July 08, 2010 - 3:40am EST by
2010 2011
Price: 3.19 EPS -$0.50 $0.40
Shares Out. (in M): 25 P/E N/A 8.0x
Market Cap (in $M): 80 P/FCF 1.3x 1.3x
Net Debt (in $M): 451 EBIT 19 20
TEV ($): 521 TEV/EBIT 27.0x 26.0x

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LodgeNet was written up once before in 2008 at around the same price per share. I suggest you read that review to understand the company's core business. In short, they have an essentially monopoly position in the video-on-demand and interactive television market in US hotels.
At the time of that writeup, LNET was looking like it might go into bankruptcy. In fact, after that writeup, the stock dropped to $0.50 per share, with its debt selling for around 60 cents.
The issue was that the company's debt has a covenant requiring LNET to maintain a consolidated leverage ratio below a fixed number which dropped from quarter to quarter. As things stood at that point, it seemed pretty clear that the company would not be able to stay in compliance with this covenant.
Since then, however, the company completed an issuance of convertible preferred stock (with a conversion price in the high $3s per common share) and a small common-stock offering.
The proceeds of these two offerings were used to pay off debt. The downside is that, because they happened when the company's stock was at a relatively low price, they were fairly dilutive. The right way to think about the company is therefore on an as-converted basis for all its equity. On this basis LNET has about 40M common shares outstanding.
LNET's results are rather confusing and poorly understood by the investment community. There are several pieces of information which are critical in analyzing them:
1. LNET has lost a lot of money in the past, but this is largely due to depreciation due to installations in hotels. Because the going-forward costs of renewing a hotel (contracts typically last around 7 years) are substantially lower than depreciation costs, Free Cash Flow is a much more useful metric than earnings in valuing the company.
2. LNET faces constant concerns that some new technology will outmode the television in hotel rooms. Most recently, concerns have centered on Apple's iPad. In fact, revenue per room is a bit higher than it was 15 years ago. This strongly suggests that, in spite of rapid change in entertainment technology, hotel customers continue to view the television as their primary entertainment source while travelling.
3. Prior to the company's purchase of its only sizable competitor -- On Command Corp -- it was very hard to make money in this business because hotel chains would constantly play the two companies off against one another. Now that LNET controls the vast majority of the market, they have far more pricing power with hotels. This has made revenue more stable, and it has decreased the cost of the physical plant on upgrades and new installs. New, cheaper television and computer technology have also helped on this score.
LNET currently generates between $60M and $65M a year in free cash flow. At current share prices, with 40M shares outstanding, the company's equity capitalization is around $127.6M. That means the Price/Free Cash Flow ratio is just a bit north of 2.
The company has a lot of debt, but at the rate it generates cash, it is paying debt down rapidly. Also, there is little concern of the company falling out of covenants on its debt. Management indicated in their most recent conference call that the consolidated leverage ratio has now reached levels that protect it from breach from now through the expiration of its credit facility.
Just a few weeks ago, the company's stock traded at twice its current levels. Since then, two of its major holders have dumped their shares, with no news from the company.
One holder was a major purchaser in a common equity offering the company did a few months back at $6 per share. That holder has accepted about a 50% loss in its sales. This strongly suggests the holder had external reasons to sell, as it's unlikely they would have signed up for a secondary offering only to dump the shares so soon afterward.
Industry trends actually suggest that LNET may have a very strong Q2. Hotel revenue per available room is up significantly from a year ago and from the first quarter. 


* Major seller completes selling out its position
* Q2 report comes out demonstrating that the company is doing fine
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