TCX - Tucows

[jgyetzer]

Thanks to valueinvestor for suggesting a new thread on Tucows.  I am a longtime Elliot Noss fan, but recently started a small position in TCX.  The main thrust here is a bet on good management with a history of solid capital allocation redirecting funds from existing cash generative businesses into fiber-to-the-home network growth. 

 

Tucows has a 19-year history as a public company.  CEO is 56-year-old Elliot Noss who has been with the company since the 1990s and is a major shareholder.  Through sound acquisition strategy and prudent share repurchases, Noss has overseen a 16.5% annualized return since IPO.  The vast majority of existing business is comprised of internet domain services (~2/3 of revenues) and a low-cost MVNO called Ting wireless (~1/3 of revenues).  These have a combined $50M of EBITDA and $40M CFO the past few years.  Consistent cashflows are derived from mostly recurring revenue sources and require very little capital reinvestment. 

 

The other leg of Tucows is their fixed broadband investment into FTTH build.  After starting at a trickle in 2015, annual investment in fiber has grown to $8-9M per quarter or substantially all of the cash produced by existing business lines.  This investment has generated 11K subscribers, 45K homes passed and 168K planned serviceable addresses with high year-over-year growth (~50%) in all three metrics.  While fiber internet has not been a financial contributor, management is anticipating those benefits will begin to emerge in 2021, which is consistent with the timelines laid out from early on. 

 

It is the fiber network and the reinvestment opportunity that I find most interesting.  The investor relations site does a very good job of laying out expectations.  Cost to build per address is $1000-1500; gross margin of $1000; take rate at year-1 is 20% and year-5 is 50%.  Elliot has mentioned that their experience with early communities are consistent with these expectations and they have confirmed these numbers repeatedly over the years.  Management's stated cash-on-cash hurdle rate is 20%, but as they have claimed fiber is expected to produce 60% net margins, the returns look to be even more attractive if things play out as planned.  Apparently these high returns are achievable by cherry-picking communities with favorable profiles.  They have also stated that their contraints are not in opportunity or in capital, but rather systems/management implementation.  For those reasons, I would anticipate reinvestment opportunity will decrease at some point.  However, given their size, fiber looks like a very attractive opportunity with substantial runway.  Elliot has commented multiple times that he sees a multi-decade opportunity.

 

As to valuation, Tucows has a market cap just shy of $600M and EV of $700M.  I'm not very enthusiastic about the MVNO business which has had issues the past few years with network provider contracts and declining revenue.  However, they've maintained low CAC and high customer satisfaction ratings for several years running.  At worst it seems returns from mobile will stagnate or run off slowly.  I'm not too worried about management allowing it to become a loss-making operation.  Internet and domain services has a decades-long track record and has been well managed.  Although organic growth has basically been minimal, they have a high renewal rate and consistent track record of cash generation.  I don't know exactly what multiple to apply to this mix of businesses, but I certainly wouldn't say TCX looks cheap here.  At 10x legacy EBITDA we would in be essence suggesting that the existing fiber network and investment opportunity is worth $200M

 

With that assumption, the market would be applying a value on a per-home-passed basis of $4,400.  That is on par with traditional cable broadband internet providers.  While that may be within shouting distance of reasonableness, the cable companies are mature and scaled businesses with no need for assumptions about take-rates or operational capabilities.

 

So valuation seems reasonable, but definitely not optically cheap.  Why invest now? 

1. I think the fundamental value of high speed broadband is under-appreciated.  The fiber reinvestment opportunity is striking.  While I do really like traditional broadband providers, I agree with Noss that FTTH is a future-proof way to invest.  Fiber assets have a decades-long lifespan.  It is hard to imagine their ability to deliver tremendous symmetric data will not increase in value to end-users as well as infrastructure investors.  If things go according to management's plan, returns will be fantastic.  In the scenario where they are wrong about timing of uptake or costs of network management, the duration of asset value and pricing power provides a margin of safety. 

 

2. The most recent conference call suggests that the COVID pandemic has created unanticipated tailwinds for both the domain registration business as well as broadband.  Earnings in the domains business were up substantially as businesses rushed to establish greater online presence.  To quote, "We are seeing first-hand the rush for offline businesses to market, transact and fulfill online. We are seeing years of economic transformation jammed into weeks or months."  Management seemed to suggest that this was only the tip of the iceberg with substantially greater benefit expected in Q2.  Meanwhile, the demand for and value of high-speed internet is bolstered for what I think are obvious reasons.

 

3. In recent quarters the company has restarted share buybacks at prices just under $50.  This is meaningful to me not only because Noss has a very good track record of prudent repurchases, but also because the timing of of their fiber buildup means he now has insight into whether plans are coming to fruition.  I don't think he would spend money on buybacks when he has substantial reinvestment opportunity at hand unless there was a real sense that he believes shares are undervalued.

 

To those reading - I hope this was not too meandering.  This was my first attempt at trying to collect my thoughts on an investment for others to read.  It's hard!

[CorpRaider]

Digging trenches and laying fiber has returns like that?  I had no idea.

[jgyetzer]

Grab a shovel

[arcube]

Thanks to valueinvestor for suggesting a new thread on Tucows.  I am a longtime Elliot Noss fan, but recently started a small position in TCX.  The main thrust here is a bet on good management with a history of solid capital allocation redirecting funds from existing cash generative businesses into fiber-to-the-home network growth. 

 

Tucows has a 19-year history as a public company.  CEO is 56-year-old Elliot Noss who has been with the company since the 1990s and is a major shareholder.  Through sound acquisition strategy and prudent share repurchases, Noss has overseen a 16.5% annualized return since IPO.  The vast majority of existing business is comprised of internet domain services (~2/3 of revenues) and a low-cost MVNO called Ting wireless (~1/3 of revenues).  These have a combined $50M of EBITDA and $40M CFO the past few years.  Consistent cashflows are derived from mostly recurring revenue sources and require very little capital reinvestment. 

 

The other leg of Tucows is their fixed broadband investment into FTTH build.  After starting at a trickle in 2015, annual investment in fiber has grown to $8-9M per quarter or substantially all of the cash produced by existing business lines.  This investment has generated 11K subscribers, 45K homes passed and 168K planned serviceable addresses with high year-over-year growth (~50%) in all three metrics.  While fiber internet has not been a financial contributor, management is anticipating those benefits will begin to emerge in 2021, which is consistent with the timelines laid out from early on. 

 

It is the fiber network and the reinvestment opportunity that I find most interesting.  The investor relations site does a very good job of laying out expectations.  Cost to build per address is $1000-1500; gross margin of $1000; take rate at year-1 is 20% and year-5 is 50%.  Elliot has mentioned that their experience with early communities are consistent with these expectations and they have confirmed these numbers repeatedly over the years.  Management's stated cash-on-cash hurdle rate is 20%, but as they have claimed fiber is expected to produce 60% net margins, the returns look to be even more attractive if things play out as planned.  Apparently these high returns are achievable by cherry-picking communities with favorable profiles.  They have also stated that their contraints are not in opportunity or in capital, but rather systems/management implementation.  For those reasons, I would anticipate reinvestment opportunity will decrease at some point.  However, given their size, fiber looks like a very attractive opportunity with substantial runway.  Elliot has commented multiple times that he sees a multi-decade opportunity.

 

As to valuation, Tucows has a market cap just shy of $600M and EV of $700M.  I'm not very enthusiastic about the MVNO business which has had issues the past few years with network provider contracts and declining revenue.  However, they've maintained low CAC and high customer satisfaction ratings for several years running.  At worst it seems returns from mobile will stagnate or run off slowly.  I'm not too worried about management allowing it to become a loss-making operation.  Internet and domain services has a decades-long track record and has been well managed.  Although organic growth has basically been minimal, they have a high renewal rate and consistent track record of cash generation.  I don't know exactly what multiple to apply to this mix of businesses, but I certainly wouldn't say TCX looks cheap here.  At 10x legacy EBITDA we would in be essence suggesting that the existing fiber network and investment opportunity is worth $200M

 

With that assumption, the market would be applying a value on a per-home-passed basis of $4,400.  That is on par with traditional cable broadband internet providers.  While that may be within shouting distance of reasonableness, the cable companies are mature and scaled businesses with no need for assumptions about take-rates or operational capabilities.

 

So valuation seems reasonable, but definitely not optically cheap.  Why invest now? 

1. I think the fundamental value of high speed broadband is under-appreciated.  The fiber reinvestment opportunity is striking.  While I do really like traditional broadband providers, I agree with Noss that FTTH is a future-proof way to invest.  Fiber assets have a decades-long lifespan.  It is hard to imagine their ability to deliver tremendous symmetric data will not increase in value to end-users as well as infrastructure investors.  If things go according to management's plan, returns will be fantastic.  In the scenario where they are wrong about timing of uptake or costs of network management, the duration of asset value and pricing power provides a margin of safety. 

 

2. The most recent conference call suggests that the COVID pandemic has created unanticipated tailwinds for both the domain registration business as well as broadband.  Earnings in the domains business were up substantially as businesses rushed to establish greater online presence.  To quote, "We are seeing first-hand the rush for offline businesses to market, transact and fulfill online. We are seeing years of economic transformation jammed into weeks or months."  Management seemed to suggest that this was only the tip of the iceberg with substantially greater benefit expected in Q2.  Meanwhile, the demand for and value of high-speed internet is bolstered for what I think are obvious reasons.

 

3. In recent quarters the company has restarted share buybacks at prices just under $50.  This is meaningful to me not only because Noss has a very good track record of prudent repurchases, but also because the timing of of their fiber buildup means he now has insight into whether plans are coming to fruition.  I don't think he would spend money on buybacks when he has substantial reinvestment opportunity at hand unless there was a real sense that he believes shares are undervalued.

 

To those reading - I hope this was not too meandering.  This was my first attempt at trying to collect my thoughts on an investment for others to read.  It's hard!

 

Very well written post with some great analysis. Thank you for sharing.

[beerbaron]

So if laying fiber is such a great investment why is there not hundreds of companies investing in that space?

 

I heard google did a few projects but never really scaled up, again, why?

 

Thanks

BeerBaron

[valueinvestor]

Thanks to valueinvestor for suggesting a new thread on Tucows. 

 

Thank you for the great post!  ;D

 

I completely agree with your thesis - I think Elliot Noss is a massively underrated CEO and Tucows will be cash-flow generative. Unfortunately, I could not bite the bullet with Tucows for one reason - dominance and quality.

 

Tucows is simple to understand and free-cash-flow generative, but I think that is mainly due to Elliot because he's a great operator/opportunist and not the business as I believe it's subpar. It's amazing what he was able to do with the domain business, where he's effectively charging a 100%+ premium for competitive advantages that I still am not able to understand or maybe I do but can't wrap my head around it.

 

Secondly, Tucows hidden assets of premium domain names, which I effectively think as online real estate can be conservatively estimated at $25M to $100M, where they are earning $5M+ with 80%+ gross margins through ad placement on those domains alone. They also have a mail bank of emails consisting of the most common names such as john@smith.com, where they bought it for I believe around $15M, which I believe is valuable and underpriced. In my humble opinion, I feel like they are under-monetizing on those assets even to this day, compared to other players such as GoDaddy, it maybe a different story today.

 

So if laying fiber is such a great investment why is there not hundreds of companies investing in that space?

 

I heard google did a few projects but never really scaled up, again, why?

+

Thanks

BeerBaron

 

Now, this is the crux of the problem, but I find it hilarious reading this because I made the same statement with Ting Mobile, and looking back I made a massive mistake.

 

Although they had problems in the past with Ting Mobile, last time I checked it was still massively profitable overall. For an operator to pivot from the domain business and carve out a completely new and unrelated business with infrastructure, as well as, brand (Ting Mobile) from scratch is next to impossible. Even to this day, I still do not believe how they pulled this off because it's one thing to be profitable but to have a net promoter score of 90+, where you're the highest in the world as a mobile operator and ahead of Amazon is ridiculous. That is why I believe the stock had a massive-run because no one expected for Elliot to pull this off - or anyone for that matter. For Pete's sake, it's an MVNO.

 

That's why I admire Elliot a lot because it is rare to find a CEO who's an operator, manager AND capital allocator. Typically in my experience, a CEO has only one of those traits, two at most, but with Elliot, he's hitting all three. He's able to take commoditized and subpar quality businesses and extract excellent returns, where many fail or at the very least would not even entertain entering. Even today, who thinks MVNO can provide great returns? Much less five years ago or even ten years ago?

 

Therefore, if you're looking for quality then Tucows is not for you, IMHO. At least, in the beginning, it would be a collection of subpar quality businesses, where Elliot is able to extract excellent returns. In fact, that's what I believe what Elliot does, he goes into markets where TAM is large and/or competition effectively close to zero, where they can limit their downside.Remember they do not need to scale tremendously, and can always let go of the lever when the returns do not meet their hurdle rate. When that happens, I'm sure Elliot will be able to reallocate the funds to another opportunity or return value to shareholders via buybacks, dividends, etc.

 

Now this brings us to valuation, as jgyetzer mentioned, it's not cheap on an asset/cash-flow basis, but I'm willing to bet it's valued less than Private Market Value. If you are investing in Tucows at this moment, I think you're effectively investing in Elliot Noss. If you comp the economics of their FTTH build with other providers like Charter, it paints a very different picture than what management is painting, however again, you may miss out as I did when I comped the economics of Ting Mobile with other MVNO.

 

This company, dare I say it - is reminiscent of Berkshire Hathaway during the textile days. A commodity business that grew into a well-respected conglomerate that we all love and admire. Looking at Elliot Noss, he may very well be on that track, but who knows, I have no idea what his aspirations are for the future. However, I would not be surprised if Tucows turns out to be a baby-Berkshire decades later because he's a huge insider with more than a decade of experience and an avid buffet follower. 

 

Either way, there are very real risks such as execution, key-man, quality, competition, buffet curse, etc.

 

Hopefully, that rounds out the view on this name.

[dwy000]

I followed this for a long time but lost track recently.  You're right, if you're looking for quality, large moat businesses this is not for you.

 

The domain business is low to zero growth but a good business that reliably churns out cash.  They used to use it to buy back stock but then went into mobile.  Mobile is not a good business (as a sub scale MVNO) but they found a small niche.  Unfortunately this is a scale business and the shrinkage is increasing.  Hurt even more by the move from GSM when they moved off of TMobile.  Ultimately they will need to convert all their customers to the new network which will generally require new phones.  This business will likely continue to shrink but throw off some cash (also shrinking).

 

They then went into fiber which was a real head scratcher for me.  To spend big cash from reliable businesses on a product that both Google and Verizon stopped building and got out of?  Not sure how they will make it work.  The numbers are not great there (although admitedly I've only done a cursory review).  Customers should grow in this business exponentially as the new markets are added and usage on the existing systems increases.  But it's not.  In 1Q they added 600 customers which on an annual basis is less that 2018 - and they have way more markets now.  From a value basis they acquired Cedar for $4.6M for 780 customers which is $6k per customer.  On the 11,600 customers Ting has it would imply a value of $70M.  But they have spent $100M in capex.  Seems cheaper to buy than build.

 

I guess they can plug along and try to make it work but that $100M would probably have been better spent on stock buybacks. 

 

I like Elliot Noss and what he's built but other than domain it's a collection of businesses with no competitive advantage against massive competitors.  They got the low hanging fruit and built a niche but I just don't see where profitable growth is going to come from and provide a good return on invested capital.  I wish they would just go back to stock buybacks.

[StubbleJumper]

So if laying fiber is such a great investment why is there not hundreds of companies investing in that space?

 

I heard google did a few projects but never really scaled up, again, why?

 

Thanks

BeerBaron

 

 

I can't give you hundreds of companies, but moving into laying fibre was the big strategic move that Boston Omaha announce over the past year.  For people who don't love Tucows' legacy businesses, Boston Omaha might be the opportunity to get exposure to fibre with a couple of pretty smart co-CEOs.

 

 

SJ

 

 

 

[jgyetzer]

So if laying fiber is such a great investment why is there not hundreds of companies investing in that space?

 

I heard google did a few projects but never really scaled up, again, why?

 

Thanks

BeerBaron

 

I think there are plenty of evidence that others are seeing value here, but it all seems to come down to capital base in relation to opportunity size, expected returns, and timeline.  In the public sector BOMH is mentioned above.  Also in Lincoln is Nelnet.  There was recently a very visible bidding war between Brookfield and Macquarie for Cincinnati Bell whose primary asset was fiber broadband.  Altice has ongoing fiber build.  Here in the midwest, we see small, private companies building FTTH to select communities and developments. 

 

You mentioned Google specifically.  I can't say for sure what their reason for withdrawing from the space.  Maybe it wasn't core to their business.  But it may also have been a matter of finding projects of enough size that offer sufficient return.  Google Fiber cities include names like Denver, Miami, San Francisco, Atlanta, etc.  Most of Tucows' communities I couldn't find on a map.  To me, this suggests that the ability to be selective with build site matters for returns.  This is not a flaw with Google by any means but a network investment proportionate to that of Tucows would imply they'd need to spend well over $100B which could be challenging.

 

Another way of thinking about it is not just investment in FTTH per se, but in the means to deliver high speed broadband internet.  From that perspective EVERYONE is investing.  Charter is one of my favorites.  As you know, they just put billions of dollars and several years into upgrading their network to deliver speeds a fraction of what FTTH can provide.  And as demand for speed increases, they'll probably do it again.  Meanwhile the mobile operators are desperately seeking ways to defy the laws of physics with 5G fixed-mobile.  This is not to suggest that cable broadband isn't a good investment - I own several of those operators too and think they'll do very well for the foreseeable future. 

 

Over time I think the value of the FTTH only increases.  Photons over glass will always be the fastest means of data transfer.  The terminal value of this thesis doesn't really work unless one believes the demand for data will continue to grow geometrically.  I just can't imagine that it will not.  I am painfully aware that being too early is the same as being wrong.  But I'm comfortable that even if only mediocre returns are possible in the short term, the longer thesis will play out eventually.

 

On that note - dwy000 - it's a good point about the small active subscriber additions in Q1 (only 600).  Management mentioned that due to the quarantines, they stop doing installs for most of March (almost 1/3 of the quarter).  They also said they'd seen a dramatic increase in demand and will be scrambling to keep up.  Because of that and for reasons stated above I gave them a pass on the weak adds.  I'm okay with Noss being off on the timing, but I think you're right - it's a number to watch.

[stahleyp]

Kerrisdale did a short piece on this a while ago:

 

https://www.kerrisdalecap.com/investments/tucows-inc-tcx/

[valueinvestor]

There was recently a very visible bidding war between Brookfield and Macquarie for Cincinnati Bell whose primary asset was fiber broadband.

 

Do you think markets will value Fiber Broadband assets valuable? Unless I remember incorrectly, Cincinnati was trading at depressed valuations for a long time.

 

Secondly, do you think the economics of what management is painting is true? I have a hard time understanding how they can achieve $1000 in gross profits, which already does not sound great to me when factoring expenses after COGs, such as SG&A and Marketing.

 

I really feel this is a jockey investment.

[jgyetzer]

100% agree the jockey is a major part of the attractiveness as compared to other fiber internet investments.  Essentially, “I like the cut of his jib,” is pretty qualitative and non-analytical.  I like the way he communicates and I can understand the business.  Plus he’s backed by 2 decades of good performance.  But that’s no guarantee going forward.

 

How the market will value the fiber assets is hard to say.  I’m confident that their utility will increase over time and once they are in the ground, very little maintenance expense is required.  As long as the company isn’t in financial distress there wouldn’t be a pressure to sell.  Like you pointed out - being able to trust management not to create an over-leveraged situation is important.

 

I don’t find it hard to believe they’ll get $1000 gross margin - that’s basically $80-90 / month subscription which is competitive with other gigabit services and provides the additional benefit of symmetric upload speed and better latency.  To me the bigger question, as you mention, is how efficiently can they operate and how fast will uptake be?  They should be able to borrow some of the successes in marketing, branding and customer service from the mobile experience.  But yes, in the near-term you have to have some faith in Noss to execute. 

[valueinvestor]

https://apple.news/AkG51xzmxQVWuMZAz7if4TQ

 

How legit is this? Not invested but if true, I think this impedes on Tucows growth.

[matts]

https://apple.news/AkG51xzmxQVWuMZAz7if4TQ

 

How legit is this? Not invested but if true, I think this impedes on Tucows' growth.

 

this article is about Canada and tucows only operates in the US. Tucows also builds fiber in small cities but still cities. It's not "rural". Besides that, satellite internet could never match the speeds and bandwidth capacity of laid fiber. So, the article really is not very relevant to Tucows.

[valueinvestor]

Awesome thanks! I was curious on the tech side and if other's can do this.