Cincinnati Bell Inc. (CBB) – Valuation Analysis

Cincinnati Bell Inc. (CBB) – Valuation Analysis

By Andrew Chung The Standing Stone

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Summary

  • Cincinnati Bell is valued as it were three years ago yet there has been a number of transformative events that have occurred between this time including: (i) the divesture of its wireless segment, (ii) its sale of CyrusOne, (iii) the completion of a 1-to-5 reverse split, (iv) its growth in fiber internet subscribers to 67% of total subscribers (up from 42% at the end of 2014), and (v) a recent purchase of SunTel Services to pragmatically expand into Michigan
  • A transformative fiber optics network is in progress. Contribution of Fioptics sales has more than doubled over the last few years.  We estimate Fioptics will be greater than 50% of total revenue in 3-5 years.  The costs of deploying fiber to the home has reduced by more than a half over the past decade and this trend will continue.
  • We think Cincinnati Bell is positioned favorably in a horizontal market. For a firm operating in a horizontal maturing market with low growth like wireline, we would like to see non-core assets diversified, and an opportunity to be easily acquired.  If not acquired, we want to see the firm positioned to compete well against peers because it holds regional scale advantages.  We want the firm to have relatively newer fiber technologies, while also having nimbleness in relative size.  These two factors will allow for better navigation in a dynamic landscape that calls for SD-WAN, IP Elastic cores, OTT offerings, and more.
  • We are currently in the midst of an infrastructure upgrade cycle which is creating uncertainty, yet also an investment opportunity. What we do know so far, is that Cincinnati Bell is able to grow its Fioptics subscribers at over 25% annually versus national averages of around 15%. We believe its success is due to its concentrated geographical footprint, regional economies of scale, and SG&A efficiencies allowing it to compete against larger cable peers.
  • We think Cincinnati Bell conservatively should be valued above $22 today. Cincinnati Bell reported ~$660mm in Strategic sales in the last 12 months.  We recategorized what we think is “Strategic” and adjust this number down from $660mm to $350mm, with the remaining deemed “Legacy”.  We looked at peer multiples from various types of wireline providers and believe a 12x and 4x EBITDA multiple is conservative for Strategic and Legacy assets respectively.  A look at its discounted (unlevered) cash flow supports our target.  We followed this up by modeling out how Cincinnati Bell should look like three years from now.  We think this three-year target has a high probability to be beat.  More importantly, three years from now its fiber-to-legacy asset mix will make it very difficult to be ignored.
  • We believe an inflection point exist in the coming years where its growth in fiber outweighs its declining copper assets. There is mounting evidence that the demand for fiber will dramatically outweigh supply over the long term.  However, there will be a number of catalysts in the near 3-year term.  This includes the development of a 5G cellular network, in addition to the next wave of video technology will rely on high throughput in addition to low latency.

Introduction

Cincinnati Bell (CBB) offers wireline services in Ohio, Indiana, and Kentucky.  It has a long history dating back to 1873 when it was the incumbent local exchange carrier (ILEC) in Ohio and neighboring states.  This means it use to be the monopoly prior to telecom being liberalized for competition.  The opportunity today exists because of a disastrous merger with ICX in 2000. Cincinnati Bell had to borrow $2.1bn to fund the merger in addition to eliminating its dividend.  Since then, they have been repairing themselves with a number of meaningful divestures in the recent years.

Today, they are focused on providing high-speed broadband internet access throughout the Midwest.  They have accelerated their fiber investments over the past few years which has proven to be successful.  Amongst its telco peers, Cincinnati Bell is the only one consistently adding internet subscribers, albeit slowly.  In the past few years, we’ve only seen the beginning of their next-generation “Fioptics” network.  Two characteristics are worth mentioning.  First, we have seen its success with capturing share versus its peers.  Second, we have seen improving cost economics in deploying fiber to the home.  It is likely these trends not just continue, but accelerate into the near-future.

Cincinnati Bell’s balance sheet has meaningfully transformed over the past few years.  This has been accomplished through the sale of non-core assets, specifically their wireless segment and stake in CyrusOne.  We think this billion and a half reduction in net debt is meaningful for a firm currently under $1.8bn in enterprise value.  Gradually, their Net Debt / EBITDA has come down from 5.2x in 2012 to 4.2x in 2016.  This has also positioned Cincinnati Bell to have a more natural equity investor base.  They have meaningfully delevered, successfully completed a 1-to-5 reverse split, diversified non-core assets, and will be in a position to institute a dividend in the coming years.

The company is currently suffering through a competitive infrastructure upgrade cycle.  Their legacy copper network is under pressure from its cable peers, but this will subside.  We believe an inflection point exist in the coming few years where their copper DSL network stabilizes while their fiber network accelerates upwards.  We believe a number of catalyst will occur in the near-term to accelerate the demand for a fiber network that presently doesn’t exist.  This acceleration should occur before the launch of the 5G cellular network, and driven by the next wave of video technology and applications which rely not just on high throughput but low latency.

Despite the uncertainty around competitive environment in wireline, what we do know from the past few years is that Cincinnati Bell can grow fiber internet subscribers 25%+ year-over-year versus the national fiber average of around 15% year-over-year.  We will investigate what is driving its success and where we expect Cincinnati Bell to be 3-5 years out.

Who Is Cincinnati Bell

For those looking for a more complete analysis, we have included Appendix A: Overview of Wireline Industry.  Here we introduce the competing technologies, the number of subscribers per technology, and its relative market share.

In Appendix B: Industry Map, we take a high-level view of the industry and look at how the various parties exchange product/services with one another.  It is not meant to be exhaustive, but rather to set to stage in [i] explaining why competitive advantage exist and, [ii] to propose what we think is a pragmatic growth strategy.

We follow the industry map with a look at the sources of competitive advantage that exist in the wireline industry (Appendix C).  Despite the escalated competitive environment, it is worth noting these key sources that drive steady profitability remains intact.

Cincinnati Bell (CBB)

The above table shows various wireline providers in the United States.  It is in no way a rigorous list but provides a quick sense of various players, their relative sizes, sales and margins.  The first observation worth noting is Cincinnati Bell’s relative size.  Although it appears relatively small and may lack scale advantages, this is not the case.  In actuality, its concentrated presence in Ohio, Indiana and Kentucky gives

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