CBEYOND INC CBEY S
September 29, 2009 - 1:41pm EST by
msdonut940
2009 2010
Price: 16.00 EPS -$0.09 $0.078
Shares Out. (in M): 29 P/E nm 205.0x
Market Cap (in $M): 475 P/FCF negative/nm n/a
Net Debt (in $M): -31 EBIT -2 5
TEV ($): 444 TEV/EBIT nm 90x
Borrow Cost: NA

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Description

 

CBeyond

Ticker: CBEY

Stock Price: $16

Market Cap: $475 mm

 

Cbeyond ("CBEY") is an IP based telecom provider focusing on small business clients that is trading over 200x earnings.  The market mistakenly views this as a growth company as it has been growing revenue by opening up new markets.  However, without any unique assets, intellectual property, or service offering, I find it hard to justify such a rich valuation for a business caught in the competitive cross hairs between cable and telco companies. As this seems like a recipe for disaster in my book, I recommend a short of this equity.

 

Business

 

CBeyond is an IP based telecommunications company whose existence is based on the ability to lease T-1 lines at a wholesale rate from the local exchange carrier and re-lease them with services to their clients.  In 2000, the company launched what was at the time a unique offering targeting small businesses with 5-249 employees.  CBEY launched originally in three markets, and was able to gain share by offering a cheap alternative to the local exchange carriers for a businesses' telecom needs.  

 

With this initial success, CBEY took themselves public in 2006 and gained the capital necessary to launch new markets.  Their target market is defined as the top 25 MSA's, where they believe there are 1.4 mm businesses.  The company currently serves 12 markets and its stated goal is to open up 2-3 new markets per year.  The company believes that by concentrating on small-businesses, they face limited competition as this customer base has been historically under-served.  According to CBEY, this customer base appreciates their high-touch sales force.  In theory, they also appreciate the fixed monthly payment structure of one to three years, allowing for budgeting simplicity. 

 

Unfortunately for CBEY, since 2000, the world has changed.  Today, instead of being underserved, small businesses are focus customers for both the cable companies and telco companies.  A bundled offering is now standard, vs unique, and the small business customer has limited access to credit and therefore may balk at a long term commitment, especially given a declining price environment.  While CBEY only admits to the economic effects, the increase in churn is likely due to all the above mentioned reasons.  CBEY's churn sits at 1.5%/month today vs 1% historically. 

 

Numeric points

While I don't deny the company showed success in its original markets (Atlanta, Dallas and Denver), it is difficult to see comparable success in their newer markets.  The original markets took 17 months to become EBITDA profitable, and today, the markets are taking at least 24 months or more. 

 

 

1st Qtr

 

Launch Date

Launch

EBITDA +

 

Houston

Mar-04

Sep-05

              6

Chicago

Mar-05

Dec-06

              7

Los Angeles

Mar-06

Dec-07

              7

San Diego

Jan-07

Dec-08

              8

Detroit

Sep-07

 

 

San Francisco Bay Area

Dec-07

 

 

Miami

Mar-08

 

 

Minneapolis

 

 

 

Greater Washington, D.C. Area

 

 

 

Seattle

 

 

 

 

The slowdown of profitability implies a steady increase in competition.  EBITDA margins in the newer markets also remain stubbornly below that of the initial markets ~ a difference of about 1000 bps exists between Houston and Atlanta despite Houston being EBITDA positive for four years.  And this margin gap has remained steady for the last five quarters. 

 

Adjusted EBITDA margin (market-level)

3/31/2008

6/30/2008

9/30/2008

12/31/2008

3/31/2009

6/30/2009

Atlanta

57.80%

54.09%

56.48%

54.25%

54.76%

54.37%

Dallas

50.30%

49.61%

58.46%

50.65%

50.31%

49.62%

Denver

52.96%

54.85%

52.83%

52.84%

52.89%

50.33%

Houston

47.38%

47.81%

52.70%

47.11%

47.37%

44.04%

Chicago

32.00%

33.86%

34.31%

39.54%

39.24%

37.55%

Los Angeles

19.21%

20.73%

21.54%

18.45%

20.71%

21.51%

San Diego

-52.23%

-21.71%

-5.35%

4.04%

15.45%

16.49%

Detroit

-135.61%

-95.64%

-51.82%

-25.38%

-18.31%

-15.31%

San Francisco Bay Area

-510.04%

-271.68%

-126.60%

-86.41%

-35.25%

-15.10%

Miami

-6007.69%

-842.75%

-350.12%

-182.58%

-104.82%

-64.89%

Minneapolis

nm

-7972.73%

-563.13%

-298.14%

-15630.00%

-15630.00%

Greater Washington, D.C. Area

nm

nm

nm

nm

-5994.12%

-910.80%

Seattle

nm

nm

nm

nm

nm

nm

Adjusted EBITDA margin (as % of total revenue)

41.48%

39.33%

41.54%

38.39%

38.27%

36.02%

 

In terms of quality of earnings, there are a number of significant problems.  There are indications that revenue is under pressure and/or the cost of acquiring customers has increased.  For example, the company showed accelerated customer growth in the 1H, yet they tempered revenue guidance.  In fact, they had the best quarterly gross adds ever, but given their rising churn rate, their overall customer growth rate decelerated.  In addition, the SG&A per market has continued to increase, resulting in the highest level per market ever, and leading to the steady margin decline.  Their cash balance has also been steadily decreasing, demonstrating a significant decrease in FCF while EBITDA has remained suspiciously steady.

 

 

Mar. 31

Jun. 30

Sept. 30

Dec. 31

Mar. 31

30-Jun

 

 

2008

2008

2008

2008

2009

2009

Customers (at period end)

36,674

38,576

40,569

42,463

44,342

      46,405

  % change y/y

25.74%

23.74%

21.88%

21.18%

20.91%

20.30%

Net customer additions

1,633

1,902

1,993

1,894

1,879

        2,063

  % change y/y

-10.42%

-5.33%

-5.63%

7.98%

15.06%

8.46%

 

 

 

 

 

 

 

Average monthly churn rate (1)

1.30%

1.30%

1.30%

1.40%

1.50%

1.50%

Average monthly revenue per customer location

$748

$754

$760

$754

$755

748

  % change y/y

0.54%

0.80%

1.47%

0.53%

0.94%

-0.80%

Implied Quarterly Churn Rate

3.95%

3.95%

3.95%

4.26%

4.57%

4.57%

  bps change y/y

           92.08

          92.08

          61.45

                -  

            61.69

        61.69

 

 

 

 

 

 

 

Qtrly Gross Adds -- implied

           3,017

          3,351

          3,517

           3,622

            3,819

        4,088

  % change y/y

 

15.84%

11.58%

14.19%

26.55%

22.01%

 






 

 

 

 

 

 

 

 

 S,G & A / Gross Add

    14,575.92

   14,033.29

    14,153.96

    14,237.42

     14,523.75

 13,988.61

  % change y/y

 

8.46%

11.82%

7.94%

-0.36%

-0.32%

Gross Adds per Avg Rev Generating Market

         251.45

        279.25

        293.09

         301.82

          318.22

      340.71

  % change y/y

 

15.84%

11.58%

14.19%

26.55%

22.01%

 

FCF: CFFO - Capex

     (10,330.0)

     (3,273.0)

         (335.0)

       (5,045.0)

        (5,210.0)

   (3,100.0)

    TTM

        2,080.0

    (10,898.0)

      (9,944.0)

     (18,983.0)

      (13,863.0)

  (13,690.0)

EBITDA

  11,473.0

 10,865.0

 13,439.0

     11,896.0

      10,920.0

 $10,180.0

     TTM

      43,638.0

     44,378.0

      47,088.0

      47,673.0

       47,120.0

   46,435.0

 

                                 

 

 

The company continues to blame a poor economy, but denies any effect from the new cable entrants.  Yet both CMCSA and TWC mgmt claim both success and substantial growth in this area at GS's annual media/telecom conference at the beginning of September. 

 

Valuation

 

The company trades at approximately 10x trailing EBITDA and over 200x next years estimated earnings.  In order to justify the rich valuation, the street has made the blanket assumption that CBEY will achieve 10% market share in all of its markets, despite its inability to reach this market penetration in even its most successful market.  CBEY's market penetration in its best market is only 5%.  And, as you see above, even if CBEY is able to attain this share, it seems probable it is either with lower revenues or higher expenses than expected. 

 

 

 

 

Catalyst

 

1)      Earnings ~ potential for a guidance decrease

2)      Realization of the truth: ultimate growth and profitability is impaired given cable competition

 

 

    sort by    

    Description

     

    CBeyond

    Ticker: CBEY

    Stock Price: $16

    Market Cap: $475 mm

     

    Cbeyond ("CBEY") is an IP based telecom provider focusing on small business clients that is trading over 200x earnings.  The market mistakenly views this as a growth company as it has been growing revenue by opening up new markets.  However, without any unique assets, intellectual property, or service offering, I find it hard to justify such a rich valuation for a business caught in the competitive cross hairs between cable and telco companies. As this seems like a recipe for disaster in my book, I recommend a short of this equity.

     

    Business

     

    CBeyond is an IP based telecommunications company whose existence is based on the ability to lease T-1 lines at a wholesale rate from the local exchange carrier and re-lease them with services to their clients.  In 2000, the company launched what was at the time a unique offering targeting small businesses with 5-249 employees.  CBEY launched originally in three markets, and was able to gain share by offering a cheap alternative to the local exchange carriers for a businesses' telecom needs.  

     

    With this initial success, CBEY took themselves public in 2006 and gained the capital necessary to launch new markets.  Their target market is defined as the top 25 MSA's, where they believe there are 1.4 mm businesses.  The company currently serves 12 markets and its stated goal is to open up 2-3 new markets per year.  The company believes that by concentrating on small-businesses, they face limited competition as this customer base has been historically under-served.  According to CBEY, this customer base appreciates their high-touch sales force.  In theory, they also appreciate the fixed monthly payment structure of one to three years, allowing for budgeting simplicity. 

     

    Unfortunately for CBEY, since 2000, the world has changed.  Today, instead of being underserved, small businesses are focus customers for both the cable companies and telco companies.  A bundled offering is now standard, vs unique, and the small business customer has limited access to credit and therefore may balk at a long term commitment, especially given a declining price environment.  While CBEY only admits to the economic effects, the increase in churn is likely due to all the above mentioned reasons.  CBEY's churn sits at 1.5%/month today vs 1% historically. 

     

    Numeric points

    While I don't deny the company showed success in its original markets (Atlanta, Dallas and Denver), it is difficult to see comparable success in their newer markets.  The original markets took 17 months to become EBITDA profitable, and today, the markets are taking at least 24 months or more. 

     

     

    1st Qtr

     

    Launch Date

    Launch

    EBITDA +

     

    Houston

    Mar-04

    Sep-05

                  6

    Chicago

    Mar-05

    Dec-06

                  7

    Los Angeles

    Mar-06

    Dec-07

                  7

    San Diego

    Jan-07

    Dec-08

                  8

    Detroit

    Sep-07

     

     

    San Francisco Bay Area

    Dec-07

     

     

    Miami

    Mar-08

     

     

    Minneapolis

     

     

     

    Greater Washington, D.C. Area

     

     

     

    Seattle

     

     

     

     

    The slowdown of profitability implies a steady increase in competition.  EBITDA margins in the newer markets also remain stubbornly below that of the initial markets ~ a difference of about 1000 bps exists between Houston and Atlanta despite Houston being EBITDA positive for four years.  And this margin gap has remained steady for the last five quarters. 

     

    Adjusted EBITDA margin (market-level)

    3/31/2008

    6/30/2008

    9/30/2008

    12/31/2008

    3/31/2009

    6/30/2009

    Atlanta

    57.80%

    54.09%

    56.48%

    54.25%

    54.76%

    54.37%

    Dallas

    50.30%

    49.61%

    58.46%

    50.65%

    50.31%

    49.62%

    Denver

    52.96%

    54.85%

    52.83%

    52.84%

    52.89%

    50.33%

    Houston

    47.38%

    47.81%

    52.70%

    47.11%

    47.37%

    44.04%

    Chicago

    32.00%

    33.86%

    34.31%

    39.54%

    39.24%

    37.55%

    Los Angeles

    19.21%

    20.73%

    21.54%

    18.45%

    20.71%

    21.51%

    San Diego

    -52.23%

    -21.71%

    -5.35%

    4.04%

    15.45%

    16.49%

    Detroit

    -135.61%

    -95.64%

    -51.82%

    -25.38%

    -18.31%

    -15.31%

    San Francisco Bay Area

    -510.04%

    -271.68%

    -126.60%

    -86.41%

    -35.25%

    -15.10%

    Miami

    -6007.69%

    -842.75%

    -350.12%

    -182.58%

    -104.82%

    -64.89%

    Minneapolis

    nm

    -7972.73%

    -563.13%

    -298.14%

    -15630.00%

    -15630.00%

    Greater Washington, D.C. Area

    nm

    nm

    nm

    nm

    -5994.12%

    -910.80%

    Seattle

    nm

    nm

    nm

    nm

    nm

    nm

    Adjusted EBITDA margin (as % of total revenue)

    41.48%

    39.33%

    41.54%

    38.39%

    38.27%

    36.02%

     

    In terms of quality of earnings, there are a number of significant problems.  There are indications that revenue is under pressure and/or the cost of acquiring customers has increased.  For example, the company showed accelerated customer growth in the 1H, yet they tempered revenue guidance.  In fact, they had the best quarterly gross adds ever, but given their rising churn rate, their overall customer growth rate decelerated.  In addition, the SG&A per market has continued to increase, resulting in the highest level per market ever, and leading to the steady margin decline.  Their cash balance has also been steadily decreasing, demonstrating a significant decrease in FCF while EBITDA has remained suspiciously steady.

     

     

    Mar. 31

    Jun. 30

    Sept. 30

    Dec. 31

    Mar. 31

    30-Jun

     

     

    2008

    2008

    2008

    2008

    2009

    2009

    Customers (at period end)

    36,674

    38,576

    40,569

    42,463

    44,342

          46,405

      % change y/y

    25.74%

    23.74%

    21.88%

    21.18%

    20.91%

    20.30%

    Net customer additions

    1,633

    1,902

    1,993

    1,894

    1,879

            2,063

      % change y/y

    -10.42%

    -5.33%

    -5.63%

    7.98%

    15.06%

    8.46%

     

     

     

     

     

     

     

    Average monthly churn rate (1)

    1.30%

    1.30%

    1.30%

    1.40%

    1.50%

    1.50%

    Average monthly revenue per customer location

    $748

    $754

    $760

    $754

    $755

    748

      % change y/y

    0.54%

    0.80%

    1.47%

    0.53%

    0.94%

    -0.80%

    Implied Quarterly Churn Rate

    3.95%

    3.95%

    3.95%

    4.26%

    4.57%

    4.57%

      bps change y/y

               92.08

              92.08

              61.45

                    -  

                61.69

            61.69

     

     

     

     

     

     

     

    Qtrly Gross Adds -- implied

               3,017

              3,351

              3,517

               3,622

                3,819

            4,088

      % change y/y

     

    15.84%

    11.58%

    14.19%

    26.55%

    22.01%

     






     

     

     

     

     

     

     

     

     S,G & A / Gross Add

        14,575.92

       14,033.29

        14,153.96

        14,237.42

         14,523.75

     13,988.61

      % change y/y

     

    8.46%

    11.82%

    7.94%

    -0.36%

    -0.32%

    Gross Adds per Avg Rev Generating Market

             251.45

            279.25

            293.09

             301.82

              318.22

          340.71

      % change y/y

     

    15.84%

    11.58%

    14.19%

    26.55%

    22.01%

     

    FCF: CFFO - Capex

         (10,330.0)

         (3,273.0)

             (335.0)

           (5,045.0)

            (5,210.0)

       (3,100.0)

        TTM

            2,080.0

        (10,898.0)

          (9,944.0)

         (18,983.0)

          (13,863.0)

      (13,690.0)

    EBITDA

      11,473.0

     10,865.0

     13,439.0

         11,896.0

          10,920.0

     $10,180.0

         TTM

          43,638.0

         44,378.0

          47,088.0

          47,673.0

           47,120.0

       46,435.0

     

                                     

     

     

    The company continues to blame a poor economy, but denies any effect from the new cable entrants.  Yet both CMCSA and TWC mgmt claim both success and substantial growth in this area at GS's annual media/telecom conference at the beginning of September. 

     

    Valuation

     

    The company trades at approximately 10x trailing EBITDA and over 200x next years estimated earnings.  In order to justify the rich valuation, the street has made the blanket assumption that CBEY will achieve 10% market share in all of its markets, despite its inability to reach this market penetration in even its most successful market.  CBEY's market penetration in its best market is only 5%.  And, as you see above, even if CBEY is able to attain this share, it seems probable it is either with lower revenues or higher expenses than expected. 

     

     

     

     

    Catalyst

     

    1)      Earnings ~ potential for a guidance decrease

    2)      Realization of the truth: ultimate growth and profitability is impaired given cable competition

     

     

    Messages


    SubjectCitron
    Entry09/29/2009 02:19 PM
    Memberzzz007

    Citron Research has been pumping this one on the short side for a while.  Worth reading their history@ http://www.citronresearch.com/index.php?s=cbey&submit=Search


    Subjectguidance
    Entry09/29/2009 06:18 PM
    Memberroc924

    When do you think the company reduces guidance and by how much? Are Street models too high?

    What was the company's return on investment in the mature markets?

    What do you think the company's return on investment will be in its newer markets? Are they going to earn their cost of capital in the new markets?

    I agree CBEY looks like a short. But the timing isn't clear to me from your report.

    Here's one take on the mature ROI in one of a few ways to look at it. If I exclude the operating losses from loss making markets then the company has about $20m in annualized operating income. One could argue that excluding losses from newer markets makes sense because the company is making an investment now for a payoff later. The company had about $120m of net operating assets (SE less cash in this case). So assuming no assets to support newer markets, which greatly penalizes the return, then the company has a 16% return on net operating assets for mature markets. Really, it's probably more like 20% since my assumption of the denominator is too high. 20% isn't stellar given the valuation, but not terrible either.

    Perhaps for this one to really break you have to have the new markets earn less than their cost of capital. Is that going to happen at the current trajectory of new market financials?

     

     

     

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