CBS’ (NYSE:CBS) stock soared recently when the company announced it is in the process of converting its outdoor business in the U.S. into a real estate investment trust (REIT).  REITs invest in real estate, get special tax considerations and offer high yield to investors. CBS’ proposed REIT is one of a kind, and the company will lease its outdoor assets such as billboards to advertising companies and earn rental income. With special tax considerations and attractive valuations that REITs are getting, CBS’ outdoor business could garner a substantial valuation upgrade.
CBS Wants To Reduce Exposure To Economic Cycles
CBS’ outdoor business EBITDA (earnings before interest, taxes, depreciation and amortization) margins fell sharply from 24% in 2008 to 13% in 2009 as the global recession took hold. There are high fixed costs associated with the outdoor advertising business and a decline in revenues hurts profits significantly. Revenues, in turn, are dependent on the health of the advertising market and the overall economy. CBS is putting more emphasis on its subscription-based business and building a content-oriented company. The conversion to REIT and a subsequent spin-off of the outdoor business can be viewed as part of this strategy.
Why REIT And Not An Outright Sale?
CBS was reportedly demanding $6 billion for the sale which, we believe, was quite steep. We estimate that CBS’ outdoor business constitutes just about 10% to CBS’ overall estimated value of $24.5 billion. This puts its fundamental value at around $2.5 billion, significantly lower than what the company was demanding. The gap in perceived value may have deterred some potential buyers.
However, the conversion to REIT will result in cost savings from taxes. In addition, REITs have garnered investor attention lately and have steadily outperformed private equity real estate funds over the last few decades, according to one WSJ article.  REITs let investors gain exposure to a different asset class like real estate without having to directly invest in real estate. This leads to better diversification and reduces risk.
There is a good chance that the valuation of CBS’ U.S. outdoor business will shoot up with the conversion. For instance, if we remove the tax part, CBS’ outdoor business’ cash flows increase by a substantial amount, leading to a much higher valuation of close to $4.5 billion. This valuation could be further aided by lower risk (a lower discount rate) if CBS diversifies its outdoor assets effectively. Good diversification has been one of the key factors behind the success of many REITs.
REITs such as Kimco Realty and Realty Income have outperformed the REIT Index’s yield (FTSE NAREIT All Equity).  Both of these companies have invested in assets diversified across different states, industries and companies.
Our price estimate for CBS stands at $38.60, implying a discount of about 5% to the market price.Notes: