First the disclaimers: This is a microcap, and not the most liquid one at that, and it operates telecom networks, that noted value investor graveyard. Despite that, it’s an interesting situation - a cheap rollup that looks set to keep on rolling. I did the writeup when the stock was at $4.20, it moves around a lot given the low liquidity.

The recent sale of TiNet by IQNT got me interested in the name on the other side of the deal. GTT (formerly GTLT) is an asset-light telecoms network provider with a history of growth by acquisition. The company has completed several deals since its inception in 2006, including the recent purchase of TiNet from Inteliquent. GTT has shown an ability to integrate its purchases successfully, but in addition to a continued pipeline of M&A opportunities, there is a new emphasis on organic growth to leverage the existing assets. Management and the Board of Directors have plenty of experience in the space. The company has recently uplisted to the Amex exchange, and started to get some sellside coverage, which should help get the story out and lower its cost of capital for future deals.

Given the trail of wreckage in the telecom space over the last decade or more, I’m not going to argue that this is a great business, but it’s a decent one. It’s capital light, with benefits to scale on the network, and in a deep rolodex of customer and supplier relationships. Management seem to have done a decent job picking assets cheaply off the carcasses of others’ mistakes (*cough* IQNT *cough*) and bolting them on to their own infrastructure.

Valued at 10x run-rate FCF it’s worth about $6. There’s a tax benefit from excess D&A over capex which should persist for a several years more. Value should compound through continued accretive M&A, increased organic growth and rising margins. Then there’s the bonus of paying down expensive mezzanine debt a couple of years out.

The business:

GTT operates an international telecommunications and data network serving high-bandwidth corporate and government customers. It is an asset-light operator, using capacity purchased from other providers around the globe, leveraging its relationships with over 800 global carrier partners throughout North America, EMEA and Asia. It has its own network of Juniper routers in over 200 points of presence (PoPs) around the world, as well as its own network operations centers in London and McLean, VA. It maintains a proprietary database on all of its carrier partners allowing it to quickly price and provide custom solutions for customers looking to create networks connecting multiple locations across the world. It helps to be seen as a neutral provider sourcing the best deals against the bigger national telecom players, and there benefits to scale when pricing against smaller competitors.

History

GTT was originally a SPAC, formerly known as Mercator Acquisition Partners Corp.. In 2006 it acquired two companies, Global Internetworking, and European Telecom and Technology, and has continued its growth through M&A since, merging 14 businesses so far. A summary of their deal history is on slide 4 of the most recent investor presentation at:

http://www.gt-t.net/GTTPDFS/GTT_company_overview.pdf

The deals have been funded with a mix of equity, mezzanine debt and term loans. GTT has been pretty good at integration from a cost perspective – usually done within a couple of quarters. In some cases, they are really just acquiring customer lists, and cutting out pretty much everything else.

Management:

For a small company, GTT has a good amount of telecom and data experience in its management team and board of directors. The Chairman and former CEO, Brian Thompson was Chairman and CEO of LCI until the merger with Qwest. Director Morgan O’Brien was co-founder and former chairman of Nextel. Director Howard Janzen was President and CEO and Chairman of Williams Communications Group. Other members of management bring experience from Winstar, MCI, Williams communications, Sprint and other major players.

Insiders have some real skin in the game. The chart below is from the most recent proxy. Having noted activists like Cannell in the stock to keep an eye on management doesn’t hurt either.

Of course, the downside of the chart above is that about 2/3 of the stock doesn’t trade, so be prepared to be patient when buying.

Financials:

The company has grown rapidly since 2006. I’ve left the LTM income statement column blank because it’s meaningless given the recent acquisitions.

Organic growth has been low to date, growth has mostly been acquisitions. The 10-K for 2006 gives revenue numbers for the predecessor companies and it looks like they were running a combined mid $50mm revenue run-rate before the acquisition. Pro forma for the recent TiNet deal, we estimate a revenue run rate of $180mm, and EBITDA of $28mm, not far from management’s stated near-term goals of $200mm and $30mm.

Return on Capital

To date, the business has been created for an investment of about $135mm, per the chart above, or 5x my estimate of run-rate EBITDA, ~6x (EBITDA-Capex).  Taxed at 40% and you get better than a 10% FCF yield, unlevered on total invested capital. GTT claims to have identified another $400mm of deals representing $50mm of pre-synergy EBITDA that it is pursuing. Given the synergies from leveraging their existing infrastructure, if they can continue to close those deals in the 5x range (pro forma synergies) so I’m happy for capital to be allocated there.

Financing

They have financed some previous deals using expensive 13.5% mezzanine debt, including a portion of the recent TiNet deal. It’s understandable that they may have needed this debt in the past, but the most recent deal primarily involved far more attractive $70mm term loan facility from Webster Bank at 6.75%. With the stock now listed on the Amex, hopefully the cost of financing future deals continues to fall. The mezzanine debt comes due in June 2016, and we expect to see it taken out at a much lower rate.

Organic growth:

Management is also talking about increasing organic growth, which is a new development, and increasing margins on new business. From the most recent call:

“We've retained the best talent across the organization, and have grown the sales organization to close to 50 sales employees across our two business units, Americas and EMEA. …With well over 60% of our revenue traversing our core network, we have transformed the value proposition of our business. We are seeing significantly higher gross margins on our new sales, and we are experiencing lower turn rates for our on-net services.”

………

“On the organic front, we are seeing good traction in our two business units. We have focused our selling efforts on our network-centric value proposition, including network -- enterprise cloud networking, and high band-width IP transit for carriers, content delivery, and hosting.”

………

“With a healthy backlog and robust demands from existing and new clients, we are poised for solid organic growth in the second half of the year, as we look to achieve double-digit organic growth rates.”

………

“So, again, back to the organic growth piece, we historically have maintained a sales force, as we mentioned previously, that was about churn replacement. We basically replaced our churn and we were a single digit, low-single digit grower for many years, were successful in replacing our churn but not being a fast organic grower. As we have moved our value proposition to be much more network centric, we've seen our churn rates fall nicely.”

Valuation:

The listed sharecount is 22.5 million, but the company has a bunch of restricted shares, options and warrants outstanding.  Call it 26.8mm shares if everything is fully vested and included. Treasury method would get you to less than 25 million by my calcs, but I’ll use 25 for now to be conservative.

That gives us a market cap of $105MM, and an EV of $190MM, and a valuation of 6.8x on my $28mm EBITDA estimate. Take the PV of the excess D&A tax asset and maybe its 6.2x..OK, but nothing great so far.

Things look better on free cash flow. Run-rate D&A is about 19mm, capex is 2-3% of revenues going forward (from previous levels closer to 1%) or about $4.5MM, interest runs just under $8mm. Using a 39% tax rate that gives a fully taxed FCF number of $15mm, or just over 14% yield on market cap. That’s a healthier valuation, if we think the cash will be used wisely.

If we assume an 8% blended cost of debt going forward and a 2/3 debt financing on future deals, then acquisitions done at 6x (EBITDA-Capex) will be solidly accretive to FCF. Failing that, there’s some expensive mezzanine debt to pay off in three years time.

So what could it be worth?

Base Case: On today’s business, 10x run-rate FCF gets us to $6. Or 9x EBITDA-Capex gets to $5/share, (ignores the tax shields which are worth maybe another 50c).

Upside case: What happens if management continue to execute, as they have shown every indication of doing:

1. GTT invests their cashflows in deals done at 6x EBITDA-Capex, financed 50%-70% with debt.  Given the $400MM of potential deals they described on the last call, this should be possible.
2. Executing the “double digit” organic growth story.
3. Refinance the expensive mezzanine debt in 2016

Plugging in 5% organic growth and reinvesting the FCF at 5x EBITDA using 50% debt, you get $1/share of FCF by 2015. Using 10x FCF you get a $10 stock.

So there you have it. High free cash flow yield today, history of accretive M&A in a fragmented industry, an emerging organic growth story and experienced board with skin in the game.

Other sources/ coverage:

Investor Presentation: http://www.gt-t.net/GTTPDFS/GTT_company_overview.pdf

Sellside coverage from Drexel Hamilton, Initiation report May 2013

Excellent writeup from MonteSol Capital blog, August 2012: http://montesolcapital.com/uploads/GTLT-Write-Up.pdf

Risks/Concerns:

• Dilution. The Byzantine mess of warrants, restricted stock and options that have to be accounted for in calculating GTT’s FD sharecount bother me. We hope the rate of granting management options and RSUs slows. Value has been created, but prefer to see more of it sticking to shareholders’ ribs going forward.
• Liquidity. You really need patience
• Competition. There are barriers to entry – scale, relationships, IT systems - but this is a business that could be recreated. GTT has bought well, but irrational competition is not unknown in telecoms. And of course, there’s always the risk of newer technology.
• Capital Allocation. Expect management to use its capital for growth – organic and (primarily) M&A. There’s the usual risk of a bad deal but we’re comforted by the history of buying well and the decent insider shareholdings.