The privately held competitive fiber operators are posting the early financial numbers this year, with Zayo Group (news, filings) turning in a big EBITDA number reflecting integration progress in its fiscal second quarter. It’s always a challenge to parse Zayo’s financials in light of their voracious M&A appetite, but here’s their numbers in some context:
| $ in millions | Fiscal Q2/12 |
Fiscal Q3/12 |
Fiscal Q4/12 |
Fiscal Q1/13 |
Fiscal Q2/13 |
|---|---|---|---|---|---|
| – Zayo Bandwidth | 64.5 | 74.8 | 76.4 | 152.1 | 158.7 |
| – Zayo Fiber Solutions | 15.3 | 19.6 | 22.7 | 65.9 | 71.5 |
| – zColo | 10.2 | 11.8 | 11.7 | 15.3 | 15.4 |
| Total Revenue | 89.0 | 105.0 | 109.6 | 229.7 | 243.5 |
| Adjusted EBITDA | 45.1 | 53.9 | 57.5 | 122.6 | 137.5 |
| Adj. EBITDA Margin | 50.6% | 51.3% | 52.4% | 53.4% | 56.4% |
| Capex | 31.4 | 42.7 | 21.4 | 66.7 | 58.9 |
| Buildings on-net | 5,193 | 5,431 | 6,055 | 10,258 | 11,104 |
Revenues of $243.5M suggest that the annual run-rate is now over $1B given the full effect of the acquisitions during the quarter, with both organic and inorganic growth being meaningful during the quarter. They had a strong bookings quarter, offset by a slightly higher than expected churn number.
Meanwhile EBITDA surged mightily to $137.5M on the back of integration progress, much of which surely came from the AboveNet synergies. That boosted the company’s adjusted EBITDA margin from its already stratospheric levels all the way up to 56.4%. Just where the ceiling will be on that number isn’t clear, but they have $40M in planned annualized synergies yet to achieve which mathematics says would take them above 60%.
Zayo added 436 buildings to the network organically, as well as 410 by acquisition of course (First Telecom, Litecast, US Carrier). That’s also a big number, reflecting growth in both on-net enterprises and towers.
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Categories: Fiber Networks · Financials · Metro fiber
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The workload can be crazy at times but I’m proud to work for such a successful company. We’ve been successful by operating in a pretty non-bureaucratic way, aligning employee incentives well, and doing almost everything through Salesforce. I believe Dan when he says that he’s trying to build a company for the long-term. The test will be how transition culturally from being the smartest kid in the class to operating in our own right, without the aid or challenge of ever-larger acquisitions to drive growth and keep things interesting. Morale needs to come increasingly from personal development, community, and respect, and less from the promise of future riches, because while growth will remain robust, the years of 50+% IRR are probably behind us.
Zayo is a very, very interesting case and it will be fascinating to watch their progress. This is particularly the case in terms of operating margins and sustainable ORGANIC growth rates.
In terms of growth, the serial acquisitions make tracking organic growth very difficult– and it is organic growth which is the primary indicia of a healthy product/pricing model over the long term.
In terms of EBITDA margins, I just can’t see how the current numbers are sustainable– it isn’t a natural occurrence in the world of telecom over any time frame other than short term. When this happens competition is quickly attracted and margins inevitably decline, witness the wireless business where early margins were also in the 60% range, but not for long. Zayo’s margins are higher than any competitor I am aware of in EACH of their revenue segments and as below shows have ramped dramatically:
FY ’09 28%
FY ’10 30%
FY 11 44%
RRATE 56%
One factor supporting such margins is CapX levels– currently running at about 30% of revenues, compared to LVLT at 12%, but that doesn’t alone explain it since TWTC spends at about the same intensity level and isn’t close to a 60% EBITDA margin. Another contributing factor may be the extent of dark fiber sales (maybe a close to 100% margin business?).
Anyway, they better have a healthy organic growth rate and they better be able to maintain margins because they have levered themselves up over 5x– a level which causes LVLT valuation issues in the public market.
All that said, they have run the business exceptionally well/ integrated without apparent issues/ and attracted some sophisticated equity backers who have access to far better internal numbers than available to the public– so that any questioning on my part is probably not well founded.
Below is an estimate of what Zayo is probably projecting in terms of EBITDA growth for the next three years. This is based on the agreed covenant in their debt agreements relating to total debt/EBITDA. Using some safe assumptions, an estimate of debt paydown from FCF, and an assumption as to the safety margin built into projected EBITDA being 15% when compared to the covenant level, projected EBITDA can be estimated as follows:
12/13
Covenant level 6/1
Debt proj.
Below is an estimate of what Zayo is probably projecting in terms of EBITDA growth for the next three years. This is based on the agreed covenant in their debt agreements relating to total debt/EBITDA. Using some safe assumptions, an estimate of debt paydown from FCF, and an assumption as to the safety margin built into projected EBITDA being 15% when compared to the covenant level, projected EBITDA can be estimated as follows:
12/13
Covenant level 6/1
Debt proj. $2,800
Required EBITDA $466 million
Plus 15% $536 million
12/14
Covenant level 5.25/1
Debt Proj. $2,725
Required EBITDA $520 million
Plus 15% $597 million
12/15
Covenant level 4.5/1
Debt Proj. $2,625
Required EBITDA $583 million
Plus 15% $670 million
This is obviously a derived set of numbers but seems reasonable, representing a 12% CAGR. Of course, more acquisitions would throw this whole exercise off.
Talk to yourself much? 🙂
mhammett,
I simply find it interest to deduce internal projections– or rather projections provided to bankers. Obviously our interests diverge and you see no value in this exercise. Go happily on your own way.
I found your analysis really interesting. Thank you.
Safe assumptions, Enron? What if one of Super Dan’s PE superstar investors find themselves in trouble and have to “DRAW” on their “MEMBERS INTEREST”? Member interest down, and cash down with it!
Yeah, I know, Super Dan is building a runway to the public markets for The Rubes to absorb as part of their exit strategy before anything bad might happen to them!
I say this while watching their “INVESTED CAPITAL RATIO,” a gift that I thought might keep giving having gone up considerably due to “acquisitions” as opposed to going down from a “trend” standpoint. The trend in the current Q seems to be turning favorably again, but it’s still significantly higher than the 4.1 trough in June, 2012. imo
“What if one of Super Dan’s PE superstar investors find themselves in trouble and have to “DRAW” on their “MEMBERS INTEREST”? Member interest down, and cash down with it! ”
Carl– you don’t understand how equity financings like this work– you don’t just get to recall your investment. So your point is just not of any significance or relevance.
Invested Capital Ratio is Total Investment in the Company divided by Annualized EBITDA. If a company has $600M of Debt, $50M of Cash, and $450M of equity was invested in it, its ICR would be $1B ($600M + $450M – $50M).
If its annualized EBITDA was $200M, its ICR would be 5X. This means that if the company was worth 5X, it would be able to pay off all its debt and its equity investors would get 100% of their money back (no gain/no loss).
If instead the company was worth 10X EBITDA, the equity would be worth closer to $1.45B. ($2B – $600M + 50M). The $450M of equity is worth 3X.
ICR allows for easier tracking of whether a company is creating value for its equity investors. It requires a judgment call on the enterprise value of the company, but is easy to calculate once an EBITDA multiple is surmised.
ICR will tend to go up as a result of bigger acquisitions, but ideally should trend downward thereafter.
I understand, and I see a more positive trend being restored again since the Above.net acquisition.
Keep working hard at “balancing” the supply/demand factors for “bandwidth pricing” which are crucial for managing the long term stability and sustainability of the global internet.
Does the capital intensity ratio(ICR) remain relevant, and if not, why not?
Rather than passing a hot potato to the public marketplace with metrics providing fewer margins of safety, I think it is becoming more plausible for Public Enterprise to wrest control of Private Enterprise notwithstanding the transparency being provided in anticipation of something different.
CarlK, you better sell your Clearwire shares because Softbank will hand you your head & put it where the sun doesn’t shine. Up yours…..
Clwr is a pimple on the elephant’s arse of what’s in play for me, unlike your friend, O. Mason, who was taken down by Dell/MSFT. I will leave the final price after pruning some to The Bush Family Dynasty for final judgment. Do you believe in JUDGMENT DAY, you SOB?
I am interested in seeing how SchmuckInsurance’s(SI’s) financial God, Sunit, navigates the currency wars taking place all around him including but not limited to Venezuela.
Super Dan’s financial CREW does not have to grapple with problems such as these. imo
http://www.nytimes.com/2013/02/09/world/americas/venezuela-devalues-currency-amid-shortages-and-inflation.html?_r=0
The currency wars and the bandwith consolidation wars are what Prem Watsa and Mason Hawkins have planned for. Dell going private with the help of Mr. Softy will be like Level 3 & Zayo rolling up into the big snowball that was planned from the beginning with Bill, Warren, and O.Mason. Hawkins has already said he will give up his LVLT shares for at least $60. Unlike Dell, Hawkins has more control of Level 3, so Microsoft will have to get the crown jewel (ZAYO) from Big Dan before he takes LVLT under.
I always knew Microsoft would control Level 3 in the end to end all bandwidth games. Get the connection ~ Knect Xbox.
Prem Watsa’s man, Sunit Patel, who unnecessarily hands out “usury” to his friends like no other CFO I have seen, has stated publicly in a wisp on a number of occasions that his Forex currency portfolio was “hedged” every which way but loose. Considering the great Hedgeman, Prem himself is, this seemed probable when hearing it.
However, I have not found this to be true while studying Sunit’s 10K. Donna Jaegers, aka, The Mouse Lady, may have been gifted with another multi ten million dollar miss unless Sunit has pulled a “white mouse” out of his pipes to throw back at her! imo
As we approach Microsoft and Sony announcements for their next generation game consoles, the rumor mill is kicking into high gear. The latest rumor has the next Xbox, codenamed Durango, performing natural language recognition in a similar way to Apple’s Siri. While the Xbox 360 currently has some voice recognition through the Kinect, it’s limited in usefulness by how restrictive the actual voice controls are currently implemented.
After the rise of motion controls in the last generation, it’s clear that the consoles aren’t just going to compete on performance anymore. Both Nintendo and Sony have bet on touch screens to different extents, so moving the SmartGlass technology forward isn’t going to be enough of a distinguishing feature for the next generation Microsoft hardware. While the Xbox 360 is currently the king of consoles in the US, it’s not doing nearly as well in the rest of the world. It’s going to need a hook of some sort, and this voice functionality just might be a big part of what Microsoft has up its sleeves.
Microsoft has had some fairly good ideas with the Kinect up to this point, but the hardware has some serious technical constraints. Originally, the Kinect was supposed to have a better camera and standalone image processing, but that was tossed out for the final version. Sadly, this meant developers were hamstrung by the hardware limitations. It’s not just the voice controls that are stilted and wonky. Still, they’ve been able to ship 18 million units, so it’s an unqualified financial success as an add-on.
The Verge has sources claiming that the next Xbox will be able to perform speech-to-text, natural language recognition, and wake on voice tasks. If Durango ships paired with a next-gen Kinect that offers substantially better voice and motion detection, Microsoft could have something special here. There are roughly 75 million Xbox 360s in the wild, but only a small fraction of those have a Kinect paired with them. If every Durango console has a next-gen Kinect, developers will actually be incentivized to create games that take full advantage of those features instead of haphazardly slapping on Kinect functionality. Financially speaking, reaching an entire user base is much more compelling than reaching the fraction that went out to buy a peripheral device.
Information is still scarce, so we don’t know all of the implementation details quite yet. The consoles will undoubtedly be much more powerful than current phones and tablets, so it seems plausible that it could handle the speech recognition on the hardware itself instead of sending it to the cloud like Siri does. It’s not a forgone conclusion, though, and having everything pass through servers does have benefits. It allows for better analysis of how people use the service, and offers on-the-fly updating to the software. Even with an iPhone sitting next to a wireless router, Siri still sometimes chokes on very basic commands. With the current always-on DRM rumors, don’t be surprised if it needs a constant network connection in either scenario.
In the cloud or handled locally, better speech is a safe bet going forward from Microsoft. Let’s hope that this time around, Redmond knocks it out of the park. It’d be nice to see the Xbox team finally deliver on the full potential of the Kinect concept since they certainly didn’t do that with the current hardware.
http://www.extremetech.com/gaming/147909-xbox-720-rumored-to-have-its-own-siri-unlock-kinects-true-potential
#spam
EBITDA is not a useful metric for a serial acquirer. Company X could buy Zayo for $3 Trillion dollars and it would still have the same levels of EBITDA and same EBITDA margins after this bad investment. With this much capital going to “I” and “D&A” there isn’t much point to measuring “earnings before…” benefits without capital burdens . Would only make sense expressed relative to the capital required to buy that same EBITDA – e.g., EV/EBITDA. Even then, interest and depreciation schedules would be key. ROIC is the punch line. Anyone can spend a dollar to make .93 cents any day.
As for margins, it is too early to tell. Zayo acquires Above and others with subscription revenues. And then (depending on your perspective) either guts the target company and/or finds “synergies”. But customer service, new sales (required to create new “E”) are lagging indicators. Also, many times serial acquisitions bring charges and balance sheet buckets which can relieve costs from OPEX.
Also, if the stats above are right, Z bought Above and levered it waay up. They used to call that plan “MFNX”…. And before that, in the extreme case, WCOM
I agree that EBITDA cannot be viewed in isolation to draw conclusions about company performance. This is true regardless of whether a company is seen as a serial acquirer
Equity Value Creation, in my mind, must be estimated. See my comment in this string on ICR — this can be used to gain insight into Equity Value Creation.
Specifically the pace of Equity Value Creation is most relevant. Equity IRR means the pace in which Equity Value is created. At Zayo, our goal (which is lofty and aspirational) is to exceed 30% Equity IRR.
I appreciate your reply. Some feedback:
– True that the EBITDA alone as unhelpful applies to other/all companies, but my point was that it is a more pronounced issue with roll-ups who buy the EBITDA with capital that is accounted for only at I, D, and A.
– Comment below re “Adjusted EBITDA” vs GAAP EBITDA is a fair point. Don’t know what was adjusted.
– IRR is one interesting metric, but is largely a function of leverage and not core performance. For example, if you borrowed another $100 MM and dividended money to shareholders, IRR would go up, but may not be a good business decision. Returns on Capital and/or Assets look past management leverage decisions at core value creation.
Have you looked at EVA and the like. Interesting way to account for the issues we each identified.
“EBITDA” itself is not a GAAP defined term. However, it is an important figure as it reveals how much cash is being generated via revenue and expense accounts. Companies who report “EBITDA” define it (since not GAAP)… drawing a distinction between “adjusted” and “GAAP” is likely off point. Definitions might vary somewhat, but my guess is not materially. Since all (or most) are clearly defined as part of filings, an analyst can probe. Most companies work with their accountants to define EBITDA in a way that is consistent with industry peers.
“IRR .. is largely a function fo leverage and not core performance” — this is simply an erroneous statement. The “for example…” is equally wrong. Anon, I would be pleased to engage you on these points one-on-one … with all respect, your understanding of Enterprise IRR, Equity IRR, leverage, value creation, and the responsibilities of management are lacking.
“”“IRR .. is largely a function fo leverage and not core performance” — this is simply an erroneous statement.”
With respect, the statement was partially correct– leverage does have a marked effect on equity IRR’s but then so does “core performance”. Improvement in performance (growth in earnings/cash flow) is accentuated in terms of return on equity (ROE or IRR on equity) by a leveraged balance sheet. this is LBO 101. Of course the downside is also accentuated– so growth is the key factor and leverage is the catalyst.
In acquiring ABVT, Zayo had a fundamental choice in terms of capitalization– the extent of debt funding versus equity funding in making the acquisition. The funding choice made was to leverage 5+/1 debt/EBITDA, and in so doing the resultant ROE (all other things being equal) will be higher than if the deal had been leveraged 3/1. Higher risk was assumed and higher returns will be the result if everything works out. It really isn’t too complicated.
Agreed. The reference was to “equity IRR”. Your point (I think) and mine is that Zayo’s substantial leverage will achieve its goal of producing outsized gains – or outsized losses – in equity value which exceed the results attributable to total capital due to company performance.
Dan is correct that ICR would account for returns on all capital – equity and debt.
Back to where we started, there is nothing surprising about Adjusted EBITDA multiples of x% in a highly levered roll up. Not a valid measure of anything. These were purchased and costs of creation are an the balance sheet – not the P&L. Proof is that Zayo could fire everyone other than a bill collector and show these margins for a year or two while running off contracts they bought. But whether it made sense to buy AboveNet – at a premium – and lever it up will only surface over time. This is why other levered telecom roll ups have struggled, reorganized and/or gone away (see, e.g., ICG, LVLT, WCOM, MFNX, XO, etc).
en_ron… your statement “EQUITY IRR does factor in leverage and core performance” is correct. It is kind of you to come to defense of anon, but anon didn’t reference Equity IRR when pointing out leverage consideration. Second, anon suggested core performance was not a factor in IRR — which is dangerously untrue. Third, they suggested Equity IRR can be driven by up by borring $100M and dividing it to shareholders. This is also untrue. If you took a $100K second mortgage on your house and put the money in your bank account, you would not create wealth. Your equity value in your house would be worth $100K less but your cash account would be worth $100K more. Finally, anon overlooks that the proper management of leverage is an important part of management’s responsibility. If Equity IRR is lower because a company is materially under-levered, management is not optimizing Equity Value Creation — which is management’s responsibility. This is what I meant by anon not understanding management’s responsibilities.
Anon — I applaud you for sharing your thoughts. Please do not take these as negative responses. My intent is shed light on my beliefs around how to measure performance and how to define the responsibilities of management to their stakeholders.
Dan,
I don’t want to seem pedantic but if you borrowed the money to pay the dividend then the prospective return to shareholders would go up in your example. Apple currently faces a similar sort of capitalization issue right now– although its a problem we would all like to have.
Separately, would much appreciate your philosophy on dark fiber sales and its long term impact on your business.
— are you cannibalizing future lit sales?
— is this sustainable over the L/T?
— would tha answers change if you had public equity?
— are incremental IRU sales 100 pct margin contributors?
Thanks–you run an admirable company.
I guess if you mean that the greater leverage will over time result in better equity returns, I’d agree… but only if the overall IRR is > the interest…
My objection was the notion that the act of paying a dividend produces equity value creation. It doesn’t. For example, let’s say Apple pays $1B of its cash as a dividend. The value of its remaining Equity should go down by the $1B the day the dividend is distributed. No value was created by shifting the $1B from the balance sheet to a dividend payout.
When dividends are announced, a stock price might move up or down as a result. This is more of a subjective response to the message that is read into the dividend payout. Is this a good event, because management is showing discipline by returning cash instead of investing it in bad projects? Or is a bad event, because management is admitting that it cannot find worthwhile investments…hence future value creation opportunities are compromised? Whatever the answer, the dividend payment itself does not produce a creation of equity value.
on dark fiber questions — it would be inappropriate to comment on Zayo specifics in this forum. I do address these question in earnings calls, investor conferences, and industry panels. Please listen in… and ask these questions where I can answer in appropriate forum.
Thanks for the compliment re: Zayo
Yes, I studied EVA… read the book… applied it in practice. Equity IRR is similar (and built on same principles) … in my opinion, it is much better and more appropriate way to guide decision making and measure performance.
The point remains that internal rates of return on equity are heavily influenced by leveraged. (Compare to returns on all capital or on assets). AboveNet had relatively low leverage. Zayo now has higher leverage on these same assets. If you borrowed more Debt, equity returns could go even higher – but with risk (at the extreme case, see Lehman).
As I recall, this thread started with a discussion of EBITDA margins. We agree that this measure has little application in measuring a levered roll-up.
With all respect, I suspect you know that I am not confused, at all.
Thanks again for your replies.
RE: Zayo Employee Comment: I AGREE with “Morale needs to come increasingly from personal development, community, and respect, and less from the promise of future riches, because while growth will remain robust, the years of 50+% IRR are probably behind us.”, though with some caveats. Employees must share in the financial success. This shouldn’t be in the form of “promise of future riches”, but those employees who are contributing to our success should be confident they will participate in the financial rewards. I agree 50%+ IRR will be difficult to sustain…but 30-40% IRR is imo achievable. You also mentioned workload. The past quarters were very taxing on Zayo employees, as we sustained growth while integrating and fighting Superstorms. As systems ad processes smooth, acquisitions become less of a factor, and familiarity by employees grows, we will find a way to get work done with better balance.
Is this really Dan Caruso?
Isn’t this “adjusted EBITDA” – which means it’s a number that they invented? What does their GAAP EBITDA look like (which if it were in the 56% range would be mind-boggling)?
Yes that is Dan… I also appreciate the insight