New Street Research: FYBR quick hit: Jana acquires stake and pushes for a sale
What’s new: Jana has taken a stake in Frontier. According to a press report, they are pushing for a sale of the company (LINK). In an intriguing twist, they say a “large communications company” has invested alongside them.
We are delighted that Jana sees what we see in Frontier - an egregiously undervalued asset that will eventually be folded into a national wireless carrier at twice the multiple and twice the EBITDA that they have today. We don’t think the Company should sell now though.
Our (very) quick thoughts in this (very) brief note.
The case for not selling
We haven’t spoken to Jana, nor heard their pitch yet. We would argue against running a process to sell the company now for the following reasons:
- Broadband multiples are artificially depressed
The broadband sector has seen multiples collapse from 12x to 7x while the equity market sorts out whether the broadband market has two players or four with FWA.
We know the answer. It is “two” for 90% of the country. FWA is capacity limited to 8-10% of the country. This limits the risk to share and pricing. If the companies retain pricing power in 90% of the country then returns will be well above the cost of capital and multiples will go back to 12x.
We are close to the point where equity markets recognize this fact. We are likely at peak FWA adds right now. Adds will likely start to fall next year, providing relief to fixed broadband trends. Multiples will expand.
Selling now would be like selling your home in the middle of a housing crisis. You would only do it if desperate. Frontier isn’t desperate.
- The asset isn’t mature yet
The asset increases in value with every location they upgrade from copper to fiber. They are at 6MM on their way to 10MM. They are close to fully funded for the 10MM. Unless they get credit for the 10MM in a sale now, they should never sell.
Frontier has developed the formula for alchemy - in this case, converting copper to gold. If you are sitting on a pile of copper that will become gold with the passage of time, you wouldn’t sell it for a penny less than the price of gold (less the upgrade costs).
We know the answer to this equation. Fiber is worth at least $3,500 per location (Cable at $3,100 + $600 for lower costs in fiber). 10MM locations are worth $35BN. We know the cost to get there. We are starting at an equity price per share of $86 before giving any value to the copper. Then add something for the 5MM copper locations.
That is the starting point: there are still big opportunities with 1) BEAD; 2) selling non-core assets; 3) decommissioning copper; 5) driving up penetration and margins in fiber markets. It’s worth noting that Dallas has a 62% EBITDA margin. The management team and current owners would be profligate if they didn’t secure value for all of this over and above the starting point.
- The buyers aren’t ready yet
Frontier will ultimately belong to one of Verizon, AT&T, or T-Mobile. Those companies don’t have complete conviction that they need it yet (they will). They are also over-leveraged after spectrum auctions and 5G deployments.
Bidding intensity will go up as the necessity for fixed / mobile convergence becomes clearer (let cable keep driving this point home for a couple of years). The amount they can pay will go up as they repair balance sheets over the next couple of years. More motive + more means = a much bigger multiple in a couple of years.
We have no idea who the “big communications company” is. If it is one of the big three, if they were ready, they would come in the “front door”. If it’s not one of the big three…well, you want it to be the big three. You want all three of them bidding. Why sell to anyone else an allow them to make money on the resale to the big three in a couple of years.
- Frontier should buy before they sell
The most valuable assets in fiber land are what bankers and PE call “platform assets”. That is an asset with a team and process that can be expanded across a much bigger portfolio. Frontier is the platform asset of platform assets. They have beaten the pants off everyone in the industry when it comes to their ability to build and penetrate fiber at scale.
Metronet, Ziply, Allo, Lumos, and others are doing a phenomenal job of deploying and penetrating fiber but they aren’t operating at close to the scale that Frontier is. AT&T is deploying more fiber, but they can’t touch Frontier on execution when it comes to penetration and margins.
Frontier, and its current owners, should capture the value of the capabilities they have built by acquiring other assets that aren’t being as capably managed. Ultimately, the platform they have built will be most valuable to the big three.
We have more reasons, but we will stop there in the interest of getting this out quickly. But please call us if the list above isn’t enough.