Description

I always use 260 million shares, although 244.4 million shares are listed. The company issued 260 million shares where 15.6 are reserved as incentive to management. Management compensation is very much focused on stock price incentives. Currently there are $244.4 million shares that at bk exit were held by old bondholders. Glendon Capital Management owns 20.84 million shares or 8.1% using 260 million shares outstanding. Ares Investment Management owns 35.205 million shares or 13.5% using 260 million shares. Neither seems to be selling. Otherwise, I would assume that there is a fairly large percentage of old bondholders that are selling FYBR equity. Since coming public about 105 million shares have traded.

Investor communications

Management has been pretty communicative as to what their plans are and one can find the recent presentations by management at the following link.

https://investor.frontier.com/news-and-events/webcasts-events/default.aspx

Fiber presentation

https://www.eff.org/files/2019/10/15/why_fiber_is_a_superior_medium_for_21st_century_broadband.pdf

Above is a link to a paper that lays out the industry dynamics that I would suggest reading first. It lays it out all from jitter, attenuation, noise, bandwidth, Shannon limit, wireless, cable, fiber, etc. …

Management

I feel management gets it. And that is important. They want to take a company valued as a declining low bandwidth copper provider with a low multiple to a high multiple highest bandwidth fiber broadband provider. This requires that the right people are in the right place. I believe they have a great team. And that comes out when listening to the management presentations. Prior management was weighed down by an excessive debt load, where new management can focus on the build out and operations.

-        They are focused on cutting $250 million out of the cost structure. And see significant opportunities to unload excess assets.

-        They have a person in charge of the copper to fiber conversion that has overseen more than 10 million conversions for AT&T.

-        They understand the importance of downtime and customer service. The current CEO executed a turn around for Vodafone UK focusing in product quality and customer service.

-        They are focused on their priorities being the conversion and driving up broadband penetration.

-        They seem to be conservative in their assumptions.

-        They are focusing on new segments where they believe they can drive significant value beyond just residential customers. They are focused on gaining share in the wholesale market and recent made downward pricing adjustments to their wholesale offering. They also realize there is significant value to be created focusing on midsized and small business offerings. Btw. small and medium businesses tend to have a much higher ARPU than residential customer have.

Anyway, management is important here, especially when it comes to the build out of the fiber network. It is not as if they are the first one to buildout a fiber network. Still good to know they have a person in that job that has done it all before.

Demand for data and the importance of the internet

Since Al Gore invented the internet there hasn’t been a month that the internet hasn’t become more important to users in the aggregate. More data, more services, more apps, more appliance, etc. It seems to be an unending move towards more data with no end in sight. Especially important for fiber has been the increase in upload data. Frontier stated that since the start of covid they have seen a faster increase in demand for upload services than the five years prior. Cable is limited when it comes to upload speeds, for example under Docsis 3.1 only 1 GB is reserved in the loop for upload traffic, fiber has 40 GB reserved per loop. Lately we have seen a significant increase in demand for upload bandwidth, a trend that will continue and benefit fiber.

Fiber

Fiber is the superior solution for the provider as well as the consumer.

First, from a provider perspective fiber is a great inflation hedge. The cost of the installed fiber stays the same for decades where over time the monthly price of the BB connection continues to increase.

Let’s start with the value to the provider. A fiber connection is more valuable to the provider because it lasts longer and requires less maintenance/upgrade capex than cable does. Cable suffers significantly more from all the data transportation issues, being attenuation, jitter, latency, noise, ect. To the point that cable is required to continue installing more nodes per user in order to increase the speed of their network to the consumer. In short, for cable more and more the last mile is becoming the last meter. All the while faster speeds for fiber only require one to switch out the optical equipment on each side.

From the perspective of the consumer the benefit of fiber is no slowdown because of the loop that one is on. Fiber has 10,000 times more bandwidth than cable does. So, depending on the size of the loop, when your neighbors get online at the same time on a cable connection one might see significant slowdowns in speed. One gets little value of the fact that one’s cable connection works at 1 GB at 3 AM when one is asleep. What is relevant is the speed one gets at 7 PM when we are all using data at the same time, especially with upload speeds.

Otherwise, fiber provides for lower latency, significantly more upload bandwidth, no data limits and faster download speeds.

-        Download speeds are faster and consistent without impact of what your neighbors might be up. There is a reason why cable providers sell “up to 400 mbps”, rather than 400 mbps.

-        Latency is significantly lower. For example, your data going through a cable repeater can cost you up to 8 milliseconds. I am not a gamer, still I always notice when I am on a cable network.

-        Upload speeds are becoming more important the last few years as video uploading, security cameras, cloud computing, gaming, etc. have all become more ubiquitous, a trend that will continue. Cable has limited upload capacity per user as well as for its loop. Often the real cable upload speeds are only a fraction of the advertised download speeds.

-        No data limits are needed with fiber. For example, in my area Xfinity charges an extra $25/month to remove the data cap. This data cap limit is not needed for fiber as it is hard to see how one maxes out a fiber loop, while on a cable loop that can cause problems.

If this data growth continues, cable’s competitive position will continue to suffer versus fiber. It is important that this trend continues. Now if it does that, the value of a fiber user will continue to increase over time.

1^st, 2^nd and 3^rd wave

FYBR breaks up its assets in 3 groups. I will value the company using these groups.

-        1^st wave: 3.2 million existing fiber passings with 1.358 million users. This asset provides $1 billion in EBITDA. Currently this asset has a penetration rate of 41.5% where it used to be 50%. Management believes that it can drive up this penetration back to 50% which would provide for significant increase in valuation. While I believe that through better customer service, less downtime and attractive pricing this is possible, I do not include this in my valuation.

-        2^nd wave: 6.8 million existing copper passings that the company has already defined as ready to be converted to fiber through 2025. 400K have already been done and another 400K are to be converted for 2021. 1 million should be converted through 2022, 1.6 million in 2023, and 1.7 million will be converted in 2024 and 2025 each year. Management believes it could physically handle more conversions that are currently planned.

-        3^rd wave: 5 million existing copper passings. Originally, I wondered about the value of this last group of passings, but am now convinced they have value. Congress is allocating significant subsidies for fiber conversions in poorer, rural areas, which can benefit FYBR in offsetting the higher costs of building out a more rural group of copper passings. Also, another sign the 3^rd wave should have value is that Apollo just paid about $1,000 per copper passing for 6.8 million copper passings in what is described by Lumen as a group of rural copper passings. This is how Lumen described the asset they were selling to Apollo, “But in terms of mix, only, call it, less than 10% of our fiber revenues are in that area because that area is largely rural, if you will. Another data point that kind of highlights that is about 60% of our CAF subsidy, CAF II subsidy and about 60% of our CAF II units are in the footprint that we're selling. And so -- but broadband revenues in those states have been relatively stable because of the competitive landscape today.”

Management discussed how they are currently assessing this 3^rd wave and will see how they can potentially convert this asset. It seems to me likely these 3^rd wave copper passings have value.

Valuation assumptions: a copper connection at $500 per passing, a fiber connection at $3,500 per passing and assuming that post 2022 each conversion to fiber adds $1,000 in debt per passing.

Before I put a valuation on FYBR I will lay out the logic I use for valuing the different passings.

A.     $500 per copper passing: Apollo just paid Lumen $1,000 per copper passing for 6.8 million mostly rural copper passings. In order to be conservative, I value a FYBR copper passing at $500.

B.     $3,500 per fiber passing: $1 billion in EBITDA for the old FIOS network times 11.5 times, a conservative multiple significantly below recent all-fiber transactions and that gets me to $3,593 per passing in value. Then I take 1.358 million users from the old FIOS network and apply $8,000 per user, a price recently paid for 5,000 users by CABO, and that gets me a value per fiber passing of $3,395. Somewhere in the middle I then picked $3,500. I believe $3,500 to be a conservative valuation per fiber passing. CHTR, a cable provider trades around $4,700 per passing. CABO trades around $6,500 per passings. CHTR is mostly a cable company, where CABO has a mix of fiber and cable.

C.      Debt per passing: FYBR declared that it has enough cash to pay for the copper to fiber conversion through the end of 2022, which will bring the total number of fiber passings to 5 million. After that point, I will assume a cost per passing of $1,000 to be added to debt on a 1 for 1 basis. This is a conservative estimate as it is clear that on a maintenance capex free cash flow basis FYBR should generate positive free cash.

Valuation – Current value based upon current sale value of FYBR

If one changes the value per copper passing to the price that Apollo paid Lumen  ($1,000 per passing) then one gets a value per share of $65.31 per share.

Valuation – Value of FYBR in 2027

By 2027 that provides for an upside of 15% compound for 6 years. Keep in mind though that I was conservative in many places and it is not hard to see a way where FYBR is worth a lot more than the $96 I come up with.

-        I do not include increases in BB ARPU, while FYBR currently has very competitive offerings versus the competition. For example, they charge $50 per 500 Mbps up and down, with free installation and free wife modem. A 1 GB offering up and down, with free installation is $74. Over time there is clearly room for increasing the BB ARPU.

-        I do not include an increase in value of the old FIOS network from an increase in penetration to 50%.

-        Here is a comparison with CABO. CABO has an EV of $17.4 billion with a business with about 2.7 million fiber and cable passings and 1.017 million users resulting in a 37.6% penetration. I value the old ALL FIBER FIOS network of 3.2 million passings with 1.358 million users and a penetration of 41.5% at an EV of only 11.2 billion.

-        I also assumed that for the post 2022 conversions we would have an increase in debt of $1,000 per new passing. Likely that number will be lower as FYBR will be cash flow positive on a maintenance capex basis.

-        I also put no additional value on the 3^rd wave beyond the $500 per copper connection. Given the infrastructure spending that is coming with significant spending for broadband subsidies I would not be surprised that soon we will see an announcement for more planned conversions using 3^rd wave assets. Or maybe they can sell a number of the 3^rd wave assets. At a price of $1,000 per copper connection I would feel good about that too. Management is clearly looking at what to do with the 3^rd wave assets.

If I put a value of $4,000 on each fiber passing (1^st and 2^nd wave) and keep $500/copper passing for the 3^rd wave assets then I end up with an IV of $116 per share.

Anyway, it looks we have an asset with an IV upon current sale of at least $42.62 per share, but if FYBR does not sell and successfully executes its strategy I come up with a value in 2027 of $96 or more, a 15% compound return.

Risks:

-        Management does not execute well on the copper to fiber conversion resulting in lower-than-expected conversion numbers. Management has mentioned multiple times that they are not worried about the pace of conversions and believe they could do more. Also, the person in charge of the conversions oversaw significantly more conversions from copper to fiber at AT&T than she is doing now.

-        Low penetration. 10 million passings have little value if there are no users. It is imperative that we get 40% penetration over time. I believe this to be a likely outcome. On a small amount of fiber conversions at the 12-month mark FYBR achieved a 30% penetration, although management guides to a slower ramp.

Catalyst

-        Bond holders selling.

-        Index inclusion.

-        A private equity or industry player seeing the copper to fiber opportunity and deciding to make a run for FYBR.

-        Conversions to fiber and penetration numbers showing a growing EBITDA.