CLTZF - The Colt Group

[SI]

I have never posted an investment idea of my own before but here it goes......

 

Description of the Colt’s Investment Opportunity @ GBp 127(Local/Bloomberg Ticker: COLT LN, Pink Sheets: CLTZF):

I believe the mkt has begun rightly pricing in a potential recovery of the European communications companies but mispricing the potential for Colt’s micro-market growth and even eventual consolidation. The Colt Group offers communications and consulting services to enterprise and wholesale customers across Europe. The company’s primary asset is its comprehensive European fiber optic network that has 20,000 ‘on-net buildings’ on its 52,000 ‘fiber miles’ across 41 metros in 192 European cities. Data networks in Europe have lagged their US counterparts in their transition off of legacy applications like voice to growth applications like IP/Data. As a result, margins and valuation multiples are lower in Europe. While a major US network may have voice applications accounting for 5-10% of its revenues, in Europe it could be 40%. Legacy voice is ~16% at Colt today with 4% in legacy data revenues.

 

As data traffic & customers needing fiber continue to increase those numbers with 4G wireless now at hand in Europe, I believe it will follow the lead of the US networks thereby putting the European networks back in the position to again grow their revenue base just as they exit an economic malaise. The company has begun growing revenue(albeit modestly) for the first time in years which is helping to offset the churn from its legacy business but today the stock was hurt on a lumpy loss of some of those legacy revenues but with their products, services and infrastructure finally relevant, I believe this will be looked back as the end of the beginning. 

 

What are we paying:

(1)          For a company transitioning from negative “low single digit” to positive revenue growth, you are paying 3.4x ebitda. By comparison, 18 months ago AT&T sold its Yellow Pages unit to private Equity for 2x ebitda for an asset that is seeing 16% revenue declines and 26% ebitda declines.

(2)          In 2012, Colt’s last publically traded peer, C&W Worldwide, agreed to sell itself to Vodaphone at a 92% premium to the pre-bid price. The deal was done at 3.1x for an organization we think was in a much worse position given CWW’s long & storied history of underinvestment. Not only was that apparent in its cash flow stream which saw more voice than data revenues but we think there were potential future problems. Bernstein said it this way, "In fact CWW is probably the poster child of telcos run for the short term cash incentives of mgmt." It is important to note that VOD was able to pay that price for CWW despite the fact that they do not think it can utilize its tax loss carry-forwards which are significant just as they are for owners in the Colt Group. Assets of that quality, like cBeyond, in the US recently inked a takeout multiple of 5.5x ebitda while the higher quality US companies are at 9.5-11x and I believe Colt’s exit price would be in middle of range.

(3)          A peer of Colt’s based in Eastern Europe(GTS) recently hired Goldman and was able to sell the company for 6.3x ebitda while a well-heeled private equity backed competitor(euNetworks) funded a buyback at prices above those capitalization rates. I think at under 7x ebitda, there are 5-6 realistic bidders that would also look at Colt if it were to become available for sale as tonight’s FT suggests: http://www.ft.com/intl/cms/s/0/8a6f2cd4-ca0f-11e3-ac05-00144feabdc0.html#axzz2zWjEUINJ

 

Other Colt Assets:

-Given Fidelity’s 62% ownership, we get private market stewardship, though to be fair this large control premium is also a source of the discount.

-A 3.287B in gross tax asset or GBp84/share, 63% of the company’s quoted stock price at 127.

-An accomplished and motivated CEO who in 2011 increased his holding by at a price 30% higher than today’s price and Spring 2012 made an incremental purchase to get his personal stake over 1M shares.  This year a Fidelity PM was made chairman which has increased the urgency in corporate efforts.

-Net cash of $265M on the balance sheet, an industry outlier that provides optionality on the recapitalization of the balance sheet.

 

Inorganic Appeal:

-The company held its first analyst day in a number of years in 2012 and has also hired someone to the role of investor relations w/ its 2nd analyst day scheduled for later this year. I believe they are working to build their currency to finally use that balance sheet either as a target which we will get at below or as an acquirer with many of the national telcos forcibly looking at portfolio pruning.

-With asset prices in the sector up in the industry’s 3rd M&A wave and a falling number of M&A targets we think there is an opportunity here. There have been an increase in those buying & reportedly looking in European telecom namely: John Malone, AT&T, Hutchison, Carlos Slim, Buffet’s underlings, Naguib Sawiris, Level 3, as well as Slovakian, Irish and French Billionaires. I think the largest pressure come from US Fiber rollup Zayo whose private equity backers may achieve 10x ebitda in a 2H14 IPO and have openly talked up buying into Europe which lead Fidelity to finally be looking to exit an asset they have held in their portfolio for 20 years to a strategic buyer who we believe could provide meaningful synergies.

 

[no_thanks]

Nice write up.  I bet ZAYO buys them. 

[SI]

Thanks.

 

Looking at the two companies customer bases I do not think Zayo would be the best fit but they may very well raise Colt's price expectations. This is more likely to end up in someone else's arms but they would be foolish to sell at this point unless there was another CEO out there with the type of confidence from his board and shareholder base that would calm Wall Street's institutionalized acrophobic premium syndrome.

[yadayada]

What do you think about retelit? What is a good way to value a fiber network? Location probably makes a big difference? Just based on miles of fibre, Colt looks cheap though. It seems there was an oversupply in fiber in the early 2000's though? And that is slowly correcting now as more bandwith is needed?

[SI]

I am aware of them but I can't say anything about the assets that you could not read in a newspaper or on the corporate website. An 8x multiple of 2015 ebitda is roughly where euNetworks traded before the shareholder led buyout.

 

For the Fiber companies I know I have always had capital invested as a yard stick to compare them to each other but it is rudimentary and should not be used in absolute terms as many of them trade at 1/5-1/2 of the cost of what they put into the ground. I think viewing the companies through a cash flow lens like cable companies would be ideal but since many of them lack capital that really does not work so ebitda is the default. The ebitda multiples are only as useful as your understanding of what in fact is in the ground: how much fiber vs. copper, datacenter mix, customer base, how much is leased or owned, their margin profile, the unique-ness of the routes, etc. From there, an understanding of the growth rate in the context of the asset base is important though as companies like Interoute are growing at a nice clip but potentially in unsustainable ways, you would  have to be careful but that's why knowing the actual asset base is so important. 

 

On your last two questions, Yes.