Abovenet ABVT.PK
December 31, 2008 - 4:02pm EST by
stanley339
2008 2009
Price: 30.00 EPS
Shares Out. (in M): 0 P/E
Market Cap (in $M): 366 P/FCF
Net Debt (in $M): 0 EBIT 0 0
TEV ($): 0 TEV/EBIT

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Description

Pitch:
 
AboveNet (ABVT) is the last remaining premier metro fiber service provider trading at a substantial margin of safety with numerous catalysts for revaluation. There’s potential for a reasonable 40-100% + upside with low odds of seeing material fundamental downside from these levels given the stability of the business, net cash balance sheet, strong cash generation, discount to peer valuations, and irreplaceable assets. 


Valuation:

We think ABVT is currently trading at 4x 2008 EBITDA, half the multiple of peers, 1/5th of replication cost, and a 20% untaxed FCF yield on maintenance cap ex (large NOL). Given the environment, lack of current financials, and history of the company it’s easy to see why it trades at current levels. Given the downside protection, clear catalysts and market’s general distaste to invest in a business of this nature right now we think it’s a great opportunity over the next 12 – 24 months, and highly contrarian.  


What has changed since initial write-up:

We wrote about ABVT in Sep 07 (near market peak) so refer to our prior write-up for more background information; a lot has changed in the world since this time. 


Buyout potential:

The original thesis was a) relatively cheap stand-alone valuation b) cheap vs. peers but c) highly interesting take out valuation on asset value and industry consolidation, which we felt was nearly certain till the credit bubble burst. Now, ABVT is a) incredibly cheap on a standalone basis and to peers b) still a great asset with high likelihood of being bought in future, but unlikely to be near term. The main consolidator in 06/07, Level 3 (LVLT), is now priced like it could go BK, given the large amount of debt coming due over the next few years; we think they are unlikely to attempt acquisitions given this dynamic, but there is some potential with other industry peers who are better capitalized. For example, Global crossing as recently as Nov 08’ announced at a conference “we see a new wave of consolidation in the next 18th months – and – we’ve been in talks with everyone.” Buyouts of these businesses at the peak were going for 15x ebitda. Even if that were to fall to 6x EBITDA in this environment, it’s still 50% upside for ABVT. We think the long term desire for consolidation in the industry is still a viable thesis. 

When management was shopping the company in late 07’ after the bubble burst we believe they were asking 1B and projected 09’ EBITDA could be 90-100m. The world is a different place now but the current enterprise value is about 1/3rd of the original asking price. 


Filings:

ABVT only has 07 financials filed so we have to make assumptions for what 08 will look like. It has taken ABVT much longer than we originally planned to get current with financials. We believe the internal goal is to have 2008 10k out on-time and that they are on track to meet this deadline.. Management has every intention to become a fully compliant public company again with conference calls and street coverage – so catalysts do not see very far off. 


Revenue growth:

With corporate America facing substantial headwinds – we no longer believe ABVT can see significant revenue growth, despite the fact that data volumes going across corporate pipes should still grow. However, we think revenues can remain relatively stable to low single digit growth until the economy improves, given the nature of the business which is contractual in nature and fact that they are spending significant growth cap ex. In addition, with their peers being in worse financial shape, it’s likely they’ll have to be more rational on pricing, which would benefit the industry. 

We spoke to management regarding the high financial institution concentration and while it’s possibly too early to say with certainty, they had not yet seen much impact on the business and have had the odd stroke of luck where their customers happened to be the banks that are buying the distressed banks. It’s not unlikely there will be some impact though as there is simply too much distress in their customer base to think otherwise. But we think the odds of revenue growth turning negative are rather low and if it were to happen we think it would be rather short-lived.  Data demand is still growing strong.   

Given the high operating leverage, which we think will prove to be greater than 65% incremental ebitda margins – even just 5% revenue growth over the next two years will generate ~ 9m in incremental ebitda, or 11% growth. 


Peer multiples:

Cogent (CCOI) and Level 3 (LVLT) are two peers we use to help value ABVT. They are off significantly from their highs but CCOI still has a 10.5x EV/EBITDA multiple while LVLT sports 8x. Both more than double where ABVT is trading. It’s interesting to note where they trade, but we take more comfort in the cheap valuation of ABVT on an absolute basis. 


Replication cost:

Refer to prior write-up for this analysis. We believe assets are generally worth the cash flow you can create with them – so replication cost is not as good a measure of value as it typically sounds – but in the case of fiber assets there are substantial and hard to value synergies to be had when networks are merged – as you can cut out much of the overlapping network cost and keep the revenues. So replication cost is a good way to think of what a buyer is paying to acquire vs. building themselves. 


EBITDA projections:

ABVT has not yet released 08 financials and the 07 financials are complicated / misleading. You have to back out the data center sale from both revenue and EBITDA. But upon doing so it’s clear that ABVT grew revenue 19% 07’ over 06’ and generated about 70m of EBITDA. If you assume revenue grew 10% at a 65% incremental ebitda margin in 08, both of which seem like conservative assumptions, then 2008 will > 85m EBITDA. 


FCF / Maint cap ex:

ABVT has not been spending maintenance levels of cap ex this year or in 2007. We’ve spoken with management and they have been upgrading the network / building pipe to new customers after underinvestment when they were bankrupt in 2001-2003. They see the ROIC of new cap ex deployed still being 20-25% so they are putting capital to work.  We’d love to see them paying more cash to shareholders but they are not at this stage. If they were to stop growing new customers and only grow with current customers demand growth cap ex would be around 20m a year. The best year to see maint cap ex is 2004, which was after emerging from bankruptcy but before they decided to build out the infrastructure – and cap ex in this year was 23m and included some minor growth cap ex. 
 


Valuation:

08’ EBITDA          85

Less interest         0* (may have drawn revolver in 08 - Libor + 275-300)

Less taxes              0* (large NOL)

Less WC                0* (we don’t value)

CFO                        85

Maint cap ex         -20

FCF                         65m
 
 
 

Stock price            $30

Shares                    12.2m

Cap                         366m

Cash                       45.8* (07A)

Debt                       0* (Have a small revolver they may have drawn in 08 – unclear)

EV                           320m
 
 

EV / EBITDA        3.8x

FCF / Cap              20% Yield* (Maint cap ex and untaxed but company will be spending growth cap ex)

               

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

Getting current with financials
Potential to be bought by peers
    sort by    

    Description

    Pitch:
     
    AboveNet (ABVT) is the last remaining premier metro fiber service provider trading at a substantial margin of safety with numerous catalysts for revaluation. There’s potential for a reasonable 40-100% + upside with low odds of seeing material fundamental downside from these levels given the stability of the business, net cash balance sheet, strong cash generation, discount to peer valuations, and irreplaceable assets. 


    Valuation:

    We think ABVT is currently trading at 4x 2008 EBITDA, half the multiple of peers, 1/5th of replication cost, and a 20% untaxed FCF yield on maintenance cap ex (large NOL). Given the environment, lack of current financials, and history of the company it’s easy to see why it trades at current levels. Given the downside protection, clear catalysts and market’s general distaste to invest in a business of this nature right now we think it’s a great opportunity over the next 12 – 24 months, and highly contrarian.  


    What has changed since initial write-up:

    We wrote about ABVT in Sep 07 (near market peak) so refer to our prior write-up for more background information; a lot has changed in the world since this time. 


    Buyout potential:

    The original thesis was a) relatively cheap stand-alone valuation b) cheap vs. peers but c) highly interesting take out valuation on asset value and industry consolidation, which we felt was nearly certain till the credit bubble burst. Now, ABVT is a) incredibly cheap on a standalone basis and to peers b) still a great asset with high likelihood of being bought in future, but unlikely to be near term. The main consolidator in 06/07, Level 3 (LVLT), is now priced like it could go BK, given the large amount of debt coming due over the next few years; we think they are unlikely to attempt acquisitions given this dynamic, but there is some potential with other industry peers who are better capitalized. For example, Global crossing as recently as Nov 08’ announced at a conference “we see a new wave of consolidation in the next 18th months – and – we’ve been in talks with everyone.” Buyouts of these businesses at the peak were going for 15x ebitda. Even if that were to fall to 6x EBITDA in this environment, it’s still 50% upside for ABVT. We think the long term desire for consolidation in the industry is still a viable thesis. 

    When management was shopping the company in late 07’ after the bubble burst we believe they were asking 1B and projected 09’ EBITDA could be 90-100m. The world is a different place now but the current enterprise value is about 1/3rd of the original asking price. 


    Filings:

    ABVT only has 07 financials filed so we have to make assumptions for what 08 will look like. It has taken ABVT much longer than we originally planned to get current with financials. We believe the internal goal is to have 2008 10k out on-time and that they are on track to meet this deadline.. Management has every intention to become a fully compliant public company again with conference calls and street coverage – so catalysts do not see very far off. 


    Revenue growth:

    With corporate America facing substantial headwinds – we no longer believe ABVT can see significant revenue growth, despite the fact that data volumes going across corporate pipes should still grow. However, we think revenues can remain relatively stable to low single digit growth until the economy improves, given the nature of the business which is contractual in nature and fact that they are spending significant growth cap ex. In addition, with their peers being in worse financial shape, it’s likely they’ll have to be more rational on pricing, which would benefit the industry. 

    We spoke to management regarding the high financial institution concentration and while it’s possibly too early to say with certainty, they had not yet seen much impact on the business and have had the odd stroke of luck where their customers happened to be the banks that are buying the distressed banks. It’s not unlikely there will be some impact though as there is simply too much distress in their customer base to think otherwise. But we think the odds of revenue growth turning negative are rather low and if it were to happen we think it would be rather short-lived.  Data demand is still growing strong.   

    Given the high operating leverage, which we think will prove to be greater than 65% incremental ebitda margins – even just 5% revenue growth over the next two years will generate ~ 9m in incremental ebitda, or 11% growth. 


    Peer multiples:

    Cogent (CCOI) and Level 3 (LVLT) are two peers we use to help value ABVT. They are off significantly from their highs but CCOI still has a 10.5x EV/EBITDA multiple while LVLT sports 8x. Both more than double where ABVT is trading. It’s interesting to note where they trade, but we take more comfort in the cheap valuation of ABVT on an absolute basis. 


    Replication cost:

    Refer to prior write-up for this analysis. We believe assets are generally worth the cash flow you can create with them – so replication cost is not as good a measure of value as it typically sounds – but in the case of fiber assets there are substantial and hard to value synergies to be had when networks are merged – as you can cut out much of the overlapping network cost and keep the revenues. So replication cost is a good way to think of what a buyer is paying to acquire vs. building themselves. 


    EBITDA projections:

    ABVT has not yet released 08 financials and the 07 financials are complicated / misleading. You have to back out the data center sale from both revenue and EBITDA. But upon doing so it’s clear that ABVT grew revenue 19% 07’ over 06’ and generated about 70m of EBITDA. If you assume revenue grew 10% at a 65% incremental ebitda margin in 08, both of which seem like conservative assumptions, then 2008 will > 85m EBITDA. 


    FCF / Maint cap ex:

    ABVT has not been spending maintenance levels of cap ex this year or in 2007. We’ve spoken with management and they have been upgrading the network / building pipe to new customers after underinvestment when they were bankrupt in 2001-2003. They see the ROIC of new cap ex deployed still being 20-25% so they are putting capital to work.  We’d love to see them paying more cash to shareholders but they are not at this stage. If they were to stop growing new customers and only grow with current customers demand growth cap ex would be around 20m a year. The best year to see maint cap ex is 2004, which was after emerging from bankruptcy but before they decided to build out the infrastructure – and cap ex in this year was 23m and included some minor growth cap ex. 
     


    Valuation:

    08’ EBITDA          85

    Less interest         0* (may have drawn revolver in 08 - Libor + 275-300)

    Less taxes              0* (large NOL)

    Less WC                0* (we don’t value)

    CFO                        85

    Maint cap ex         -20

    FCF                         65m
     
     
     

    Stock price            $30

    Shares                    12.2m

    Cap                         366m

    Cash                       45.8* (07A)

    Debt                       0* (Have a small revolver they may have drawn in 08 – unclear)

    EV                           320m
     
     

    EV / EBITDA        3.8x

    FCF / Cap              20% Yield* (Maint cap ex and untaxed but company will be spending growth cap ex)

                   

    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

    Getting current with financials
    Potential to be bought by peers

    Messages


    Subjectlong-range growth
    Entry01/01/2009 07:11 PM
    Memberbriarwood988
    Thanks for the idea. What do you think the long-range EBITDA growth rate for this company is?

    SubjectRevenue growth
    Entry01/02/2009 12:32 AM
    Memberneo628
    Given that financials have not been released, why do you think 10% revenue growth for 2008 is the right or conservative assumption? Communications costs are falling rather rapidly, so I think the revenue growth for 2008 and on needs to be carefully scrutinized.

    SubjectJust released 3Q08 #s
    Entry02/09/2009 01:57 PM
    Memberstanley339

    Financials are now out up to Q308.  They look great other than the large amount of cap ex.  EBITDA looks like it will come in at 85-90M FY.  Putting ebitda valuation at around 4.5x, or half of their peers.  Incremental ebitda margins were 70%.  Net cash balance sheet.   


    SubjectRE: RE: Just released 3Q08 #s
    Entry02/09/2009 07:40 PM
    Membergreenshoes93

    Any thoughts on growth vs. maintenance capex? LVLT has mentioned 5% of rev maintenance, which in this case would be $12mm for the first 9 months and $70mm in growth on only $44mm in revenue growth. Obviously very tough to have any sort of precision in a business like this, but even on 50% incremental EBITDA margins, that's a lot of capital spending. It's a great business and I own it, but just concerned management isn't focused enough on FCF and are happy enough with fcf breakeven that they aren't concerned abt spending for the highest returns on capital.


    SubjectQuestion on growth
    Entry06/17/2009 12:29 PM
    Memberutah1009

    Stanley, great writeup at $30.  Now that it's back to the price of your original post, do you still think it has the same upside as before?

     

    I can't figure out the revenue growth of this company for 2009.  2008 was a monster year even after backing out the one-time cancellation payments, with revenue growth easily +20%.  Q1 looks like it was very high teens after adjustments.  This is a relatively capital intensive business and they're still spending more than they were last year and 2007.  So if they continue to plow a whopping 36% of sales (almost all of the cash flow from ops) back into capex, why are they only guiding for 8-9% revenue growth in 2009?  Either their guidance is laughably low or they are spending a lot more to get a lot less (presumably because pricing is weaker?).  Stanley, do you or anyone else have thoughts on this?  Have they hit some sort of inflection point or is the guidance just silly?  Thanks

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