AboveNet ABVT.PK
September 17, 2007 - 2:37pm EST by
stanley339
2007 2008
Price: 77.50 EPS
Shares Out. (in M): 0 P/E
Market Cap (in $M): 903 P/FCF
Net Debt (in $M): 0 EBIT 0 0
TEV ($): 0 TEV/EBIT

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Description

 
AboveNet (ABVT) is the last remaining premier metro fiber service provider with irreplaceable assets trading at ~ 60% of replication cost per route mile and close to half the ebitda & free cash flow multiples of peers (CCOI / LVLT) due to unique, but quickly clarifying circumstances, including trading on pink sheets and not having filed a 10K in 6 years.  

1)       We believe we can make a probability weighted IRR of 65% over the next 9 months as a 10K is filed for the first time in 6 years, mgmt is allowed to share the story, and the financial reality is better understood by the market.  

2)       We are buying in at FCF yields of 5% 08’, 9-10% 09’, 14% 2010 and growing > 25% thereafter. 

3)       Plausible take out candidate by LVLT or other once financials are filed

 

ABVT presents a unique opportunity largely underappreciated by the market because it has no current financial statements and has not filed a 10K in 6 years.  03 to 05 financials were filed in an 8K in mid July but this was the first time since 2001 investors have seen results.  While investing in a business without current financials might seem like a tough proposition we believe researching the recent performance of peers, understanding the enormous operating leverage of a metro fiber business model, and taking factual clues from the 03-05 results allow us to forecast with a relatively high margin for error.  In the event we’re too aggressive in our assumptions we take comfort in the significant asset value and top tier markets / enterprise customers ABVT serves.  In short, we see multiple ways to win and clear reasons why the market is failing to properly value the business. 

 

We feel the release of 2007 EBITDA will be a key catalyst.  Here is what we know today and the assumptions we use to drive the forecast:  2005 EBITDA was 31m.  We grow top line 20% for 06, and 25% for 07 on a 70% and 63% incremental ebitda respectively, while backing out the data center assets that were sold end 06, which we believe produced sales of 35m and ebitda of 9m, conservatively.  Getting us to ~ 65m of ebitda for 2007. 

 
Valuation (millions):
 
Capital Structure:
Price             77.50
Shares          11.65 (10..55 + 1.1 Warrants)
Cap               903
Cash             101  (05A end + data center sale + few m for 06' generation)
Debt              0
EV                  802
NOL worst    ~ 25 or $2 per share
NOL best      ~ 140 or $12 per share +
 
 
(mm)

2004A

2005A 2006E 2007E 2008E 2009E 2010E 2011E
*D-cntr sold
Rev 189 220 264 286 357 429 493 567
  Y/Y change 16% 20% 8% 25% 20% 15% 15%
EBITDA 5 31 62 67 106 145 181 218
Interest -10 -5 0 0 0 0 0 0
Taxes -1 0 -6 -7 -20 -34 -47 -60
CFO 26 44 56 60 85 111 134 158
Cap ex -23 -42 -45 -48 -48 -48 -48 -48
FCF 3 2 11 12 38 64 86 111
End cash / sh $8.72 $9.78 $13.04 $18.49 $25.91 $35.40
 
Incremental
Ebitda %
84% 70% 63% 55% 55% 55% 50%
Ebitda margin 23% 23% 30% 34% 37% 38%
 
 
FCF yield * 1.6% 5.1% 9.2% 14.4% 22.5%
Target Yield 5%
Upside 84.7%
EV/EBITDA ** 11.8x 7.1x 4.7x 3.3x 2.3x
Target 11.0x
Upside 55%
* FCF yield is taken ex- the growing cash balance
** EV / EBITDA only includes current cash in EV and does not back out future cash generation per year.  Our EBITDA does NOT include deferred rev
 
Peer Group EBITDA Multiples (CCOI our #s, LVLT street)
CCOI* 22.4x 10.4x 6.5x 4.9x
LVLT* 14.4x 10.1x 8.4x 7.3x
* these multiples are down a few turns from where they were prior to recent sell-off so potentially depressed
 
 
 
Key investment points:

1)       Truly a special situation.  Pink sheets. Quiet mgmt. No 06’ financials.  Filed 03-05 #s in July 07.  No 10K filed in 6 years

2)       Enormous operating leverage: 50-60% + incremental ebitda margins conservatively & ~25% y/y VAR verified growth allow high margin of error for forecasting off 05’ #s

3)       Bandwidth needs forecast to grow 75% + y/y next few years dropping to 50% y/y growth for 20 years due to video, VPN, IP phones.  ABVT most under radar play and industry has rationalized w/ 200 players 5 years ago to ~ 12 today.

4)       Irreplaceable assets & customers in top 14 metro markets such as NYC, SF, & DC trading at ~ 60% of replication cost.

5)       Potential to get taken out by LVLT or other.  Strong, net cash balance ~ 9% of mrkt cap 06E. at least $2/ shr NOL - potential $12

6)       Peers suggest business is going very well and mgmt is pleased.  Experts see assets as attractive and highly capable

 

Description:

AboveNet owns and operates 1.5 million fiber miles (3,852 route miles) in the top 14 United States metro markets and London to provide private optical network services to 1,300 + buildings comprised of large enterprises/institutions.  It has a highly attractive customer base including top financial & pharmaceutical institutions, 200 + Fortune 500 companies, universities, ISPs etc.  Though bandwidth is a commodity, ABVT provides a unique service by allowing its customers to privately and directly connect with their data centers, disaster recovery sites, satellite offices and other points over a private network rather than sending/receiving the data through multiple public internet peering points.  The advantage is security, reliability, scale, and costs.  ABVT charges for each unit of data that travels across its network and we believe it will be a large beneficiary of the greatly increasing trends in bandwidth needs. 

 

Truly a special situation that is quickly resolving with the 03-05’ financials filed in mid July 07 and an 06’ 10K on the way.  A long standing, inactive, & concentrated shareholder base (Kluge, billionaire) combined with a multi-year SEC investigation into accounting controls that was resolved in March 2007 are the reasons why ABVT has not filed a 10K since emerging from bankruptcy in 2003.  We believe this presents an enormous opportunity to get an edge on the business. Brief conversations with management suggest getting a 10K in order is a high priority and could be a few months/quarters  away, though they will not confirm.  While the SEC investigation is now old news, it gives us comfort that an ex-VP strongly believed it was not foul play but a poor legacy accounting system / atrocious paper documentation to match – “it was the wild west when it came to documentation.”    

 

Enormous operating leverage of 50-60% + incremental ebitda seems conservative given facts & research

           03’ bankruptcy projections estimated 50-60% incremental ebitda à included data center biz of lower op. leverage à sold 06’

           04/05 had an 84% incremental ebitda margin and 77% incremental gross margin vs. 86% incremental gross margin 03/04

           Ex-VP and VP atcompetitor felt 80% incremental for current subs was fair, 30% for new

           Peer CCOI has ~75% incremental ebitda blended, and ABVT should be lower but not far off

Although we do not have much financial information with which to project, there are factual points to hang our valuation hat.  04/05 shows ABVT had an 84% incremental ebitda margin.  In addition, bankruptcy projections from 2003 projected an average of 56% incremental margins till 2010 - a time when the industry was much less rational on pricing and when ABVT owned significant data center assets of lower incremental ebitda margins they did not dispose of till 05 & 06.  Former ABVT VP & a VP at a peer felt On-net (current customers / buildings where cap ex is spent) have 80% + incremental ebitda w/ new customers being 30%.  Current customers have high incremental margins b/c there is very little cost associated with each additional unit of bandwidth consumed.  New customers, on average, require some capital expenditure to construct the private network so the incremental margin is lower, but industry observers claim > 25% IRR.  Specifically, two senior managers at peers felt that of 25% revenue growth, 20% is new customers and 80% is existing customers.  This blend would imply 70% incremental ebitda margins - well below what we assume on avg for the next 5 years

 

Conversations with five senior managers at peers suggest ABVT is likely growing revenues 25% a year. A survey of industry experts suggested revenue is growing between 20 -40% for metro fiber businesses, with 25% being a mid point for the next couple of years.  Y/Y 04 to 05’ revs grew 16% for ABVT and we believe demand trends have increased greatly since this time.  In addition to comments from industry observers, the drivers of bandwidth growth outline below logically support this forecast. 

 

Bandwidth needs are expected to grow 50-80% CAGR for the next 10 years according to Bernstein Research and others. Video, increasing graphic quality, IP phones, VPN networks, disaster recovery requirements, & other drivers are creating tremendous bandwidth demands.  The CEO of Dell recently pointed out that YouTube alone consumes as much bandwidth as the whole internet did in 2000.

 

Relative MB needs:

Website                  1

Song                       15

Music video          43

Full screen TV      1731

Full screen HD      8654

 

The industry built for this growth in the late 90s but was too early; after nearly 10 years demand has finally caught up to supply.  After a massive over build, price wars, and a number of high profile bankruptcies (including ABVT) the industry has rapidly consolidated from 200+ players 5 years ago to ~12 today, and continues to consolidate.  The industry has been growing annual unit volumes 50%-75% w/ 20-25% price declines and with further consolidation expected this could improve, despite it being a commodity.

 

 

Irreplaceable assets & high quality customers in top 14 metro markets trading @ 60% of replication cost. During the late 90’s ABVT spent close to 5B building out its fiber network across the top metro markets in the US.  Our research indicates ~30% of the network ($ basis) is in Manhattan with  20% in DC. 

 

Metros served & estimated % of Network:

Manhattan                               30%

Washington DC                        20%

Dallas                                     10%

Chicago                                  10%

San Francisco                           8%

Los Angeles                             5%

* Remainder Phoenix, Miami, Atlanta, Seattle, Houston, Philadelphia, Denver, Boston, London

 

The barriers to build new networks in these cities is very high including permits, construction moratoriums, restricted conduits, disruption to business etc.  VAR from VP of a peer suggests “no one is going to re-dig Manhattan” to build new fiber networks and “many cities have build moratoriums, especially in restricted conduits like the Manhattan to NJ conduit under the Hudson River that ABVT owns.”  In some unique instances, Verizon has been adding fiber to Manhattan etc. at $100 / ft for the installation  (NY Times, 2006).

 

http://www.nytimes.com/2006/08/14/technology/14verizon.html?ex=1313208000&en=469743f49334baa6&ei=5088&partner=rssnyt&emc=rss

 

Small metros can run $35 to $50 a foot.  Applying an average of $65 / ft across ABVT’s 3,852 route miles would yield 1.32B of network value, or about 60% upside.  Although we do not typically view replication cost as a strong investment case for telecom businesses, the scarcity of these assets and the quality of the markets served excites us.  On top of asset valuation, take out multiples on peers have been increasing, reinforcing our view of scarcity. 

 

As ABVT resolves its current standing it could become an attractive take over target.  The industry has consolidated greatly in the last 5 years and the pace has not slowed, with Level 3 (LVLT) being the serial acquirer in the space.  Take out multiples have been climbing steadily, with recent transactions at 15x ebitda and 3x revenues for comparables.  Colleagues familiar with LVLT’s network believe ABVT assets could be highly synergistic, as you shutdown overlapping networks removing the costs but keeping the revenue.   Applying the 15x take out multiple to a medium case 08E ABVT ebitda the upside is ~ 80%.

Target Buyer Metric Multiple Date Note:
Broadwing LVLT EBITDA, Rev 15.2x, 3x Dec 06'
NEON RCN EBITDA 15.3x June 07'
Yipe Reliance Telecom Rev 6x July 07' *Not direct comp

 
If we apply 15x as a plausible takover price it is hard to see a scenario where ABVT does not present an excellent risk reward:  50m, 90, or 120 of 08' EBITDA would result in EV targets of 750, 1350, and 1800m respectively.  And ABVT produced 42m of EBITDA in 05' (36m ebitda + 6m cash ebidta from deferred revenue, prior to data center sale).
 
Conclusion:

In conclusion, ABVT is a complicated special situation with premier assets and a strong risk/reward that will be valued more in line with peers and possibly taken over by a competitor as financials are made current and management is allowed to share the story.  Upside to our valuation NOT yet factored in:

a)       NOL that could be worth $12 per share (we use $2 / share).  There are limitiation factors due to ownership changes and it's somewhat unclear.

b)       6m of annual cash ebitda from deferred revenue where costs are essentially sunk so the stream is pure cash generation (& growing)

c)       Potential the data center assets were producing much less ebitda than our estimates, as they were sold for $45m, which would only imply a 5x ebitda sales price when public peers haved traded at 15 -35x.  So we might be taking away too much ebitda from the sale. 

   

         

Risks:

       1) With 05’ being most recent financial year our estimates could be off but even if ebitda is only 50m à downside limited.  And our estimates are      not including cash ebitda of 5 to 6m ($7/shr upside on 15x multiple) from deferred revenue fiber lease IRUs or NOL. 

      2)   High operating leverage – valuation depends on growth

      3)  Broadband is a commodity – pricing could become more competitive and offset the growth in volume but + to see consolidation

           4) Lack of real communication with management à they will not speak in detail till a 10k has been filed

           5) Economic recession would hurt financial institutions, reducing work force, reducing IT spending needs à monitor this closely       

                                                                                                                                                               

 

DISCLOSURE:  We and our affiliates are long AboveNet (ABVT.PK), and may long additional shares or sell some or all of our shares, at any time.  We have no obligation to inform anybody of any changes in our views of ABVT.  This is not a recommendation to buy or sell shares. 

Catalyst

Filing 10K (months to quarters away. Analyst coverage. Mgmt beginning to communicate story. Plausibe take over target

Re-listing / Analyst coverage / Management beginning to communicate with street

Strong free cash flow generation / fundamentals
    sort by   Expand   New

    Description

     
    AboveNet (ABVT) is the last remaining premier metro fiber service provider with irreplaceable assets trading at ~ 60% of replication cost per route mile and close to half the ebitda & free cash flow multiples of peers (CCOI / LVLT) due to unique, but quickly clarifying circumstances, including trading on pink sheets and not having filed a 10K in 6 years.  

    1)       We believe we can make a probability weighted IRR of 65% over the next 9 months as a 10K is filed for the first time in 6 years, mgmt is allowed to share the story, and the financial reality is better understood by the market.  

    2)       We are buying in at FCF yields of 5% 08’, 9-10% 09’, 14% 2010 and growing > 25% thereafter. 

    3)       Plausible take out candidate by LVLT or other once financials are filed

     

    ABVT presents a unique opportunity largely underappreciated by the market because it has no current financial statements and has not filed a 10K in 6 years.  03 to 05 financials were filed in an 8K in mid July but this was the first time since 2001 investors have seen results.  While investing in a business without current financials might seem like a tough proposition we believe researching the recent performance of peers, understanding the enormous operating leverage of a metro fiber business model, and taking factual clues from the 03-05 results allow us to forecast with a relatively high margin for error.  In the event we’re too aggressive in our assumptions we take comfort in the significant asset value and top tier markets / enterprise customers ABVT serves.  In short, we see multiple ways to win and clear reasons why the market is failing to properly value the business. 

     

    We feel the release of 2007 EBITDA will be a key catalyst.  Here is what we know today and the assumptions we use to drive the forecast:  2005 EBITDA was 31m.  We grow top line 20% for 06, and 25% for 07 on a 70% and 63% incremental ebitda respectively, while backing out the data center assets that were sold end 06, which we believe produced sales of 35m and ebitda of 9m, conservatively.  Getting us to ~ 65m of ebitda for 2007. 

     
    Valuation (millions):
     
    Capital Structure:
    Price             77.50
    Shares          11.65 (10..55 + 1.1 Warrants)
    Cap               903
    Cash             101  (05A end + data center sale + few m for 06' generation)
    Debt              0
    EV                  802
    NOL worst    ~ 25 or $2 per share
    NOL best      ~ 140 or $12 per share +
     
     
    (mm)

    2004A

    2005A 2006E 2007E 2008E 2009E 2010E 2011E
    *D-cntr sold
    Rev 189 220 264 286 357 429 493 567
      Y/Y change 16% 20% 8% 25% 20% 15% 15%
    EBITDA 5 31 62 67 106 145 181 218
    Interest -10 -5 0 0 0 0 0 0
    Taxes -1 0 -6 -7 -20 -34 -47 -60
    CFO 26 44 56 60 85 111 134 158
    Cap ex -23 -42 -45 -48 -48 -48 -48 -48
    FCF 3 2 11 12 38 64 86 111
    End cash / sh $8.72 $9.78 $13.04 $18.49 $25.91 $35.40
     
    Incremental
    Ebitda %
    84% 70% 63% 55% 55% 55% 50%
    Ebitda margin 23% 23% 30% 34% 37% 38%
     
     
    FCF yield * 1.6% 5.1% 9.2% 14.4% 22.5%
    Target Yield 5%
    Upside 84.7%
    EV/EBITDA ** 11.8x 7.1x 4.7x 3.3x 2.3x
    Target 11.0x
    Upside 55%
    * FCF yield is taken ex- the growing cash balance
    ** EV / EBITDA only includes current cash in EV and does not back out future cash generation per year.  Our EBITDA does NOT include deferred rev
     
    Peer Group EBITDA Multiples (CCOI our #s, LVLT street)
    CCOI* 22.4x 10.4x 6.5x 4.9x
    LVLT* 14.4x 10.1x 8.4x 7.3x
    * these multiples are down a few turns from where they were prior to recent sell-off so potentially depressed
     
     
     
    Key investment points:

    1)       Truly a special situation.  Pink sheets. Quiet mgmt. No 06’ financials.  Filed 03-05 #s in July 07.  No 10K filed in 6 years

    2)       Enormous operating leverage: 50-60% + incremental ebitda margins conservatively & ~25% y/y VAR verified growth allow high margin of error for forecasting off 05’ #s

    3)       Bandwidth needs forecast to grow 75% + y/y next few years dropping to 50% y/y growth for 20 years due to video, VPN, IP phones.  ABVT most under radar play and industry has rationalized w/ 200 players 5 years ago to ~ 12 today.

    4)       Irreplaceable assets & customers in top 14 metro markets such as NYC, SF, & DC trading at ~ 60% of replication cost.

    5)       Potential to get taken out by LVLT or other.  Strong, net cash balance ~ 9% of mrkt cap 06E. at least $2/ shr NOL - potential $12

    6)       Peers suggest business is going very well and mgmt is pleased.  Experts see assets as attractive and highly capable

     

    Description:

    AboveNet owns and operates 1.5 million fiber miles (3,852 route miles) in the top 14 United States metro markets and London to provide private optical network services to 1,300 + buildings comprised of large enterprises/institutions.  It has a highly attractive customer base including top financial & pharmaceutical institutions, 200 + Fortune 500 companies, universities, ISPs etc.  Though bandwidth is a commodity, ABVT provides a unique service by allowing its customers to privately and directly connect with their data centers, disaster recovery sites, satellite offices and other points over a private network rather than sending/receiving the data through multiple public internet peering points.  The advantage is security, reliability, scale, and costs.  ABVT charges for each unit of data that travels across its network and we believe it will be a large beneficiary of the greatly increasing trends in bandwidth needs. 

     

    Truly a special situation that is quickly resolving with the 03-05’ financials filed in mid July 07 and an 06’ 10K on the way.  A long standing, inactive, & concentrated shareholder base (Kluge, billionaire) combined with a multi-year SEC investigation into accounting controls that was resolved in March 2007 are the reasons why ABVT has not filed a 10K since emerging from bankruptcy in 2003.  We believe this presents an enormous opportunity to get an edge on the business. Brief conversations with management suggest getting a 10K in order is a high priority and could be a few months/quarters  away, though they will not confirm.  While the SEC investigation is now old news, it gives us comfort that an ex-VP strongly believed it was not foul play but a poor legacy accounting system / atrocious paper documentation to match – “it was the wild west when it came to documentation.”    

     

    Enormous operating leverage of 50-60% + incremental ebitda seems conservative given facts & research

               03’ bankruptcy projections estimated 50-60% incremental ebitda à included data center biz of lower op. leverage à sold 06’

               04/05 had an 84% incremental ebitda margin and 77% incremental gross margin vs. 86% incremental gross margin 03/04

               Ex-VP and VP atcompetitor felt 80% incremental for current subs was fair, 30% for new

               Peer CCOI has ~75% incremental ebitda blended, and ABVT should be lower but not far off

    Although we do not have much financial information with which to project, there are factual points to hang our valuation hat.  04/05 shows ABVT had an 84% incremental ebitda margin.  In addition, bankruptcy projections from 2003 projected an average of 56% incremental margins till 2010 - a time when the industry was much less rational on pricing and when ABVT owned significant data center assets of lower incremental ebitda margins they did not dispose of till 05 & 06.  Former ABVT VP & a VP at a peer felt On-net (current customers / buildings where cap ex is spent) have 80% + incremental ebitda w/ new customers being 30%.  Current customers have high incremental margins b/c there is very little cost associated with each additional unit of bandwidth consumed.  New customers, on average, require some capital expenditure to construct the private network so the incremental margin is lower, but industry observers claim > 25% IRR.  Specifically, two senior managers at peers felt that of 25% revenue growth, 20% is new customers and 80% is existing customers.  This blend would imply 70% incremental ebitda margins - well below what we assume on avg for the next 5 years

     

    Conversations with five senior managers at peers suggest ABVT is likely growing revenues 25% a year. A survey of industry experts suggested revenue is growing between 20 -40% for metro fiber businesses, with 25% being a mid point for the next couple of years.  Y/Y 04 to 05’ revs grew 16% for ABVT and we believe demand trends have increased greatly since this time.  In addition to comments from industry observers, the drivers of bandwidth growth outline below logically support this forecast. 

     

    Bandwidth needs are expected to grow 50-80% CAGR for the next 10 years according to Bernstein Research and others. Video, increasing graphic quality, IP phones, VPN networks, disaster recovery requirements, & other drivers are creating tremendous bandwidth demands.  The CEO of Dell recently pointed out that YouTube alone consumes as much bandwidth as the whole internet did in 2000.

     

    Relative MB needs:

    Website                  1

    Song                       15

    Music video          43

    Full screen TV      1731

    Full screen HD      8654

     

    The industry built for this growth in the late 90s but was too early; after nearly 10 years demand has finally caught up to supply.  After a massive over build, price wars, and a number of high profile bankruptcies (including ABVT) the industry has rapidly consolidated from 200+ players 5 years ago to ~12 today, and continues to consolidate.  The industry has been growing annual unit volumes 50%-75% w/ 20-25% price declines and with further consolidation expected this could improve, despite it being a commodity.

     

     

    Irreplaceable assets & high quality customers in top 14 metro markets trading @ 60% of replication cost. During the late 90’s ABVT spent close to 5B building out its fiber network across the top metro markets in the US.  Our research indicates ~30% of the network ($ basis) is in Manhattan with  20% in DC. 

     

    Metros served & estimated % of Network:

    Manhattan                               30%

    Washington DC                        20%

    Dallas                                     10%

    Chicago                                  10%

    San Francisco                           8%

    Los Angeles                             5%

    * Remainder Phoenix, Miami, Atlanta, Seattle, Houston, Philadelphia, Denver, Boston, London

     

    The barriers to build new networks in these cities is very high including permits, construction moratoriums, restricted conduits, disruption to business etc.  VAR from VP of a peer suggests “no one is going to re-dig Manhattan” to build new fiber networks and “many cities have build moratoriums, especially in restricted conduits like the Manhattan to NJ conduit under the Hudson River that ABVT owns.”  In some unique instances, Verizon has been adding fiber to Manhattan etc. at $100 / ft for the installation  (NY Times, 2006).

     

    http://www.nytimes.com/2006/08/14/technology/14verizon.html?ex=1313208000&en=469743f49334baa6&ei=5088&partner=rssnyt&emc=rss

     

    Small metros can run $35 to $50 a foot.  Applying an average of $65 / ft across ABVT’s 3,852 route miles would yield 1.32B of network value, or about 60% upside.  Although we do not typically view replication cost as a strong investment case for telecom businesses, the scarcity of these assets and the quality of the markets served excites us.  On top of asset valuation, take out multiples on peers have been increasing, reinforcing our view of scarcity. 

     

    As ABVT resolves its current standing it could become an attractive take over target.  The industry has consolidated greatly in the last 5 years and the pace has not slowed, with Level 3 (LVLT) being the serial acquirer in the space.  Take out multiples have been climbing steadily, with recent transactions at 15x ebitda and 3x revenues for comparables.  Colleagues familiar with LVLT’s network believe ABVT assets could be highly synergistic, as you shutdown overlapping networks removing the costs but keeping the revenue.   Applying the 15x take out multiple to a medium case 08E ABVT ebitda the upside is ~ 80%.

    Target Buyer Metric Multiple Date Note:
    Broadwing LVLT EBITDA, Rev 15.2x, 3x Dec 06'
    NEON RCN EBITDA 15.3x June 07'
    Yipe Reliance Telecom Rev 6x July 07' *Not direct comp

     
    If we apply 15x as a plausible takover price it is hard to see a scenario where ABVT does not present an excellent risk reward:  50m, 90, or 120 of 08' EBITDA would result in EV targets of 750, 1350, and 1800m respectively.  And ABVT produced 42m of EBITDA in 05' (36m ebitda + 6m cash ebidta from deferred revenue, prior to data center sale).
     
    Conclusion:

    In conclusion, ABVT is a complicated special situation with premier assets and a strong risk/reward that will be valued more in line with peers and possibly taken over by a competitor as financials are made current and management is allowed to share the story.  Upside to our valuation NOT yet factored in:

    a)       NOL that could be worth $12 per share (we use $2 / share).  There are limitiation factors due to ownership changes and it's somewhat unclear.

    b)       6m of annual cash ebitda from deferred revenue where costs are essentially sunk so the stream is pure cash generation (& growing)

    c)       Potential the data center assets were producing much less ebitda than our estimates, as they were sold for $45m, which would only imply a 5x ebitda sales price when public peers haved traded at 15 -35x.  So we might be taking away too much ebitda from the sale. 

       

             

    Risks:

           1) With 05’ being most recent financial year our estimates could be off but even if ebitda is only 50m à downside limited.  And our estimates are      not including cash ebitda of 5 to 6m ($7/shr upside on 15x multiple) from deferred revenue fiber lease IRUs or NOL. 

          2)   High operating leverage – valuation depends on growth

          3)  Broadband is a commodity – pricing could become more competitive and offset the growth in volume but + to see consolidation

               4) Lack of real communication with management à they will not speak in detail till a 10k has been filed

               5) Economic recession would hurt financial institutions, reducing work force, reducing IT spending needs à monitor this closely       

                                                                                                                                                                   

     

    DISCLOSURE:  We and our affiliates are long AboveNet (ABVT.PK), and may long additional shares or sell some or all of our shares, at any time.  We have no obligation to inform anybody of any changes in our views of ABVT.  This is not a recommendation to buy or sell shares. 

    Catalyst

    Filing 10K (months to quarters away. Analyst coverage. Mgmt beginning to communicate story. Plausibe take over target

    Re-listing / Analyst coverage / Management beginning to communicate with street

    Strong free cash flow generation / fundamentals

    Messages


    SubjectNew Writeup
    Entry09/17/2007 02:37 PM
    Memberstanley339
    Description:
     
    AboveNet (ABVT) is the last remaining premier metro fiber service provider with irreplaceable assets trading at ~ 60% of replication cost per route mile and close to half the ebitda & free cash flow multiples of peers (CCOI / LVLT) due to unique, but quickly clarifying circumstances, including trading on pink sheets and not having filed a 10K in 6 years.  

    1)       We believe we can make a probability weighted IRR of 65% over the next 9 months as a 10K is filed for the first time in 6 years, mgmt is allowed to share the story, and the financial reality is better understood by the market.  

    2)       We are buying in at FCF yields of 5% 08’, 9-10% 09’, 14% 2010 and growing > 25% thereafter. 

    3)       Plausible take out candidate by LVLT or other once financials are filed

     

    ABVT presents a unique opportunity largely underappreciated by the market because it has no current financial statements and has not filed a 10K in 6 years.  03 to 05 financials were filed in an 8K in mid July but this was the first time since 2001 investors have seen results.  While investing in a business without current financials might seem like a tough proposition we believe researching the recent performance of peers, understanding the enormous operating leverage of a metro fiber business model, and taking factual clues from the 03-05 results allow us to forecast with a relatively high margin for error.  In the event we’re too aggressive in our assumptions we take comfort in the significant asset value and top tier markets / enterprise customers ABVT serves.  In short, we see multiple ways to win and clear reasons why the market is failing to properly value the business. 

     

    We feel the release of 2007 EBITDA will be a key catalyst.  Here is what we know today and the assumptions we use to drive the forecast:  2005 EBITDA was 31m.  We grow top line 20% for 06, and 25% for 07 on a 70% and 63% incremental ebitda respectively, while backing out the data center assets that were sold end 06, which we believe produced sales of 35m and ebitda of 9m, conservatively.  Getting us to ~ 65m of ebitda for 2007. 

     
    Valuation (millions):
     
    Capital Structure:
    Price             77.50
    Shares          11.65 (10..55 + 1.1 Warrants)
    Cap               903
    Cash             101  (05A end + data center sale + few m for 06' generation)
    Debt              0
    EV                  802
    NOL worst    ~ 25 or $2 per share
    NOL best      ~ 140 or $12 per share +
     
     
    (mm)

    2004A

    2005A 2006E 2007E 2008E 2009E 2010E 2011E
    *D-cntr sold
    Rev 189 220 264 286 357 429 493 567
      Y/Y change 16% 20% 8% 25% 20% 15% 15%
    EBITDA 5 31 62 67 106 145 181 218
    Interest -10 -5 0 0 0 0 0 0
    Taxes -1 0 -6 -7 -20 -34 -47 -60
    CFO 26 44 56 60 85 111 134 158
    Cap ex -23 -42 -45 -48 -48 -48 -48 -48
    FCF 3 2 11 12 38 64 86 111
    End cash / sh $8.72 $9.78 $13.04 $18.49 $25.91 $35.40
     
    Catalyst: Filing 10K (months to quarters away. Analyst coverage.

    Subjectquestions
    Entry09/19/2007 08:36 AM
    Memberoscar1417
    Thank you for the idea and the write-up. I've been nosing around the telecom sector lately since it seems to be largely forgotten. I have some questions, and general comments on the industry. If you read the Q&A for the recent GLBC write-up here, I have basically some of the same questions.
    Your thesis hinges primarily upon revenue growth of 20-40% per year, which would be spectacular given recent performance by telecom service providers who have been starving for revenues for years. Where is the tremendous projected revenue growth coming from? New customers, or increases from existing customers? Who are these customers, and how can you be sure that their increases in demand will offset increases in capacity? Heavyweights like Verizon appear to be choosing "build" instead of "buy" to increase supply. Are there really enough small businesses to provide this new revenue? 20-40% growth far outpaces growth in metro population, corporations, real estate development, etc. so there must be some other strong dynamic.
    Incidentally I have the same question about LVLT, which is also projecting strong revenue and EBITDA growth for 2007 and 2008, yet I don't see what has changed to allow this since their revenues have been flat-or-worse for a long time. Though LVLT today is much more of a vertically integrated company than the transport provider they set out to be.
    Despite the exponential growth in network usage, there was an incredible amount of capacity available, and constant improvements to fiber and network gear allow constant increases in capacity from existing plant (i.e. Corning just announced their "nano fiber"). I assume this is true in metro fiber too (relevant to ABVT). Rather than irreplaceable, I wonder if the telecom networks of 8 years ago are already obsolete. LVLT often touted their 3-7 year depreciation schedules while they were building out their network.
    Telecom bulls (which includes service providers) have been predicting the inflection point whereby overcapacity is used up and pricing improves. My struggle is trying to find data to help understand this dynamic. It is hard to trust figures from each company which of course are bullish, and also suffer because the same metrics are calculated differently at different companies. Do you have any insight here?
    I also wonder if there are other dynamics at work. For instance, I wonder if businesses that use telecom services are more willing to outsource when they are smaller, but as they get larger, they tend to build their own capacity. This is demonstrated by large companies like Verizon, Comcast, and SBC building and owning their own capacity. This would leave the service providers like LVLT and perhaps ABVT perpetually stuck with the bottom end of the market, and customers who leave just when they start to get big, which would explain why their revenues are constantly flat even though overall usage is increasing rapidly.
    Thank you in advance for any info or insights.

    SubjectOscar
    Entry09/20/2007 11:26 AM
    Memberstanley339
    Growth ?

    20-40% revenue growth is what similar peers have been seeing and expect going forward - median # mentioned was 25%. Data demands have been increasingly greatly for the reasons outlined in the report and it fits logically. We serve a very broad base of customers including data centers, many of the top internet service providers (rumored to be all the top 10), majority of large investment banks, movie production studios etc. so it is easy to imagine why there volume needs are growing on top of the figures we have included.

    Our research indicates the growth is primarily from existing customers, hence the high incremental margins, but recent press releases confirm they are winning new customers as well, which is good to see.


    Obsolete Networks ?

    We do not see the networks as being obsolete - industry participants speak very highly of the ABVT network.


    Capacity growth / lost customers / price declines ?

    Capacity abilities do improve each year and technically, one strand of fiber will have near infinite improvements over time which is why we value the network replication cost per route mile rather than per fiber mile (ABVT has 1.5m fiber miles - 864 strands wrapped into one in some areas).

    Other capacity related elements to consider - A private network has been custom built for that customer, so just because industry capacity is growing with technology improvements, does not mean new capacity is being generated right where we serve our customers - they'd still require the network to be specifically built for most instances. It's tough to comprehend but these private networks are not simple broadband pipes - we're talking about a true dedicated network with numerous private feeds into buildings, data centers that is mission critical and with ultra high speeds. The cost of even the slightest downtime in this setup is enormous, especially as daily data needs grow. Some articles discuss enterprises build their own private optical network and lease dark fiber, but our discussions in the industry suggest this is a weakening trend in ABVT customer base rather than an increasing trend. I'm not saying they will never lose or have lost a customer, but there are hurdles to consider. As of Sep 2005 the CEO stated this in an interview:

    "AboveNet has lost customers, but this is an infrequent occurrence. The most common reasons prompting a company to terminate a contract are relocation - moving to a location that AboveNet does not serve, or changing service requirements - taking the customer out of AboveNet’s target market.

    The majority of losses have been with IP and data centre customers as these services have become increasingly commoditised. It should be noted that AboveNet has not lost any customer following investment in metro network infrastructure to serve that customer."

    http://www.abovenet.com/newsandevents/pressreleases/pr050902.html

    CIO / CTOs pricing outlook positive for ABVT:

    Furthermore, despite the tendancy for capacity to naturally grow over time, our questioning of CIO / CTOs planned budgets over the next few years vs. historical has noted a significant drop in expected price declines going forward from their private optical network service supplier --> more evidence something has changed this time around and demand seems to be outpacing capacity.






    SubjectOscar 2
    Entry09/20/2007 11:31 AM
    Memberstanley339
    And we use the term "irreplaceable" from a location standpoint not a technology standpoint.

    Subjectwarrants
    Entry09/20/2007 01:54 PM
    Memberoscar1417
    Thank you for the well thought out reply. A few more questions:
    I see two publicly traded warrants, and the 8K says they have a strike of $20 and $24, compared to a current quote of $80. That seems a little out of kilter, what are the terms on these warrants? Does the capital structure that you presented include all of the distributions they're planning in Aug and Sept?
    The 15x EBITDA figure seems to be the current gospel, LVLT is trading in the market at an EV/EBITDA multiple of around 15, and is also projecting about 38% EBITDA growth next year. Do you have any thoughts about LVLT? The current multiple is the same, as are revenue and EBITDA growth projections (about 15% for the former and 35% for the latter). LVLT is obviously much larger, in multiple lines of business, and with a lot of debt, but also has not gone through an accounting scandal and has current financials. TIA.

    SubjectWarrants
    Entry09/21/2007 09:07 AM
    Memberstanley339
    In the recent 8k it states:

    "five year warrants to purchase 709,459 shares of common stock with an exercise price of $20.00 per share (expiring September 8, 2008) and (ii) seven year stock warrants to purchase 834,658 shares of common stock with an exercise price of $24.00 per share (expiring September 8, 2010)"

    Modeling these explicity using the Treasury share method gets you to about 1.1m warrants to add into the share count, which we have done in our capital structure.

    I do not know enough about LVLT to intelligently comment. I will say that the street's incremental ebitda margins for that business are high ~ 50% and I'd expect ABVT's to be considerbly higher, so it's a nice sanity check from that standpoint






    SubjectFollowup
    Entry01/10/2008 03:50 PM
    Membermiser861
    I have just started looking at this name and had a few q's:

    - 2005 Rev adjusted for Data center sales consisted of what sort of rev breakdown between Metro revs and long haul revs?
    - do you have any new data points as to metro rev growth in 2007 and 2008?
    - have you heard any updated info on when a 10k for 2006 might be filed?
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