Description

CNSL is a classic and timely VIC “special situation” with 10x or more potential upside and multiple ways to win.  Recent public takeover interest has changed the risk/reward, meriting an updated write-up.

Thesis

CNSL is executing a transformation from a “dying” wireline to a high-quality, “growing” fiber business.  We believe this fundamental, company-specific change in the business is likely to create tremendous shareholder value.

CNSL is uniquely positioned to execute such a transition due to its tier-one in-place infrastructure and attractive end-markets.  Because CNSL already has a fully-invested footprint of long-haul fiber, is primarily exposed to attractive markets like Northern New England with aerial (above-ground) infrastructure, and 94% of CNSL’s footprint is favorable monopoly or duopoly markets, we think CNSL has a tremendous structural advantage in that its cost-to-pass is materially lower than peers (for example, FYBR’s cost-to-pass is +44% higher than CNSL’s) and CNSL’s fiber penetration and ARPU trajectories are likely to be best-in-class.  In other words, CNSL has by far the most attractive unit economics of any fiber build-out in the public market, and perhaps the private market as well.

As CNSL progresses with its aggressive and fully-funded fiber roll-out (no debt maturities until 2027 at the earliest), we think the company is on the cusp of inflecting to significant revenue growth, margin expansion, and a multiple re-rating.

Our projections show revenues growing from $1.25 billion in 2022 to over $1.6 billion in 2025/26.  We also project EBITDA margins approach 50% over a similar timeframe.  This implies approximately $800M in EBITDA in 2025/26.  Using a 12x EBITDA multiple (in-line with fiber peers), the company’s enterprise value would be $9.6B.  Subtracting $1.5B of future net debt, we see equity value of $8.1B - indicating a fair value of $70+ per share (114M shares outstanding). 

This represents 11x upside from the current share price of $6.62 per share.

Business Overview

Consolidated Communications Holdings, Inc. (“Consolidated” or “CNSL”) is a US telecommunications company headquartered in Mattoon, Illinois.  CNSL’s equity market capitalization is about $750M, with trading liquidity on the NASDAQ Stock Exchange of $3-4M/day.  The company went public in July 2005.

Headwinds to the Wireline Business Model

Consolidated’s business model is often referred to as a “wireline” telecommunications provider.  A wireline connects physical copper telephone wires to the premises of each paying customer in its service area.  Historically, these customers would then receive landline telephone access via the copper wires.  More recently, with the arrival of the internet age in the 1990’s, wirelines shifted their business model to also provide internet access via either (1) a dial-up connection, which utilizes a telephone line such that only one connection (either internet or telephone) can exist at a time, or (2) a digital subscriber line (“DSL”) connection, which utilizes different frequency bands of the same telephone line to allow internet and telephone to be used simultaneously.

This wireline business model, however, has faced a painful challenge: competition from new technologies. 

In the 2000’s, the use of cellular/mobile phones exploded, presenting an existential threat to landline telephones.  Why call a residence when one can directly dial the specific recipient on a mobile phone?  As cellular phones increased in popularity (according to Pew Research, 97% of US adults now own a cellular phone), growth in residential landline telephones plateaued and then fell into pronounced structural decline.

Demand for faster internet speeds led to the emergence of another formidable competitor: cable internet.  The first cable companies formed in the 1940’s to provide television services via underground coaxial (copper) cable networks.  Like the wirelines, cable companies pivoted their business model in the 1990’s to offer internet access – and with faster speeds than dial-up or DSL, cable competition quickly dented wireline internet growth aspirations.

Consolidated sprinted just to stand still.  Faced with falling landline subscribers and tough cable competition, wirelines sought to cut costs and merge with peers to gain scale.  Consolidated followed this playbook to a “T” – CNSL acquired North Pittsburgh Systems in 2007, SureWest Communications in 2012, Enventis Corporation in 2014, Champaign Telephone Company in 2016, and FairPoint Communications in 2017 – all to no avail. 

From an IPO price of $13 per share in 2005, CNSL’s shares fell more than -50% to just $6 per share today.  Including reinvested dividends, CNSL shares’ total shareholder return has been a middling +3% per year since IPO.

The Fiber Opportunity

CNSL’s acquisition spree did, however, have an important silver lining: the purchase of FairPoint Communications in 2017 brought with it an exceptional and highly-strategic footprint of fiber-optic (“fiber”) infrastructure.

Fiber is widely-viewed as the best and most “future-proof” solution for internet connectivity.  Over time, we believe fiber is likely to substantially displace copper-based internet solutions (including dial-up, DSL, and cable).

We point to four reasons why we think fiber is the long-term winner.

First, fiber offers the fastest speeds.  Dial-up, DSL, and cable all transmit data via electric current over metal (copper) wires.  Fiber is different.  First used in telecommunications in the 1970’s, fiber transmits data via light over hundreds of thin strands of glass or plastic.  This is advantageous as (1) with no electric current, fiber is less susceptible to signal interference from bad weather or nearby electrical equipment and (2) fiber has far lower attenuation (transmission loss) over long distances.  But the most important advantage is simple physics: sending data at near the speed of light is about as fast as humanity can transmit any information, and orders-of-magnitude faster than sending electricity over metal (or using satellite or wireless networks).  Fiber’s speed is “future-proof”.

Second, fiber is symmetrical.  Legacy internet solutions have bandwidth limitations.  They are therefore designed to offer slower speeds for uploads than downloads (i.e., they are asymmetrical).  Fiber internet, by contrast, can tap into a broader range of frequencies.  This killer combination of greater bandwidth and faster speeds allow fiber to offer symmetrical data.  Cable might provide 100 Mbps (megabits per second) downloads and 25 Mbps uploads.  Fiber’s standard “One-Gig” offer is 1 GBPS (gigabit per second) speed for both download and upload.

Third, fiber is not subject to data throttling.  Cable internet is structured as a shared network solution.  During times of peak demand, data is often throttled (reducing internet speeds) to accommodate user bandwidth requirements, causing buffering and other issues.  This is not a problem for fiber internet networks.

Fourth, fiber is less expensive to maintain.  Fiber lines, made of tightly-bound strands of glass or plastic, are strong and durable.  Copper wiring is more problematic.  By relying on electricity to conduct data, copper is susceptible to outages (due to weather, electromagnetic interference, or local power supply issues) and to damage (due to temperature changes, fires, environmental factors, exposure to the elements, and natural degradation) that are expensive to fix and replace.  Copper also requires more infrastructure to operate and maintain – HVAC cooling systems, telecommunications closets, data rooms, and more.  Fiber requires just a transmitter and a receiver.  Fiber networks are simpler, more resilient, more reliable, and less vulnerable to costly outages and damage.

Real-world evidence indicates fiber is winning.  In US markets where fiber has been deployed, penetration often reaches 40% within a few years.  And in a number of markets, fiber has already captured a majority of households.

Fiber Networks Are Extremely Valuable

Given these advantages, it’s no surprise that fiber networks receive premium valuations from investors.

Telecommunications firms (“telco’s”) are generally valued using a multiple of enterprise value (“EV”) to profit (“EBITDA”).  This normalizes the valuation multiple to account for debt levels (telco’s are generally resilient businesses with recurring revenues, so they often maintain a level of net debt) and depreciation (which can be significant following network build-outs).  Depending on the quality of the telco – its market position, industry trends, growth opportunity, etc. – telco’s are often valued at 5-8x EV/EBITDA.

Fiber businesses, however, trade for 11-13x EV/EBITDA – or roughly double the valuation multiple of traditional telco’s (see Exhibit A).  This reflects the attractive characteristics of a fiber business: (1) “future-proof” technology, (2) a meaningful growth opportunity as fiber wins market share from legacy internet networks, (3) pricing power as fiber networks increase average revenue per user (“ARPU”) over time, and (4) a significantly better cash flow profile than traditional telco’s due to lower maintenance costs to manage a fiber network.

Exhibit A

Sources: Company Reports, Author

Importantly, this 11-13x EV/EBITDA valuation range applies to fiber companies that are predominantly (but not exclusively) fiber.  100% pure-play fiber companies command super-premium multiples – we are yet to find a pure-play fiber company in either the US or Europe that has transacted below 20x EV/EBITDA (examples include MetroNet, Hyperoptic, Inexio, IP Only, and Jazztel).

From Wireline to Fiber

In September 2020, Consolidated announced a game-changing shift in its strategy. 

Searchlight Capital Partners, L.P. (“Searchlight”), a respected NYC-based hybrid public/private investment firm specializing in telco’s, agreed to invest $425 million into Consolidated to fully fund the roll-out of fiber across CNSL’s network.  In return, Searchlight received 34.6% of the equity, a subordinated note, and two Board seats.  At the same time, CNSL announced the full refinancing of its debt and extended its earliest maturities to 2027.

In our view, CNSL’s transformation from wireline to fiber can create extraordinary shareholder value.

Consolidated currently operates a network with 2.7 million residential “passings” (premises to which an operator can connect in a service area) across 22 states from California to New England.  The goals of the roll-out are (1) to pass 70% of CNSL’s network with fiber (1.6 million passings) by 2025 and (2) to achieve more than 40% fiber penetration across all markets over the medium-term.  We forecast that once CNSL reaches these targets, the company will generate 80-90% of its EBITDA from fiber customers.

The fiber roll-out is already ahead of schedule.  In 2021, Consolidated initially guided to 300,000 new fiber passings.  The final total was 331,000, over 10% better than forecast.  In 2022, Consolidated expects to deploy a further 400,000 fiber passings – but public commentary from CNSL executives indicate the company is already ahead of pace.  More importantly, CNSL leadership has recently called out that fiber penetration numbers are coming in better than the company’s modeled fiber penetration curves.  With CNSL’s recent launch of a dedicated fiber brand (“Fidium Fiber”) backed by a marketing campaign, we expect fiber penetration to accelerate.

The crux of our investment thesis is that CNSL is uniquely positioned to drive value from its fiber transformation due to the quality of its infrastructure, which makes such a transformation highly economic.

One key advantage is CNSL’s long-haul fiber network.  Long-haul fiber serves as the backbone of any fiber network, but also can be difficult, expensive, and time-consuming to build.  With over 20,000 long-haul fiber route miles already in place, CNSL can focus on passings and connections instead of constructing a long-haul backbone.

Another advantage is CNSL’s New England service area (courtesy of the FairPoint acquisition).  Of its 1.6 million targeted fiber passings, 1 million will be in New England.  This is fortuitous, as over 80% of CNSL’s New England footprint is aerial infrastructure (above-ground, which is less expensive to upgrade to fiber than below-ground infrastructure).  As a result, CNSL has one of the lowest fiber costs-to-pass of any operator in the country.

Finally, Consolidated has a favorable competitive market position.  11% of CNSL’s footprint is a “monopoly” with zero competitors.  Another 83% of CNSL’s footprint is a “duopoly” with just a single competitor.  The remaining 6% is an “oligopoly” with two competitors.  As 94% of its markets are either monopoly or duopoly, Consolidated has a strong incumbency advantage to help accelerate fiber adoption in its service areas.

A side-by-side comparison with Frontier Communications Parent, Inc. (NASDAQ: FYBR; “FYBR”), a $7 billion market cap wireline that is also shifting its focus to fiber, may be instructive:

• Long-Haul Fiber.  100% of CNSL’s network is covered by a fiber backbone vs. 80% of FYBR’s network.  Over 90% of CNSL’s network can support 50 MBPS+ speeds vs. just 50% of FYBR’s network.

• Cost-To-Pass.  CNSL’s aerial-heavy footprint results in an average $550 cost-to-pass vs. an average $790 cost-to-pass for FYBR’s network (+44% more expensive cost-to-pass for FYBR).

• Competitive Market Position.  The numbers tell the story.  CNSL’s fiber churn rate is immaterial to-date vs. 1.6% for FYBR.  CNSL’s copper churn rate is 0.5% vs. 2.1% for FYBR.  CNSL’s average fiber ARPU is $75 vs. an average fiber ARPU of $63 for FYBR.

Consolidated has a superior network, a lower cost-to-pass, and a far better competitive market position than FYBR.

Why Now

If converting from wireline to fiber is so obvious, why did Consolidated (or FairPoint) not upgrade its network to fiber years ago?

The answer, in our view, is simple economics.  5-10 years ago, the transformation to fiber would not have been possible because the investment returns were unattractive.  However, unit economics have significantly improved in recent years driven by (1) lower build costs, (2) higher ARPU, and (3) better market adoption and penetration.

The cost to deploy fiber has declined over time due to dozens of improvements to fiber technology that make installation easier (labor is the #1 cost).  By way of example, fiber cabling today is flexible, whereas in the past it was fixed.  This meant an installer had to stop and splice the fiber cable whenever the conduit went around a corner.  Flexible fiber allow installers to save time and improve productivity, reducing cost-to-deploy.

Consumers also increasingly recognize the value of having the best available internet speeds in their homes.  As a result, ARPU’s and fiber adoption curves are notably better than even a few years ago.  It’s not just lower deployment costs – it’s a quicker payback as customers adopt faster and pay more for a high-quality fiber product.

The Math

Consolidated is set to earn roughly $420M of EBITDA in 2022.  With 114M shares outstanding and a $6.62 share price, the market cap is about $750M.  The company also has net debt of roughly $2.2B (including the Searchlight note) for an EV of $2.95B.  This puts CNSL on a 7x EV/EBITDA multiple.  Sell-side analysts consider this fair (in-line with traditional telco’s) and generally either have “neutral” or “sell” ratings on the stock.

Our variant view is that this valuation framework is backward-looking.  As Consolidated progresses with its fiber roll-out, we think the company will see revenue growth, margin expansion, and a multiple re-rating.

We project $1.25B of revenues in 2022, implying a 34% EBITDA margin.  Our research indicates fiber companies generally earn EBITDA margins above 50% (higher ARPU, lower maintenance costs).  Our due diligence also indicates Consolidated should earn similar or better EBITDA margins than peers given its favorable markets.

On a recent CNSL earnings call, management provided the following commentary:

“We will go net broadband positive in H2 2022.  And from there follows the revenue and EBITDA growth.  (…) We have a strong path forward for growing the trajectory on revenue and seeing significant margin expansion.  Our models do not have EBITDA flat lining from 2021/2022 through 2025.  We’re showing some pretty significant EBITDA growth and margin expansion throughout.”

Our projections show revenues growing from $1.25 billion in 2022 to over $1.6 billion in 2025/26.  We also project EBITDA margins to approach 50% over a similar timeframe.  This implies approximately $800M in EBITDA in 2025/26.  Using a 12x EBITDA multiple (in-line with fiber peers), the company’s enterprise value would be $9.6B.  Subtracting $1.5B of net debt, we see equity value of $8.1B - indicating a fair value of $70+ per share.  This represents 11x upside from the current price of $6.62 per share.

Searchlight’s Ambitions

Naturally, we are not the only ones who see considerable upside in CNSL’s common stock.  There are a number of “smart money” investors towards the top of the shareholder register.

And, of course, Searchlight is well aware of the value too.

In connection with its 2020 investment in Consolidated, Searchlight signed a standstill agreement preventing Searchlight from increasing its position in the company’s shares.  On March 7, 2022, almost immediately after the standstill expired, Searchlight filed a Form 13-D disclosing that it is considering “making open-market purchases of Common stock” and also evaluating “the possibility of a further investment in, or full acquisition of the Issuer” and that it wishes to “have discussions with the Issuer, and sources of co-investment and debt financing, concerning the foregoing.”

Searchlight is intimately familiar with the value creation opportunity in fiber.  Searchlight has a private investment in a firm called Ziply (previously owned by FYBR), a telco undergoing a similar conversion from wireline to fiber in the Pacific Northwest.  Searchlight acquired Ziply for $1.35B and has invested a further $500M in the business.  We understand Ziply’s fiber roll-out is going extremely well.  Searchlight knows the fiber value-creation roadmap.

Our reaction to Searchlight’s filing is three-fold.

First, it is gratifying to see Searchlight wishing to increase its investment.  We have deep respect for Searchlight’s investment acumen in the telco space.  Searchlight’s confidence in CNSL’s equity story is supportive of our thesis.

Second, we plainly do not wish to see CNSL taken private, and much prefer that Searchlight (1) purchase shares in the open market and (2) assist the company in better communicating its equity story to the capital markets.  As we note below, a major reason for CNSL’s share price disconnect is that the company’s investor relations program is ineffective and the company is yet to share a complete investment case with the market.

Third, in the event CNSL is acquired, we would expect to see a deal price at a significant premium not only to the current share price, but also to the stock’s 52-week-high.  In our view, the best approach to valuing CNSL would be to select a fair discount rate and assess CNSL’s value relative to the company’s prospective future value as a predominantly fiber business.  Our understanding is the CEO of Consolidated deeply values his reputation in the capital markets (he took pride in sharing with us that no investor sued the company following the discontinuation of CNSL’s dividend in connection with Searchlight’s investment).  Given the company’s sophisticated investor base, we suspect many voices would be raised to oppose any bid that is not sufficiently attractive.

Risks and Considerations

As with any investment, there are a number of risks to consider with an investment in CNSL.

One is execution.  Our thesis hinges on CNSL successfully building out and winning customers to its fiber network.  So far, Consolidated has executed well and we are confident in the continued success of the fiber roll-out.  That said, should this not play out as expected, our thesis could prove wrong.

Two is debt.  Consolidated currently has $2.2B of net debt, a number that should go modestly higher (as CNSL invests in its fiber roll-out) before declining notably from 2023/2024.  While this debt level is undemanding relative to future EBITDA, it is sizable relative to current profits.  CNSL’s debt is termed out until 2027/2028.

Three is investor relations.  We believe CNSL’s stock trades at a meaningful discount to intrinsic value in large part due to ineffective investor relations.  No single individual at Consolidated is fully devoted to investor relations (one individual handles both corporate communications and IR, a structure we have seen prove unworkable at other firms).  The Board requires stronger expertise and oversight of capital markets communications.  CNSL has failed to present a compelling vision for the future, including medium-term targets, a clear financial roadmap, and specific metrics such as fiber penetration by cohort.  In this respect, CNSL compares unfavorably with FYBR, a company that has done an outstanding job communicating its equity story.  We have shared our views with CNSL’s leadership, and they have indicated a desire to improve investor relations going forward.

Four is an unsolicited takeover.  Given Searchlight’s 13-D filing and CNSL’s undervalued share price, the company is clearly in play.  As mentioned, our desire is for Consolidated to remain independent and focus on (1) executing its fiber roll-out and (2) clearly communicating its equity story to investors via an improved investor relations program.  However, our eyes are wide open that a takeover bid could happen at any moment.

Conclusion

Our investment approach is to seek out businesses undergoing meaningful, company-specific change where the controlling factor for a great investment return is not the latest headline in The Economist or The Wall Street Journal, but instead the development of the underlying business.

CNSL is a perfect match for our investment philosophy.  As Consolidated transforms itself from a “declining” legacy copper/DSL business to a far more valuable “growing” fiber internet business, we believe the company is positioned to create extraordinary shareholder value in the years ahead.

From a current share price of $6.62, CNSL has the potential to increase its intrinsic value by 11x simply by executing its current strategy and more clearly articulating its equity story.  In addition, we view downside risk as protected via a possible takeover by the company’s top shareholder.  This rare combination of meaningful upside, downside protection, and “multiple ways to win” create, in our view, a compelling and timely risk/reward.

Disclaimer

The author of this posting and related persons or entities ("Author") currently holds a long position in this security.  Author may purchase additional shares, or sell some or all of Author's shares, at any time.  Author has no obligation to inform anyone of any changes to Author's view of CNSL US.  Please consult your financial, legal, and/or tax advisors before making any investment decisions.  While the Author has tried to present facts it believes are accurate, the Author makes no representation as to the accuracy or completeness of any information contained in this note.  The reader agrees not to invest based on this note, and to perform his or her own due diligence and research before taking a position in CNSL US.  READER AGREES TO HOLD AUTHOR HARMLESS AND HEREBY WAIVES ANY CAUSES OF ACTION AGAINST AUTHOR RELATED TO THE NOTE ABOVE.  As with all investments, caveat emptor.

Catalyst

-Inflection to positive net-adds in H2 2022

-Inflection to significant revenue, margin, and EBITDA growth beginning in 2023

-Valuation re-rating as market appreciates this is an extremely high-quality fiber asset

-Possible takeover by Searchlight