Sunday, August 3, 2008

Too Many Reillys, Too Many Issues: Why It May be Good to Short Lamar

Those of you who follow the company Lamar Advertising (LAMR) know that, with only two exceptions (one rather brief and one lasting roughly two years), the company's stock price has been extremely range bound. That range has been, more or less, between $30 and $40. After a recent bull run, which saw Lamar's share price touch $70, the stock has recently entered this range again.

With the shares trading at $37.53 as of Aug. 4, 2008, it is actually at the high end of this range and I think that Lamar's upcoming earnings report on August 6 may disappoint and send the share price back down to the low end of this range. This could give traders a chance to pick up some puts or short some of Lamar's shares and make what could potentially be a quick profit.

I do think that Lamar may miss their earnings target on August 6, but even if I am wrong about them missing their upcoming earnings, I still view Lamar as a good medium term short play, or at least until the share price touches the low end of what has been a consistent range. Traders can potentially play Lamar's shares over and over again, shorting the shares once they touch the top of the range (near $40) and covering once they touch the low end of the range (near $30).

First of all, the main reason that I see Lamar missing on their upcoming earnings is because of the high put activity that I am seeing in the options market. I have found that time and again, the options market is a reliable (but not infallible) indicator about upcoming earnings.

I compare the ratios of calls to puts by looking at the open interest levels for the single option with the highest open interest and also the total call/put ratio. For the August options, the August 35 puts are showing the highest open interest at 5,739. The straddle option for this put would be the August 40 calls which are only showing an open interest level of 1,496. This means that the straddle call/put ratio is a high 3.8 to 1.

I generally also look at the same strike ratio for the option with the high open interest as well as the opposite ratio which compares the option with the highest open interest against the option on the other side (call or put) with the highest open interest. In the case of the Lamar options, the same strike (35 calls) also happen to be the calls with the highest open interest, meaning that the same strike ratio and opposite ratio are the same in this case, the ratio being 1.8 to 1 in favor of the puts.

Lastly, the total put to call ratio adds all of the open interest up on the put side and divides it by the total open interest on the call side. In the case of Lamar Advertising the total put open interest is 14,197 versus a total call open interest of 5,647. This gives a ratio of just over 2.5 to 1 in favor of the puts.

These ratios are all on the high side and are an indicator that the options buyers, for whatever reason, are under the impression that Lamar may miss their earnings and that Lamar's share price will be below $35 by the third Friday of August.

The options open interest levels are why I think that Lamar may miss on their upcoming earnings report, but they are not the reason that I think Lamar will be range bound for a long while to come.

The first issue that makes me wary of Lamar Advertising is the prevalence of members of the Reilly family in corporate governance and operation. Though the company is publicly traded, the Reilly family controls 67% of the corporate voting power by virtue of their ownership of Lamar's class B shares. The class B shares, created by CEO Kevin Reilly Jr. and COO Sean Reilly, carry an incredible 10 votes per share. This means that the Reillys have free reign over the fates of Lamar Advertising and there is nothing that any discontented shareholders could do about it.

Reilly family members hold the aforementioned positions of CEO and COO. Furthermore, Kevin Reilly Jr. also holds the title of Chairman of the Board, Wendell Reilly holds a seat on the board of directors and Anna Reilly also serves as a director.

While the fact that the Reilly family holds stern control over Lamar is not an issue that should sit well with outside investors, it does not automatically disqualify Lamar from being a profitable company. The biggest issue with Lamar is the nature of their business in outdoor billboard advertising.

Outdoor billboard advertising can be a profitable business, requiring a large upfront cost followed by only minimal maintenance costs and a steady stream of revenues. The problem with the business is the lack of growth that the industry has historically shown.

Since the days of LadyBird Johnson, billboard advertisers have met resistance with virtually every new billboard that they attempt to erect. Many people view billboards as eyesores that detract from the natural beauty along the nation's highways and also as accident causing hazards that attract people's attention away from driving. The billboard opponents have been very successful in the courts at severely limiting the construction of new billboards. In fact, if you are to look at Lamar's recent headlines, there are always several news articles dedicated to legal battles that are currently ensuing regarding the construction of new billboards.

As a result, new billboard construction is not a reliable source of growth, but Lamar has adapted to this over the past years and has produced growth by constant acquisition of smaller outdoor advertising companies. The issue with this type of growth is that it will eventually be terminal, and also one has to assume that Lamar and its competitors have already purchased the best of these available companies.

A new type of billboard, the digital billboard, is offering Lamar a new opportunity that will offer many times more revenue and much higher margins than the traditional billboard. Many on Wall Street are expecting that digital billboards will give Lamar and other outdoor advertisers a significant boost, but the problem is that digital billboards are meeting even stricter resistance from the public and local governments.

Lamar has faced a legal battle for many of the digital billboards that they have constructed in such cities as Omaha, NE, Mufreesboro, TN, Fayetteville, NC, Kansas City, KS and many more. Opponents claim that the flashing billboard signs cause an even greater distraction to drivers and still present just as much of an eyesore as their predecessors.

The end result is that Lamar's growth is stunted by an inability to construct new billboards. There certainly is an ample supply of customers for Lamar and other outdoor advertisers even under these weakened economic conditions, but without the ability to produce new billboards Lamar cannot recognize maximum revenue potential.

The bottom line is that many factors point to Lamar being a good short play in both the short term and the longer term. The August 6 report could shed further light on the current situation for the company, but I think that this is an excellent short play going into that report. The options market is pointing to the short side for Lamar's report and several other indicators are pointing to the short side for the longer term. In my view, Lamar simply has too many Reillys and too many issues.
(disclosure: author intends to take a short position in LAMR)

Happy Trading


1 comment:

Salmanshahid said...

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