Company Description

Cincinnati Bell Inc. is a full-service regional provider of data and voice communications services over wireline and wireless networks, a full-service international provider of data center colocation and related managed services, and a reseller of information technology and telephony equipment. The Company provides telecommunications service to businesses and consumers in the Greater Cincinnati and Dayton, Ohio areas primarily on its owned wireline and wireless networks. The Company also provides business customers with outsourced data center colocation operations in world-class, state-of-the-art data center facilities, located in the Midwest, Texas, England and Singapore. In connection with the data center colocation operations in the Midwest, the Company also provides business customers with a full range of managed IT solutions.

Current Situation & Recent History

• CBB is one of the few Independent Local Telecom Company that provide both Wireline and Wireless services on its own network

-    Most wireless providers are national or are affiliates of national wireless providers

-    Both Wireline and Wireless Revenues have been declining

• Wireline Revenues have declined from from $763 million in 2009 to $725 million LTM
• Wireless Revenues have declined from from $307 million in 2009 to $211 million LTM
• To offset this revenue declines, CBB purchased Cyrus Networks (now called CyrusOne), a data center operator, in 2010 and started investing in FiOptics.

-    Data Centers are a high growth, high margin business and a natural fit for a telecom operator like CBB

-    Revenues have grown at CyrusOne from $41 million in 2009 to $249 million LTM

-    Since the value of its data center business was not being reflected in CBB’s stock price, CBB elected to IPO this business (Cyrusone – ticker CONE)

• Company successfully completed an IPO in January 2013 at $19 and the stock has subsequently traded up to $21.5
• CBB retained a 69% ownership in CONE currently valued at $980 million and CBB intends to sell down its stake in CONE over time and use proceeds to pay down debt

-    Additionally, CBB has recently invested in FiOptics (like Verizon's FiOS), that provides video and high speed internet to consumers

• CBB currently covers over 30% of their territory and has a 25-30% penetration rate
• expectations to increase coverage over the next 2 years to 50% of territory and ramp to 25-30% penetration within 12 months of offering service
• CBB had been spending $40-$50 million a year in Capex to roll out this product and has increased its capex spend for Fioptics in 2013 to $75 million
• Subscriber lines have been growing rapidly from 13,800 lines at YE 2009 to 74,300 in the last quarter
• Many “event driven” investors piled into CBB in 2012 to take advantage of the unlocking of value that would be achieved through the IPO of CONE and as a result CBB became a “hedge fund hotel”

-    CBB hit a high in early October of $5.89 a share and was trading above $5.5 a week before the IPO

-    Ever since the IPO of CONE, investors have rushed for the exits

• At the end of January 2013, Jack Cassidy, announced his plans to retire as CEO of CBB (but was going to remain vice chairman) and was replaced by Ted Torbeck, who was the president of CBB’s wireline business
• At the end of February, CBB announced earnings and provided projections that disappointed the street (the New CEO sandbagged numbers)

-    As a result the stock dropped 30% subsequent to its earnings release, as investors still caught in the CONE trade were now forced to sell

• On the next 3 earnings releases CBB has beat street estimates (and even raised guidance on the last conference call) and reiterated its intent to sell the wireless business
• From recent management commentary it seems that CBB is having a difficulty selling its Wireless Business and would prefer running it for cash flow than accepting a below market price

Investment Thesis

• CBB's management is extremely focused on reducing debt and increasing shareholder value

-    The fastest way to accomplish both is through a split up of the entire company.

-    Company has already announced its intentions to sell off its stake in CONE (although they have a 1 year lock which expires in January 2014), and its wireless business

• CBB has over $1 billion of NOL, which will shield them from paying taxes on these asset sales
• Pro-Forma for the CONE stake, CBB would have net leverage of 2.9x EBITDA
• Once leverage is below 3.0x, CBB should be able to refinance much of its existing debt at much lower interest rates
• A rapid decrease in interest expense will be a large factor to the increase in free cash flow
• Wireline Business

-     Wireline revenues are expected to strengthen as revenues for Data & Entertainment (which have been growing) has now surpassed revenues for voice and has become the largest source of revenue for the company.

• Inflection point expected in the 4^th quarter of 2013
• Company has projected for year over year growth in 2014 – which is UNUSUAL for a wireline telecom company

-    Unleveraged free cash flow in the wireline business is expected to be approximately $173 million in 2013 and $186 million in 2014

• These cash flow numbers are suppressed by the increased CAPEX spend on the Fioptics buildout
• As the Fioptics buildout becomes largely complete in 2014 and the company focuses on increasing penetration rather than increasing footprint, the free cash flow will grow rapidly to over $240 million in 2015
• Wireless business

-    The main reason for underperformance of the wireless business is CBB's lack of a national presence and cost of subsidies

-    Company has stated that their wireless asset is much more valuable in the hands of a national wireless provider, especially because of the synergies that it can provide

• Most obvious buyer would be T-Mobile as even after its merger with PCS it has very little spectrum depth in Cincinnati & Dayton
• Valuation - Sum of the Parts:

-    Wireless - Wireless comps (USM, LEAP, TMUS, NTLS & S) trade on average at 7.0x E. 2013 EBITDA.  However, none of these comparables have any real FCF to merit a FCF multiple.

• Using 5x 2013 EBITDA, the Wireless Business would equal $330 million, which would also equal 7.1x unlevered FCF.  Using liquidation value, the Wireless business is worth $300 million ($200 million for the spectrum & Equipment and $100 million for NPV of the cash flows)

-    CyrusOne - as stated earlier CBB’s ownership of CONE is currently valued publicly at $980 million

-    Wireline & IT - ILEC's (CTL, WIN, FTR, HCOM & CNSL) trade at 5.5x 2013 EBITDA which results in a Enterprise Valuation of $1.765 billion for the wireline business

-    Additionally, there is corporate expense of $26 million, using a 5.6x multiple, that would equal a decrease in value of $142 million

-    All together, the value of the segments are worth $3.09 billion which is a $983 million of equity value

-    The resulting valuation would result in a stock price of $3.98 or 26% higher than today

• Valuation –Free Cash Flow & P/E

-    Before $50 million the one-time CAPEX associated with the buildout of Fioptics, and assuming that CBB uses proceeds from CONE to pay down 8.375% Senior Bonds and they refinance their 8.75% sub bonds at 7%, their Pro-Forma free cash flow would equal $132 million in 2014. Comps trade at 7.5x Free Cash Flow (which I think is a low FCF multiple for CBB, since unlike their comps, they will be growing both revenues and free cash flow) which would equal a $992 million equity valuation, which would equal $4.77 a share or 50% higher than today

-    Comps trade at 20x 2014 Earnings.  Assuming paydown of senior debt with proceeds from CONE and the refinancing of the sub debt, CBB should earn $95 million in 2014, or $0.46 a share (fully taxed – which is an aggressive assumption since they will still have a large NOL left even after selling their CONE stake) which would equal $9.18 a share for CBB.  Even using the lowest comp of 15.2x earnings would yield a price of $6.97 a share which is 120% higher than today

• Path to value creation – the company has many catalysts that will create value for investors

-    Resolution regarding wireless business - as stated earlier, the company is actively looking to sell its wireless business.  This business has been in decline and a sale coupled with a paydown of high coupon bonds will immediately add comfort and value to the company.  Even an announcement that they are no longer selling the business, which may be a momentary negative, would help investors start thinking about CBB as a wireline pure play.  A resolution is expected by release of year end numbers

-    Refinancing / Paydown of high coupon senior and sub debt

• Through the sale of its wireless business and further sale of its shares in CONE, the company will pay down debt and radically improve its credit profile, allowing the company to refinance at much lower interest rates and improve free cash flow generation.  Expectations that this should occur in January when the lockup period against selling CONE shares expires

-    Improvements & growth in its wireline business.

• The inflection point is expected to occur in the 4^th quarter of 2013 where the growth generated from Fioptics and buildout of metro fiber overtakes the revenue loss from the slowing of the legacy telephone business.  At the very least, this should come to light when CBB gives 2014 guidance

-    Free Cash Flow and Dividends

• Although the company is not expected to generate free cash flow in 2013 (mostly due to a large paydown of its pension and a one time “bonus” to management for the sale of CONE) but will generated free cash flow in 2014 and will most probably institute a dividend in 2014.  Company has restrictions against paying dividends as long as debt/ebitda is greater than 4.0x.  As stated earlier, their debt/Ebitda raion is expected to drop to under 3.0x in 2014 which should allow the company to institure a dividend

-    Additional upside:

• Buyout (or merger) of entire company - Company has made it clear that all assets are up for sale.  Logical buyer would be CTL which has operations all around Cincinnati and Dayton and would realize significant synergies through a merger or a cable company such as TWC that sees CBB making headway with its Fioptics product
• 2013 increase in interest rates should lower the companies unfunded pension.  Lowering of the amount that the company has to contribute to its pension (now modeled at $40 million a year) will materially add to its free cash flow

Variant Perception

• Recent downturn was primarily driven by CBB being a “hedge fund hotel” loaded with “Event Driven” investors selling on the news of the CONE IPO and then getting out at any cost on bad earnings

-    These investors were not in for the “long haul” and are not interested in the long term growth prospects of the company

• Company does not have a natural equity investor base causing equity values and asset coverage to be understated

-    Classic Wireline (ILEC) investors are not interested because CBB does not pay dividends

-    Wireless investors are not interested since wireless is such a small part of the business and there is no national presence

-    Value of CyrusOne are too small relative to the rest of the Company to garner interest from high growth investors and they have announced their intention to exit their stake in CONE

• High Capex associated with Fioptics scares the investors that are looking for free cash flow

-    CAPEX and other one-time cash expenses will casue the company to BURN cash in 2013.  However, it is expected that the company will grow and deliver free cash flow to investors in 2014

• Fundamentals of Wirline business has been weak for the past few years

-    Unlike CBB, most wireline companies are not growing revenues and therefore they are not the focus of most investors. 

• Wireless business has lost share to national competitors and is winding down.  Value of this business is much greater (through synergies) in the hands of a competitor than with CBB

Risks – What Can Go Wrong? (Level of Impact – Small/Medium/Large; % Likelihood)

• Failure to sell the wireless business (Small; 50%)

-    While failure to sell the entire business would be disappointing, there is much value to the Assets” of this business.  The loss associated with the operating business could mean a loss of 50 cents to the stock

• Further deterioration of wireless business – resulting in a lower sale price (Small; 30%)

-    Valuation of business is already conservative and asset value provides a nice floor

• Deterioration in the price of CONE (Medium; 30%)

-    Every $1 change in the price of CONE causes a $0.21 change in the value of CBB stock

-    This risk can be easily hedged out

• Issues with the rollout of Fioptics business (Medium; 15%)

-    This is the main growth driver of the company and setbacks in this area will cause value to dissipate

-    Company has been highly successful thus far in it roll out

Catalysts:

• Sale of Wireless business – as stated earlier, the company is actively looking to sell its wireless business.  This business has been in decline and the sale coupled with a paydown of high coupon bonds will immediately add comfort and value to the company.  This sale is expected to occur in the next 2 months

-    This is the main near term catalyst, but is significant, especially since wireless has been the biggest drag on fundamentals

-    Now that T-Mobile (the most logical purchaser) has completed its merger with PCS, it is likely that the wireless business will be sold soon

• Refinancing / Paydown of high coupon senior and sub debt

-    Through the sale of its wireless business and further sale of its shares in CONE, the company will pay down debt and radically improve its credit profile, allowing the company to refinance at much lower interest rates and improve free cash flow generation

• Improvements & growth in its wireline business.

-    The inflection point is expected to occur in the 3^rd or 4^th quarter of 2013 where the growth generated from Fioptics and buildout of metro fiber overtakes the revenue loss from the slowing of the legacy telephone business