Description

I wrote up Boingo as a short in August 2015, just after the company released its quarterly earnings results and the stock had spiked to $10, $1 above its previous recent three-year high.  I said:

My bullish scenario for the business, if everything goes as management hopes, yields an $8 DCF valuation for the stock, 20% downside.  I think it more likely that something goes wrong and fair value is closer to $5, 50% downside.  This downside could come quickly if something bad happens to the business, or, if everything goes well for the business, it could come through years of alpha as the stock stagnates while the S&P 500 pays dividends and marches higher.  The likely result is somewhere in the middle: The stock will probably present good trading opportunities from the short side, bouncing around such that you can cover lower and re-short higher.  

That prediction has proven correct.  The stock promptly fell 25% in the three weeks after I posted, versus 4% for the S&P 500, for 21% alpha, and I covered the position both in real life and in VIC-space.  It continued falling to $5.50 in the January/February market dump before recovering sharply along with all the other dodgy stocks.  Today, two trading days after the company’s latest quarterly earnings release, the stock has spiked to $11, $1 above its high achieved just before my previous write-up.  I have re-shorted and invite you to join me.  I have enough to say about the last 15 months’ developments to merit another write-up rather than just a comment-board post.  The thesis remains valuation plus a catalyst that is not precisely knowable yet is reasonably likely among a host of possible candidates.

See my earlier write-up for a detailed description of Boingo’s various business lines and how they were likely to develop.  Almost everything has played out as predicted.  The net effect of all the news is to make me slightly more negative about the business while the average investor/trader is probably more positive.  To summarize the developments: (1) The overall financial picture is worse than I thought, margins are not improving and now appear less likely to ever improve the levels required for my $8 bull case; (2) growth is about to fall to near-zero in Boingo’s good business (military) while it is accelerating in the bad business (DAS); (3) reported revenue growth will probably turn negative in the medium-term because so much of it is up-front build-out payments from carriers.

Now here are the detailed updates, starting with each business line:

Military (25% of total 3Q revenues) is probably Boingo’s best business by far because it has an effective monopoly with contractually-fixed prices and a bargaining partner (the Department of Defense) who is unlikely to turn the screws when it’s time for contract renewal.  However, as predicted in 2015, this business is about to fall from triple-digit growth to near-zero growth.  Boingo has been rapidly installing networks at new military bases, increasing the “covered bed” count, increasing the subscriber count even faster as subscriber penetration of covered beds increased, and therefore growing revenues by 341% in 2015 and a still-high 91% in 3Q16.  Management always said that they would hit full build-out of 300,000 beds by year-end 2016, and as of 3Q they are on-track at 286,000 beds.  Growth in penetration of covered beds has slowed to one percentage point per quarter, and that sequential growth number is more likely to go down than up.  So sequential growth will be near-zero starting in 1Q17.

Distributed Antenna Systems (DAS) (39% of total), which is Boingo’s worst business in terms of return-on-capital, enjoyed a sudden growth explosion in 3Q.  The company added 500-800 DAS nodes per quarter in 2015, 1,600 in 1Q16, and 1,000 in 2Q16.  During 3Q it added eight new venues (e.g. stadiums) and therefore 4,200 new nodes, which drove the YoY growth in nodes from 42% to 71% and DAS revenue growth from 15% to 22%.  Management said 4Q will be another big quarter for added venues and nodes.

Retail wifi (15% of total) continued dying but has, at least for now, stabilized for three quarters at around 185,000 subscribers and $6.6m in revenue.  For now, this development is a genuine positive.  It remains to be seen whether this stabilization lasts.  I doubt it.  The business is still showing 15% YoY revenue declines and will not lap them to get to 0% until mid-2017.

Wholesale wifi (14% of total) stalled out from 45% revenue growth 2015 to -6% in 2Q16 and 7% in 3Q16 because Boingo lost a big customer in 2Q.  Growth will probably pick up again as the lap the customer defection.

Advertising & other revenue (5% of total) is pretty much dead by now, falling 61% in 3Q.

The aggregate of business-line-level developments have not been kind to the key overall numbers and won't be in the future.  Last year when I calculated that WIFI’s stock was worth only $8 in a bullish scenario, that scenario included EBIT margins rising from their then-current -15% to +13%, above previous all-time highs.  If margins were going to rise anywhere near there, they should have started doing so already in 2016 because the business mix has shifted towards the better military business (up from 14% to 25% of total revenues), plus margins are presumably improving in the military business itself as penetration per bed increases (up from 26% to 30%).  Yet company EBIT margins have been down 1-2% YoY each quarter in 2016.  That development makes it less likely that future margins will rise anywhere near my earlier bullish case.  With the military business about to stall out, where is the margin growth supposed to come from?  Obviously the rapid recent DAS buildout has dragged down margins and DAS margins will increase as those networks fill up, but that future increase does not look like nearly enough to get total margins into double digits.

Free cash flow is better but still not good.  Roughly half of WIFI’s doubling off the bottom since February is due to the general rise since then in all dodgy stocks, and the other half is due to management’s promise throughout the year that the business would have “positive free cash flow” in 2H16, which is better than I had modeled last year.  The final stock price spike up following the 3Q release, despite management maintaining its revenue and profit guidance, was probably because they achieved that goal; operating cash flow less capex through 9M16 was $1.5m. 

To management’s credit, positive FCF does mean that the business won’t burn through the last of its cash and need to raise capital in the near future.  However, hitting the promised target does not suggest that there is much positive free cash flow in the company's future.  To start with, management is playing the usual game of profit-challenged, cash-challenged businesses by increasing stock compensation much faster than the business is growing – in this case, by 50% YoY vs. 15% revenue growth.  Stock comp has totaled $10m YTD.  Thus free cash flow for valuation purposes, as opposed to how-soon-until-a-liquidity-crunch purposes, was -$8m.

More importantly, $64m of their YTD cash flow is an increase in deferred revenue resulting from up-front cash payments by carriers to fund their capex for the DAS network build-outs.  Of Boingo’s $92m total capex, $66.4m has been funded by these up-front payments by carriers.  Typically when a telecom company that is “spending for growth” hits FCF-breakeven, the path forward is substantial FCF growth as capex recedes and the network gets filled.   That will not be true for Boingo.  When its capex recedes, so will the build-out payments from carriers.  It will be left with only the access fee payments, which financials to date suggest will be negative-margin forever.

As a final side-note, the build-out payments become deferred revenue and get recognized as revenue over the estimated life of each carrier contract.  This amortized build-out revenue is currently 2/3 of all DAS revenue and 23% of total company revenue.  When Boingo stops building new DAS nodes at such a breakneck pace, its reported build-out revenue is going to turn negative fairly quickly and, given the lack of other growth drivers now that military revenue is about to stall out, total company revenue may turn negative again.  That won’t matter to how I view the business’s economics, but it will look bad optically to – I’m so glad I can borrow this phrase from cfavenger – “the stocktwits crowd” and anyone else who has not been paying close attention.

Catalyst

Margins disappoint.

Revenue growth turns negative.

Stocks of money-losing businesses with no net cash take another dive many times as large as the S&P 500's (as in August 2015 and January 2016).