Why should CBS sell despite this recovery and growing cash flows?

The Rationale For Sale

Perhaps the sale is strategically aligned with CBS’ long-term objective of attaining a more efficient and predictable cost structure. The company has been restructuring itself over the past few years and in the process, has improved margins across its different businesses. Getting rid of billboard (outdoor advertising) business will reduce fixed cost, thus giving the company more flexibility of maintaining margins in tough economic environment.

Furthermore, the trend of ad dollars shifting to online media and across social networks continues to be a future challenge that might affect the billboard business. Although billboards retain their effectiveness and local appeal, there could be innovation in this segment.

The Price

CBS is reportedly demanding $6 billion for sale which, we believe, is quite steep.^[1] We estimate that CBS’ outdoor business constitutes just under 10% to CBS’ overall estimated value of $22.5 billion. This puts its fundamental value at around $2 billion, significantly lower than what the company is demanding.

Our price estimate for CBS stands at $23.10, implying a premium of about 20% to the market price.

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