TERREMARK WORLDWIDE INC TMRK S
September 28, 2010 - 1:54am EST by
roc924
2010 2011
Price: 10.34 EPS -$0.50 -$0.65
Shares Out. (in M): 66 P/E 0.0x 0.0x
Market Cap (in $M): 679 P/FCF 0.0x 0.0x
Net Debt (in $M): 454 EBIT 31 39
TEV ($): 1,133 TEV/EBIT 36.0x 29.0x
Borrow Cost: NA

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Description

 

TMRK ($10) is a short. The company should/needs to raise equity soon, the stock is very expensive, expectations for the company are high, and the entry point for the short is solid with the stock up significantly to name a few reasons. I do not delve into a discussion of the industry here; interested readers can reference the recent RAX and EQIX reports.

The company needs to raise equity, or perhaps issue more converts. At the company's current rate of cash burn, low return on capital and upcoming expansion plans, the company should/must raise money soon. My guess is the company will issue equity or a convert with a low interest rate given the company's already high debt level (debt net of cash is 6.4x equity) and interest payments that are growing far faster than operating income.  There is no tangible equity.

TTM ended:

30-Jun-09

30-Sep-09

31-Dec-09

31-Mar-10

30-Jun-10

Operating income

 24

  31

  30

  31

  30

Interest expense

 32

  39

  45

  50

  55

Operating income less interest expense

 (8)

  (8)

 (15)

 (19)

 (25)

Note that TMRK capitalizes about 7% of its interest expense. Including capitalized interest, the $55m TTM interest expense above would be $59m.

Business model generates returns less than the cost of debt. The main reason why TMRK's interest payments are growing so much faster than operating income and interest payments have eclipsed operating income (see above) is that the company does not earn its cost of capital. (For point of reference, TMRK raised $50m of senior secured debt at a 9.25% YTM in April.) Cloud computing seems unlikely to help returns either, given undifferentiated nature of this service. Besides, cloud computing is only 8% of revenue.

 

30-Jun-09

30-Sep-09

31-Dec-09

31-Mar-10

30-Jun-10

Operating return on average net operating assets*

6.5%

8.1%

7.3%

7.4%

6.7%

*TTM operating income divided by average net operating assets (equity plus debt less cash).

 

Here's another way to see the company's poor returns: Net operating assets are up 45% while cash flow is down by 50% from two years ago.

TTM period ended:

Jun-08

Jun-09

Jun-10

Cash flow from ops ($m)

$30

$22

$14

Net operating assets

$362

$394

$525

PP&E

$267

$308

$429

Net debt

$268

$304

$454

Note shares outstanding increased about 11% over the past two years.

 

TMRK has issues with its accounting

  • Revenue recognition red flags
    • The company's 10-K shows unbilled revenue (accounts receivable) at March 31, 2010 (end of FY2010) as $16,089. The most recent 10-Q, filed only two months after the 10-K, shows that same line item as $12,182 on March 31, 2010, with no explanation why the company revised this figure down 25%. Regardless of the issues raised by this change, unbilled revenue was up 140% (or 202% using the 10-K figure) versus the balance at the end of the FY09 ($5,312). Revenue during the same period increased 39%.
    • Deferred revenue growth slowed to 0% while revenue growth remained at 20%.
    • Days sales outstanding rose to 66 in the June 2010 quarter, up from 58 days a year ago.
  • The company could not file its most recent 10-Q on time due to an "error surrounding the calculation and presentation of unpaid purchases of property and equipment balances in the Statement of Cash Flows." The company explained this issue in an August 2010 10-Q NT filing. I think the magnitude was large; the company says its not material.
  • The company missed an interest payment in its December 2009 quarter. "Under the terms of the senior secured notes, the Company was required to pay to the holders approximately $245,000 of this additional interest when it paid the scheduled interest payment payable on December15, 2009. The Company did not make this payment of additional interest at this time. The Company has since paid the additional interest and is in compliance with the terms of the senior secured notes."
  • Construction in progress more than tripled y/y in the June quarter. As the company places this CIP into service, depreciation will accelerate, pressuring income. TMRK capitalizes about 8% of its interest expense.

Valuation is high. The company trades at about 10x book value and has an enterprise value to revenue of 3.8x. That is a lofty valuation for a company without earnings and whose return on assets is low and declining.  The company's EV is 2x its gross investment in PP&E, which is quite high for a company with limited barriers to entry over the medium term, significant assets that depreciate rapidly, and that doesn't earn its cost of capital.

Most analysts value stocks in TMRK's group based on EV/EBITDA. (Let us for now ignore the pitfalls of using this metric on a standalone basis.) TMRK trades at the same 12x EV/EBITDA as EQIX, the company most analysts consider the strongest. TMRK is near most analysts' price targets (mean price target is $10.50). Given these two facts, I would not be surprised to see analyst downgrade TMRK on valuation.

Solid entry point for the short. The stock is up 30% in the past month and has outperformed industry bellwether EQIX by over fifty percentage points in the past year.

Management track record. Management's primary job is to allocate capital. See above for their track record in that regard. Management missed its annual revenue and/or EBITDA guidance in three of the past four years (different years for some). Management missed either EBITDA or revenue guidance every year in the past four.

No insider buying.

 

Catalyst

Company issues equity.
Company only meets or misses analyst estimates.
Gravity takes hold. Companies with high valuations, poor incremental returns on capital and that need financing almost always succumb to gravity.
 
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