Rising competitive fiber operator Zayo Group (news, filings) reported its fiscal Q1 earnings yesterday in the wake of Zayo Bandwidth COO John Scarano’s recently announced departure. There were few surprises but a bit of more accurate information on the AFS deal. Because of Zayo’s frequent M&A activity, it is always rather difficult to find an apples to apples comparison. In this case though, Q1 included a full quarter from the former AGL Networks, whose acquisition closed on July 1 and whose revenues all went toward the ZFS segment along with $1.4M of dark fiber revenue transferred from Zayo Bandwidth. With that in mind, here’s a quick table summarizing their performance alongside the prior quarter:
| $ in millions | Fiscal Q3/10 | Fiscal Q4/10 | Fiscal Q1/11 |
|---|---|---|---|
| –Zayo Bandwidth | 45.5 | 46.6 | 47.2 |
| –Zayo Enterprise | 8.8 | 9.3 | 8.2 |
| –ZColo | 6.9 | 7.1 | 7.2 |
| –Zayo Fiber Solutions |
0.0 |
0.0 |
7.5 |
| Total Revenue | 59.8 | 61.4 | 68.6 |
| COS | 19.5 | 19.8 | 19.9 |
| Adj.EBITDA | 21.4 | 22.8 | 28.6 |
| Adj.EBITDA Margin | 35.8% | 37.1% | 39% |
| Capital Expenditures | 16.9 | 21.6 | 21.4 |
| On-Net Buildings | 2256 | 2418 | 3100 |
| On-Net Towers | 913 | 1045 | 1300 |
Revenue: AGL’s contribution went entirely toward ZFS, and was apparently about $6.1M, which means that organically Zayo as a whole added about $1.1M during the quarter. If Zayo Bandwidth still had the $1.4 it transferred to ZFS, it would have grown by $2M sequentially or 4%. However Zayo Enterprise Networks fell back $1.1M, cutting into that growth. Zayo also said that with the new year it will be transferring Zayo Enterprise’s bandwidth and colo customers to ZB and ZColo, leaving it with just managed services and CLEC revenues. That will of course make apples to apples comparisons even more difficult, however it suggests that Zayo didn’t find a benefit in segregating itself by customer size, and will instead do so by function.
EBITDA: Costs remained in check as adjusted EBITDA margin surged, but part of this was due to the inclusion of AGL’s revenue, which is of the high EBITDA margin variety. Nevertheless, Zayo’s current levels of 39% continue to rise, and following the AFS integration I would not be surprised to see them above 40%.
AFS Details: Zayo said that pro forma revenue including American Fiber Systems would have been $76.3M, which allows us to derive AFS’s Q3 revenue to be approximately 7.7M during the quarter, for a $30M annual run rate. At approximately 40% EBITDA margins, that would be $12M in annual EBITDA. The purchase price of $114.5M therefore appears to have been at an EV/EBITDA multiple of about 9.5. However, that is probably skewed by the valuation of AFS’s ownership interests in US Carrier.
Summary: Zayo is a tough one to keep up with, but I try to keep track as their rise has been so rapid. Organic growth hasn’t been stellar of late – still in the single digits annually, but EBITDA margin expansion has been quite good. In his departing comments, John Scarano seemed to indicate that the days of big change at Zayo may be ending. Does that mean the M&A run is over or that the company is big enough that further M&As won’t be that big relative to the whole? I suppose we’ll just have to see.
Another possibility is of course that the company’s backers will themselves look to cash in. Zayo’s adjusted EBITDA will enter 2011 at a run rate of about $120M, for which a multiple of 8-10x would bring them a very nice profit on the money they’ve put into the company. But I doubt Caruso himself would want to sell at this point, it’s just getting interesting.
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Categories: Financials · Metro fiber
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at risk of re opening a prior discussion, i still don’t follow this story — is there a risk that this could be (yet another) roll up w/o organic growth?
how do you use 20+% private equity and 10.25% debt to buy 8% “assets”? Of the assets, at fibertel and elsewhere, looks like some are “intangible”. on the colo and agl side there are tangible assets – but not sure that the real world useful life of fiber and colo assets matches gaap?
I am not sure where you are getting the 8%. Is this cash on cash? If so, you may be missing the “growth” component in terms of expense. If the company were mature and steady-state, the cash flow margin would be substantially higher.
The other area you may be overlooking is the terminal value. These assets are being accumulated to be merged with someone else down the road. The strategic value of the asset is of course not represented in your 8%. The terminal value (9-12x ebitda multiple) is quite real as we have witnessed with all the m&a happening this year in the sector.
the 8%, this is an approx cash on cash return when one buys companies at or near 12.5x “ebitda”. the point isnt really any different at 10x or even 9x. if one uses OPM to buy assets that yield at, near or below their cost of capital, they destroy value. some simply recirculate value but add in dilution due to management equity, etc. read the “synergy trap” by sirrower — not a complicated or easily disputed thesis.
to your second point, beware. terminal value, to a roll up, requires one to accept the “greater fool” theory (and let me clarify that i don’t think zayo is a fool at all) – the point being that to buy a seriies of businesses at one multiple and sell for a gain, requires (greater terminal value) requires another, larger acquiror to buy at a greater multiple.
for this reason, sharp analysts watch roll ups and other acquirors for signs of health in the core business. organic growth is the key metric (compare an organic grower like cisco with a pure roll up like worldcom). otherwise there is a risk of a zero sum or even negative sum game
You hit the nail on the head with organic growth. It is hard to track at a company like Zayo but they do have organic growth and their margins are consisitently higher than any of the companies that they have purchased, outside of AGL.
Also a large part of the money that Zayo has secured has not gone to acquisitions but to large fiber builds. FTT and network builds that don’t have scheduled paybacks until the 3, 4, and 5 year marks. I would definitely say Zayo is of the variety that knows how to combine inorganic growth with organic growth to produce a solid return.
Anon, all sound points. Just don’t fall into the “vacuum” that the assets purchased are static. Zayo or others can certainly do more with these assets in terms of cash flow production than the seller. The same is the case to a strategic buyer who can offload a ton of last mile expense with these assets. Certain analysts seem to look at the world as they exist today and not at what management can create up and above the here and now. The value of all these regional operators as one national provider will enhance cash flow of the aggregated assets. They will be able to reach more customers and provide enhanced services that none of these regional providers could do on their own, etc. etc….
The issue is not solely whether the Zayo managers can out-manage the prior managers (who in the cases of AGL and AFS were capable & motivated).. But even if so can they do so in amounts which justify the significant premiums paid for the assets. Using AGL as a case study, it is unlikely that buyer has a lower cost of capital than seller – an investment grade utility – so cost to carry also impacts the analysis. Lastly recall that AGL and others bought distressed assets from insolvent 2000 era disasters, so not plausible that second owner can reproduce same returns at full+ basis
It isn’t about out managing….it is out investing. Zayo is pairing metro and long haul assets to create value. AGL and AFS both ran pretty good companies but neither one was expanding significantly and many of their customers needed solutions that could be taken out of a single market. Previous entities couldn’t (or used someone to do it), Zayo can and will. Also Dan and co are quite savvy financially, he is an operational CEO and has a firm grip on market prices. I personally would take Dan over any other telecom CEO when it comes to evaluating assets.