|Shares Out. (in M):||196||P/E||13.6x||12.2x|
|Market Cap (in M):||691||P/FCF||3.3x||2.8x|
|Net Debt (in M):||2,180||EBIT||323||325|
Summary Investment Thesis:
I believe that Cincinnati Bell (“CBB”) is an orphaned hybrid stock that is out of favor with yield-seeking telecom investors and largely overlooked by data center / technology-focused investors. Due to this disconnect, CBB's large and growing data center colocation business trades like a telecom business.
With financial leverage as a result of an ill-timed acquisition under former management, CBB has spent the last few years reducing its debt burden and pushing out maturities. The current CEO has the majority of his liquid net worth in CBB stock, and has been working hard to unlock long-term shareholder value.
With growing earnings, free cash flow that is shielded by NOLs and boosted by ongoing debt reduction, and possible corporate action that may serve as catalysts, I believe that CBB is an attractive investment. In addition, agreeing with my views, the largest shareholder of CBB is Peninsula Capital, whose founder Ted Weschler was just hired to manage the public investment portfolio at Berkshire Hathaway.
Compelling Valuation – CBB trades at 5.4x LTM EBITDA. Ascribing industry multiples to the wireless (assuming 6x LTM EBITDA), wireline (assuming 5x LTM EBITDA) and IT (assuming 4x LTM EBITDA) businesses implies that the data center business is trading at less than 5x LTM EBITDA, despite its strong growth potential and the fact that its data center peers trade at significantly higher multiples. For example, Rackspace Hosting trades at 21x LTM EBITDA and Equinix at 12x due to lower maintenance capital requirements of the business model, and high free cash flow growth over the last ten years as companies have moved to outsource data. In the private market, as shown below, multiples paid are substantially higher than that implied for CBB's data center business at the current stock price.
Recent Data Center Acquisitions
Acquiror Target Date Announced Deal Value ($MM) FY1 EV / EBITDA
CenturyLink Savvis 4/27/2011 $2,500 10.9x
Verizon Terremark 1/27/2011 1,400 18.0
Equinix Switch and Data 10/21/2009 856 9.4
CincinnatiBell Cyrus One 5/12/2010 526 12.5
Equinix IXEurope 6/28/2007 482 14.0
ABRY Partners Q9 Networks 8/24/2008 345 13.1
Time Warner Navisite 2/1/2011 230 10.0
I believe that CBB may seek to separate the data center business to capture its full value, and that management is appropriately incentivized to do so.
Attractive, High Growth Data Center Colocation Business – Heightened data consumption, internet usage and new regulatory requirements are driving the need for more complex, secure and redundant networks, leading to increasing demand for data center services, since the cost of running such complex solutions in-house can be prohibitive. According to research estimates, the global data center industry is $12 billion in size, growing at 18-20% as internet usage and cloud computing ramp up. As a data center colocation provider, CBB provides cabinets, power, operations space and storage space rentals for customers’ IT infrastructure equipment. The business is characterized by 3-5 year contracts, sticky customers due to high switching costs, and extremely stable recurring cash flows. Moreover, as CBB grows this business in the US and overseas, management is keen to emphasize that 50% of new growth comes from simply following existing customers to new locations. Currently it provides data center colocation services in Cincinnati, Houston, Dallas, Austin, Chicago, South Bend, London and Singapore, with new growth planned in Phoenix, Arizona. CBB's data center business caters only to non-technology Fortune 500 companies who are looking to outsource the capex and inconvenience of running a data center in-house.
Stable, Cash-Generative Wireline and Wireless Assets – The core telephony wireline and wireless assets are a strong source of cash. As a regional market leader in the Ohio area offering a full bundle of integrated telecommunications services, the company has successfully defended market share against intense competition, and held EBITDA margins stable at approximately 30% in the wireline business and high teens in the wireless business through aggressive cost reductions. Industry work indicates that CBB is a highly effective telecom operator, running low-cost infrastructure at high margins. As a result, even as revenues have declined in these secularly challenged businesses, I estimate that the wireline and wireless businesses combined generated approximately $360 million of EBITDA less maintenance capex in the LTM period ending September 30, 2011. In total, the company generated $220 million in LTM levered free cash flow (excluding growth capex), after a $215 million interest payment on its debt, and the bulk of this cash flow was generated by the telephony assets. Thus the wireline and wireless assets are a relatively stable and defensive source of funding for the company's data center investments. Moreover, the high frequency of M&A activity in the wireline space bodes well for the takeout potential of these assets by a large strategic buyer.
Management Compensation Plan may be Indicative of Impending Corporate Actions – Post the Cyrus One acquisition, management has housed the data center colocation assets in a separate holding company. The company also moved CFO Gary Wojtaszek, who joined from a KKR portfolio company, to head CyrusOne as President and CEO, indicating that the company may be poised for a separation in 2012. Moreover, per a new compensation plan drawn up in December 2010, management stands to gain financially (exact details not disclosed) if they generate $1 billion or more of organic value creation in the data center business, as ascertained by a "qualifying transaction". The Board may also permit a proportional payout if value creation exceeds $500 million. Moreover, compensation plans for the other telephony and IT businesses have also been configured to participate in any upside in the data center colocation business. Reading between the lines of these various actions, I am inclined to believe that management is highly likely to separate the data center colocation business once it can demonstrate organic value creation of $1 billion or more. The business currently generates approximately $110 million in run rate EBITDA, and with public and private market EBITDA multiples in the range of 9 - 12x, is already worth $990 million to $1.3 billion in aggregate, and this value could increase rapidly as the capacity currently under construction comes online in 2012 and 2013.
Other corporate actions that may help unlock value include the reinstatement of a dividend, which will attract traditional yield-seeking telecom investors, or an opportunistic share repurchase.
High Free Cash Flow Yield and Solid Capital Allocation – CBB's LTM levered free cash flow yield (before discretionary growth capex) on its equity value is approximately 36%, and the LTM unlevered free cash flow yield (before discretionary growth capex) on the enterprise value is approximately 13%, assuming a normalized tax rate (although the company currently has NOLs). Moreover, management has been a prudent allocator of this cash flow. Since 2007, the company has bought back 22% of its shares outstanding. Now, as discussed previously, the company is reinvesting the cash flow into the high ROIC data center colocation business.
Enhanced Returns Due to Leverage – 90% of CBB's debt maturities are in 2017 and beyond. Meanwhile, the company continues to generate stable free cash flow that is shielded by approximately $1 billion of pre-tax NOLs. The 4.5x Net Debt / EBITDA ratio implies that the returns to the equity holders will be magnified as the company delevers from the relatively high ratio.
Declining Wireless and Wireline Businesses – The company's traditional telephony business faces challenges from intensifying competition in wireless, and secular declines in the consumer wireline business. The advent of smart phones has hit the company especially hard, since the roaming charges on data (which the company bears), are onerous. While the company has done an excellent job of focusing of profitability and has maintained EBITDA margins at approximately 30% in wireline, and high teens in wireless by cutting costs aggressively, the fact remains that these businesses are under pressure.
Heavy Dependency on Data Center Industry – The success of CBB's strategy of investing the proceeds from its mature telephony businesses into growing its data center colocation business is heavily dependent on continued growth in the data center industry. While diligence suggests that demand continues to outpace supply in the industry, that pricing and competitive dynamics are rational, and that the underlying fundamentals support the high multiples across the data center industry, a change in these facts will change the outlook for CBB.
Low Liquidity – CBB only trades about $4 million worth of shares a day. This limits flexibility to enter and exit the position.
Sensitivity of Price Target to Telephony (Wireline & Wireless) and Data Center 2012 EBITDA multiples
2012 EBITDA Break-down: Wireline = $323MM, Wireless = $75MM, Data Center = $120MM, IT Services = $24MM, Other = ($19MM)
Wireline & Wireless Multiple on Horizontal Axis; Data Center Multiple on Vertical Axis
3.5x 4.0x 4.5x 5.0x 5.5x 6.0x 6.5x 7.0x
6.5x $0.68 $1.47 $2.27 $3.06 $3.79 $4.52 $5.25 $5.95
7.0x $0.97 $1.77 $2.57 $3.33 $4.06 $4.79 $5.53 $6.20
7.5x $1.27 $2.06 $2.86 $3.60 $4.34 $5.07 $5.78 $6.45
8.0x $1.56 $2.36 $3.14 $3.88 $4.61 $5.34 $6.03 $6.70
8.5x $1.86 $2.66 $3.42 $4.15 $4.88 $5.61 $6.28 $6.95
9.0x $2.16 $2.95 $3.69 $4.42 $5.15 $5.86 $6.53 $7.21
9.5x $2.45 $3.23 $3.96 $4.69 $5.42 $6.11 $6.78 $7.46
10.0x $2.75 $3.50 $4.23 $4.96 $5.68 $6.36 $7.03 $7.71
10.5x $3.04 $3.77 $4.50 $5.23 $5.93 $6.61 $7.28 $7.96
11.0x $3.31 $4.04 $4.77 $5.51 $6.18 $6.86 $7.53 $8.21
11.5x $3.58 $4.31 $5.05 $5.76 $6.43 $7.11 $7.78 $8.46
12.0x $3.85 $4.59 $5.32 $6.01 $6.69 $7.36 $8.04 $8.71
12.5x $4.13 $4.86 $5.59 $6.26 $6.94 $7.61 $8.29 $8.96
13.0x $4.40 $5.13 $5.84 $6.51 $7.19 $7.86 $8.54 $9.21
13.5x $4.67 $5.40 $6.09 $6.76 $7.44 $8.11 $8.79 $9.46
14.0x $4.94 $5.66 $6.34 $7.01 $7.69 $8.36 $9.04 $9.71
|Subject||Cyrus One true data center comps|
|Entry||02/02/2012 12:06 PM|
Many of the comps mentioned seem inappropriate. Terremark and Savvis had roughly equal colo and managed-services revenues when they were acquired. They were also truly global businesses. Global managed services is a much better value-add to Fortune 1000 than pure colo at a few big centers. Terremark's colo business also had an extremely high-security DC-area gov't niche that seems impossible to replicate due to the virtuous cycle of first-mover advantage leading to scale as well as gov't uber-stickiness. Navisite and Rackspace have zero colo revenue and thus I don't view them as very relevant either (all managed services/cloud stuff from their centers which is worth a significantly higher multiple). EQIX seems to be the best comp; I am not as familiar with them but it seems like their truly global scale and very high number of centers is a significant factor to getting a high multiple. I know Cyrus One is present in Singapore and London but they are doing this out of leased centers and therefore it's a low-margin, low value-add biz, IIRC from the calls. Essentially, why is Cyrus One worth the towering EBITDA multiple of the mentioned comps, especially considering EBITDA there was actually down sequentially?
|Entry||02/02/2012 04:04 PM|
Thanks for the note. We were aware of the Peninsula distribution. Two points— 1) Given that Mr. Weschler is 40% of the fund capital and keeping all of his holdings as he transitions to Berkshire, we view it as a very favorable vote of confidence in the investment. 2) As for the remaining LPs who were distributed CBB stock, the distribution of the shares to unnatural holders during 4Q 2011 created noise in the stock and the buying opportunity.
|Subject||RE: Cyrus One true data center comps|
|Entry||02/03/2012 01:00 PM|
Cincinnati Bell’s data center offering, Cyrus One, is a co-location business and not managed services. Given the short list of public comps in the space, we included recent private market transactions as some relevant data points including Terremark and Savvis. A pureplay colo business in the public markets such as DLR (Digital Realty Trust) trades at 17x trailing EBITDA and 15x forward EBITDA, if you’d prefer to use that as a valuation comp instead. While we’re not claiming to be experts on the data center space, we are simply recognizing three things-- 1) there is a massive valuation gap between what an investor in CBB pays for Cyrus One, and what public and private comps in the data center space are valued at, 2) company management is incentivized to close the gap, as they get paid significant bonuses if value is recognized through a transaction (sale or spin), and 3) we are not smart enough to figure out exactly what multiple an independent Cyrus One will re-rate to, but the matrix of outcomes gets to a 100% return for a CBB investor at the low end of re-valuation, and 200%+ return it if re-rates to DLR-type multiple in the bull case.
We focused most of our time on underwriting the downside, and were very comfortable creating Cyrus One at CBB’s overall multiple with comps valued 5-10x EBITDA turns higher.
|Subject||RE: Cincinnati Bell to Explore Alternatives|
|Entry||02/10/2012 11:42 AM|
CBB yesterday announced the company is exploring strategic alternatives with the data center business. The thesis is being realized, and we continue to believe there is material upside remaining in the stock as the company continues to unlock value through this separation.
|Subject||RE: Wireline valuation?|
|Entry||03/01/2012 06:06 PM|
Comps CTL, FTR, and WIN are at 5-7x EBITDA.
|Subject||RE: Business Quality/Comps|
|Entry||04/18/2012 03:55 PM|
We generally thought the mix of CTL, WIN and FTR was appropriate as a comp given the lack of many publicly traded peers. Our diligence indicated that CBB management were much better operators than FTR management, and in line with CTL and WIN. Based on our work on the incumbent business, we’re comfortable underwriting it to continued pace of line losses and cost takeouts to offset and a generally flat to slightly declining EBITDA and cash flow profile.
As for hedging the position, we don’t hedge individual names, and have shorts on in other sectors. Given the valuation of the CBB business, we’re comfortable underwriting the data center segment at a lower-than-market multiple and creating the wireline/wireless business at a very low multiple of earnings and free cash flow, and just taking a view that the FCF stream won’t go to zero in 4 years. At prior times we have been short FTR due to the overpayment of the dividend and subpar management of the asset.
|Subject||Data Center Short (CBB Hedge)|
|Entry||05/29/2012 10:18 AM|
To follow-up on the hedging question, we researched the other publicly traded data center players, and decided to short Digital Realty Trust, not just as a hedge to CBB but also on it's own merit. Our research into the company showed a dramatic overvaluation to replacement cost (30-50% overvalued by various metrics), an understatement of maintenance capex in the subjective AFFO calculations, serial equity raising, insider selling of stock, and weakening of rent trends in their core markets which are much more competitive and commoditized than CBB's niche markets. More importantly, the valuation at 18x AFFO is double the valuation assumption we were using for CBB, giving a significant margin of safety for the valuations to converge.
|Subject||RE: Net Debt|
|Entry||03/04/2013 11:09 AM|
Net debt is lower than what you're using b/c of an intercompany loan from CyrusOne to CBB that was paid off before the CONE IPO. When the 10-k is filed the new net debt number will be clearer but it's closer to $2.1 billion.
|Subject||Anyone still following?|
|Entry||03/27/2013 07:34 PM|
I have spent a little time on this and was curious if anyone was still following. On the face of it, if you take CBB's enterprise value of about $3.5B according to capital IQ, back out 69% of the market cap of CONE ($300M), back out CONE's net deb of around $600M, you are still left with an incumbent metro telco with $2.6B of EV on $390M of ex-CONE EBITDA or about 6.7x. Doesn't seem particularly cheap and no dividend. It seems like the event of initiallyl separating the data center business has passed, is there another reason this would be interesting?
|Subject||RE: Anyone still following?|
|Entry||03/27/2013 09:32 PM|
Taking the ownership partnership units of CONE(which can be converted to common shares at will I believe) CBB owns about 42.47M shares of CONE. There are a total of 62M common shares and operating partnership units. So the stake in CONE is worth $955M at $22.50/share.
So that is ~5.1X based on your calcs, still not interesting enough for me.
|Subject||RE: RE: Anyone still following?|
|Entry||03/28/2013 10:57 AM|
The interesting angle here is that the CONE shares could be distributed to CBB shareholders with a minor tweak to the bank agreement.
CBB ownes $5 per share roughly of CONE equity. If this entire CONE equity were distributed to shareholders there is roughly 70% upside from the current share price assuming the CONE equity were distributed, and CBB traded with some low stub equity value.
I am unaware of any arbitrage situations in the public markets with this wide a spread, though achieving these returns will likely take a big change in thinking at the Board level.
Still, the fact that the CONE shares can be freely distributed to CBB shareholders provides a good amount of downside protection to the CBB equity here.
If the CONE shares are treated as cash, you are still created the telecom business at a value below that of the comps.
|Subject||RE: RE: RE: RE: Anyone still following?|
|Entry||03/28/2013 11:57 AM|
Referring to the revolver which is most likely undrawn so not highly relevant right now. The revolver requires that CONE equity sales go to pay it down.
|Subject||RE: RE: RE: Anyone still following?|
|Entry||03/28/2013 12:16 PM|
CBB retains 69% ownership of CONE, so a distribution of CBB's entire stake of CONE to CBB shareholders would be a TAXABLE spin-off.
|Subject||RE: RE: RE: RE: Anyone still following?|
|Entry||03/28/2013 02:30 PM|
Our understanding is that there are ways to do this tax efficiently given the large NOL balance. Whether it is spun off or shares are sold and cash distributed accomplishes the same thing.
|Subject||Thanks for the responses- question|
|Entry||03/29/2013 04:48 PM|
So, based on the responses I spent a little more time digging in and while I appreciate the corretion on the actual shares O/S and value of CyrusOne, I am still struggling with why this would be interesting. I understand that the company owns $5.01 per share of CONE equity which seems like a great arbitrage on a $3.25 share price, however, the management is pretty clear they intend to monetize CONE (which should be largely tax-free due to the NOLs) and use the proceeds to pay down debt.
So I get a $661M market cap for CBB, less $1,010B for its stake in CyrusOne, plus $2,690 of debt, less $618 of CONE debt, plus $155M face value of preferred stock (which could be converted to common dilutively) plus $300M of unfunded pension and I get an EV of $2,171 which is 5.6x the CBB ex CONE EBITDA of $390M for 2013. Not that interesting to me considering the company is not free cash flowing or paying a dividend, and outlined a plan that includes probably 3-4 more years of fiber investment. It seems like this thing is a bet on whether or not their fiber strategy works 5 years from now.
Note that even if they sold their wireless business for $1,000 per subscriber or 6x EBITDA (about $400M) the calculation wouldn't change much. I did a back-of-the-envelope on their spectrum value alone and only got to about $150M so there is probably not any unrealized value there.
Am I missing something? Of course if they distributed the full CONE proceeds to shareholders and rolled the dice with a 5x debt/ebitda stub equity it would be interesting, but given their lack of free cash flow I don't think they will take that chance.
|Entry||03/29/2013 04:53 PM|
I guess I understand mikeperry's comments now... it would take a change of thinking at the board level for the arbitrage to be realized. What are the chances of this? Any shareholders making noise? I was a little disturbed to see that management was paying employees a total of $40 to $50M in bonuses for successfully IPOing CyrusOne, when it has not benefited shareholders since this original writeup.