Description

Introduction

Boingo Wireless, Inc. has been written up as a short on the VIC in 2015 and 2016, and as a long in 2011 and 2014. I have observed the company for a long time, and believe that the long time bulls have been “right for the wrong reasons”, which of course is still better than being wrong. However due to recent developments I think the time is finally right to be short WIFI (note that when I am referring to the broadband wireless technology standard I use “WiFi” and when referring to the company/stock I use all caps “WIFI”). The company has a lot of moving parts, some better than others, and I will briefly discuss each of them in turn. I will demonstrate why I believe that Wall Street’s use of company-defined literal “EBITDA” is misleading in Boingo’s case and the valuation based on true cash EBITDA is obscene. Like so many of these “profitless prosperity” companies, significant FCF or accounting earnings are nowhere in sight. While theoretical discussions of financial analysis, valuation and real economic earnings are interesting (at least to me), they haven’t gotten me far as a short seller in this bull market and indeed I have not shorted WIFI until relatively recently. I finally got off the sidelines due to a noticeable slowdown in growth, first observable in balance sheet metrics but now apparent in revenue guidance. If the continued growth slowdown continues and reality sets in, applying a reasonable multiple to real cash EBITDA results in over 50% downside.

Business Overview

Boingo has a lot of moving parts, and I would encourage you to read the writeups linked above to get a sense for its business. The company helpfully breaks out revenue from each of its business units so investors can track their performance over time. Generally, Boingo’s strategy is to pay the owners of venues or locations for the ability to offer ancillary wireless communications services to carriers and consumers. When company went public in 2011 it primarily offered WiFi in airports and similar locations. However, retail WiFi (think travellers using airport WiFi on their laptops) stalled out as a business as LTE was rolled out and many found it more useful to simply use LTE on a smartphone and/or tether to their computers. Boingo has grown revenue in recent years as they broadened both their offerings and the venues they operate in. I think of their various business lines as the good, the bad and the ugly.

The Good

Military: Boingo won the right to install WiFi networks in major U.S. military bases and then offer WiFi subscriptions to soldiers. Previously, soldiers generally had to rely on cellular networks or packages from the local cable company. Why the military doesn’t operate a WiFi network for its personnel the same way it provides them with room and board instead of relying a private company is beyond me, and also beyond the scope of this discussion. Although exact EBITDA and FCF from this initiative is hard to isolate out from the rest of the business, from all appearances the Military segement has been successful. WIFI gives metrics including “beds” covered, penetration rate and ARPU.  This business has ramped up from less than $5M in revenue in 2014 to $16.7M in Q2 2018 alone, which still represented 24% Y/Y growth. However, growth has stalled out as they finish their buildout at about 350K beds and ex the Elauwit Networks acquisition was actually down sequentially in Q3 2018 (albeit still up 19% Y/Y), supposedly due to seasonality and hurricanes. Still, this has been a successful new initiative, and I imagine will grow modestly going forward as they increase the penetration rate and put in gradual price increases. I believe this business generates a decent EBITDA margin.

Elauwit Networks: On August 1, 2018, the company announced its acquisition of Elauwit Networks for $28M, a relatively small sum for a company with a $1.1B EV. Elauwit operates a similar business model as WIFI’s military business, targeting student housing and other multi-dwelling units. Elauwit contributed about $5M in revenue for the partial quarter of Q3 2018, and should do something like $7.7M during its first full quarter owned by WIFI in Q4. Due to the similarity in business model, Elauwit is being combined with the military unit for reporting purposes (which also masks the unit’s organic growth slowdown).

Wholesale WiFi: Boingo offers access to its WiFi network through wholesale partners, traditionally airlines, hotels and credit card companies but more recently as “WiFi offload” to wireless carriers. For a long time this segment has been the focus of investors, as on a spreadsheet even at a modest tens of pennies per user per month, the numbers would get very large if all the nation’s major carriers signed with Boingo and let their subscribers roam freely to their network when in Boingo locations. Legion Partners (who filed a 13D on Boingo back in August 2016) delivered this pitch at ValueXVail around the same time in which they called for the carrier portion of wholesale WiFi to be a $145-$150M annual revenue business. In actuality, the results in this segment have been far more modest, as to date only Sprint and AT&T have gone live in any significant way. Pre carrier offload in 2014 wholesale was a $15M annual business, it generated about $22M in 2015 and 2016 as Sprint slowly ramped up, and then began growing rapidly to $31.5M in 2017 as AT&T came on board. Growth continued to accelerate in the first half of 2018 when the company hit $13.5M in Q2 2018, 85% Y/Y growth. However, the business declined sequentially in Q3 to $11.7M, still 41% Y/Y growth but well off the peak. I am guessing this is due to the fact that the carriers tightened the metrics on their smartphone software that decides whether a subscriber rolls over to the Boingo network. Naturally, carriers much prefer that mobile traffic goes over their network rather than outsouricng to Boingo. It appears to me that growth is set to slow again unless they can bring on T-Mobile or Verizon.

The Bad

DAS: DAS stands for “Distributed Antenna Systems”, which are extensions of a wireless carriers’ physical network infrastructure into user-dense locations where the macro cell towers do not provide sufficient capacity. Basically, Boingo contracts with a location (airport, subway station, sports stadium, mall etc.) to get the rights to put up mini cell towers, and then contracts with the wireless carriers to install their equipment which broadcasts the carrier’s signal on the carrier’s own spectrum rather than WiFi. As Boingo describes it they need at least one carrier to sign onto a location, and they can add on additional carriers at a relatively small incremental cost.

The DAS segment generates revenue in two ways: build out revenue and access fees. As I understand it, after they sign a contract to deploy a DAS node for a carrier, the carrier pays them an upfront fee that covers the capex for the buildout along with a profit margin of 20-30%. However this payment is capitalized and the revenue is recognized over the term of the agreement in the form of build-out project revenue. The expenses for buying and deploying equipment are also capitalized and expensed against the build-out revenue. DAS build-out revenue has been one of the primary engines of growth the past few years, reaching an estimated $71M in 2018, up 21% after growing 44% in 2017. The carriers also pay them ongoing access fees, which are split with the venue. Access fees are a smaller portion totalling an estimated $23M in 2018. In theory the access fee stream is attractive, sort of like rent paid to a tower company, but for some reason access fee revenue has been only growing single digits despite the huge increases in reported venues and nodes.

If you are wondering why I classified the DAS business line as the “bad”, it is due to the much poorer-than-believed economics and the apparent slowdown in new bookings. This will be further explained below.

The Ugly

Retail: Boingo began its life by offering retail WiFi subscriptions, but as mentioned above this business has been in decline for several years now with the availability of LTE, going from $46M in 2012 to an estimated $18M in 2018 (down about 28% in 2018 alone). This business is expected to decline for the foreseeable future and I ascribe very little value to it.

Advertising and Other: This business is largely advertising impressions delivered to customers who have to land on a Boingo web page to log into WiFi and is also in decline, albeit a more gentle one. I expect this segment to generate about $11.5M in 2018 revenue, down 5%, and to keep declining in the future. While it generates some EBITDA due to the small size and declining trajectory it is also not worth very much.

Tired of Fake News? How About Fake EBITDA?

As alluded to above, I believe WIFI management and the Wall Street analysts that follow it significantly misrepresent WIFI’s EBITDA. EBITDA is traditionally thought of as operating income from ongoing revenue without the charges from depreciation and amortization and a proxy for the operating cash flow of a business. Strictly speaking, WIFI’s calculation of EBITDA does not deviate from this definition. However, if you examine the components of WIFI’s EBITDA it misrepresents the economics of their business to a much greater extent than other telecom companies due to the way the DAS business is accounted for.

It is important to understand exactly how the DAS buildout revenue is accounted for. When a carrier customer signs a deal with Boingo, the capital required to build the DAS node plus a margin is advanced to Boingo and goes into deferred revenue. Boingo then performs the buildout, all of which is capitalized. When the node goes live, Boingo begins linearly recognizing the revenue over the term of the agreement (usually five years) and recognizing the costs of the buildout as D&A over the same time. So while a new DAS deal involved a bunch of cash paid upfront, Boingo spends 75% of this immediately on the buildout and Boingo receives no additional cash over the course of the agreement other than the ongoing access fees which as discussed above are small and not growing like one would expect. Thus, the DAS buildout revenue is by definition 100% EBITDA margin although they only make 25% margins on a cash or real economic basis. At the time that DAS buildout revenue begins to be recognized, all of the cash for the life of the agreement has already been collected and the vast majority has been spent in the buildout.

These 100% DAS buildout revenues (with no ongoing cash collection) account for an enormous percentage of Boingo’s reported EBITDA. I believe on a real “cash EBITDA” basis you have to apply the actual 25% margin to them. Arguably, the best way to look at “cash EBITDA” is on a bookings basis rather than an accounting basis. Below is a table that shows Boingo’s EBITDA, the percentage coming from DAS buildout revenue and estimated EBITDA at 25% of DAS revenue and 25% of DAS bookings. The stock is vastly more expensive if you look through the misleading 100% EBITDA margin DAS revenue:

As shown above, the multiple goes from normal-looking to extremely expensive when you see through the 100% margin DAS buildout revenue farce. If you are wondering how a company can more than double “EBITDA” in two years without showing any accounting earnings or generating any appreciable FCF despite the fact that much of its capex is immediately reimbursed by carriers you have your answer.

Why Now?

I am not the first person to notice the divergence between Boingo’s reported EBITDA and actual cash EBITDA. For those of you that have access to BTIG research, Walter Piecyk initiated with a sell rating and a $6.85 price target in July of 2016 for basically the same reason. While this was a spectacularly bad stock call, I believe it was analytically correct but wrong for several reasons: (1) the company was going through a surge in DAS bookings which led to growth in reported revenue and EBITDA; (2) other businesses such as military have done better than expected and wholesale WiFi grew even if less than expected; and (3) the company is good at playing the “beat and raise” game. A hedge fund also pitched Boingo as a short at an event in mid 2018 from what I understand. The stock has been a good performer in a bull market where investors don’t look too closely at what they own or at real underlying economics. However, I believe the timing is finally right to be short Boingo for a number of reasons:

Weak DAS Bookings and Deferred Revenue Shrinkage: While there is some noise from retail subscriptions, substantially all of Boingo’s deferred revenue comes from DAS buildout contracts. As shown in the chart above, DAS bookings were a robust $112M in 2016 but declined substantially in 2017 to around $66M and are also down in 2018 on a YTD basis, although I believe that ASC 606 caused some revenue to be recognized faster (flattering apparent revenue growth) but not go into deferred revenue (making the deferred revenue growth look worse). Due to the lag between the bookings, completing the buildouts and recognizing the revenue, deferred revenue showed rapid growth through 2015, 2016 and the first part of 2017. However, by the third quarter of 2017 deferred revenue had peaked and it has declined Y/Y during 2018. I believe this portends slowing future revenue growth, and indeed DAS buildout revenue growth slowed from 36% in Q3 2017 to only 12% in Q3 2018. Meanwhile, the growth in access fee revenue has been far lower than the growth in nodes and is only expected to be 5% in 2018. The below chart shows the change in estimated DAS bookings and deferred revenue, note that I am giving them credit for a significant improvement in bookings in Q4 2018 and 2019 in the earlier chart:

Shift in DAS Business Model: For the past couple of years, Boingo management has trumpeted robust DAS venue signings and implied they expected a return to growth in DAS bookings. However, to date it hasn’t happened. Over the last couple of quarters Boingo management has talked about “self funding” buildouts, I guess hoping to charge higher ongoing access fees. I believe this shift in business model is bearish and implies that carriers are not as interested in Boingo’s new venues. After 16 years in business Boingo finally became marginally FCF positive during a couple of quarters of 2017. I have the old Jefferies model post Q3 2017, and they expected $32M in FCF in 2018 and $52M in 2019.  Now, Wall Street expects FCF during 2018 and 2019 to be virtually non-existent. I am not sure why carriers are reluctant to sign new DAS deals and the pending Sprint/T-Mobile deal may have something to do with it, but to me the decline in bookings and business model shift in their growth engine business does not bode well.

Rapid Growth Slowdown and Weak Q4 2018 Guidance: While Boingo has never shown any significant FCF or accounting profitability, the stock has done well the last three years because of the growth in revenue and what I argue is fake EBITDA. Management also plays the “beat and raise” game well. The stock reacted poorly to another beat in Q3 because despite revenue “beats” in the first three quarters of the year, the company did not raise 2018 revenue guidance. As mentioned above the previously robust Y/Y growth in Military and Wholesale revenue slowed considerably in Q3, with both categories showing surprise sequential declines that imply much slower growth going forward. At the same time, no other revenue category is picking up the growth slack. Maintaining the yearly revenue guidance implied a range of $60M to $67M in revenue, an unusually wide range for a company with steady subscription and deferred revenue recognition based businesses. Keep in mind that the recent Elauwit acquisition added $5M in revenue in Q3 and an estimated $7.7M in Q4. I expect Boingo to beat its revenue guidance as usual, but if you subtract $7.7M from the $67M top end of the range, you get $59.3M in organic revenue, a scant 3.5% Y/Y growth rate from Q4 2017’s $57.3M. At the low end of the guidance range organic revenue shrinks 9%! Any way you slice it organic growth is collapsing, and I suspect the Elauwit acquisition was at least partially motivated by a desire to mask deteriorating growth and change the subject as existing revenue sources slow.

Even considering they will benefit from a full year of Elauwit in 2019 I have a hard time seeing them reaching Wall Street’s estimated revenue growth of 17.5%, and my estimates assume their DAS bookings and revenue growth pick back up.

CBRS and 5G: This is not a major part of the thesis, but I would note that the initial rollout of 4G/LTE was bad for Boingo. As carriers implement new technologies that enhance the capacity of their networks they may have less need of Boingo’s offerings which are essentially supplementary capacity in congested areas. For example, If AT&T’s deploys its 5G network on macro cells in  area of an airport they may no longer want or need their subscribers to roll over to WIFI’s WiFi.

Consistent Insider Sales: Boingo is hardly unique in this regard during this long bull market cycle, but its executives have become fabulously rich selling stock granted to them in a “business” that has been around for 17 years without generating any significant FCF, accounting earnings or tangible return on investment. The CEO and CFO have sold tens of millions and millions of dollars of stock, respectively, and other executives and board members have been significant sellers as well. As of 9/30/2018 investors have contributed $241M of capital, the company has generated accumulated losses of $130M and somehow the the market values the equity of the company at $1.1B.

Conclusion and Price Target

Having observed Boingo for a number of years and chuckling at the silliness of valuing them based on “EBITDA”, I believe the recent deterioration in growth makes them a compelling short target. Q4 results should confirm the company has fallen to single digit organic revenue growth rates, and I would be surprised if they can meet current Wall Street 2019 revenue consensus numbers without another acquisition. The stock has levitated 33% since its late December lows along with other questionable small cap tech stories, and reporting Q4 2018 and guiding for 2019 may reverse this appreciation.

Even giving them credit for returning to $96M in DAS bookings in 2019, I think 2019 cash EBITDA will be only $54M. 10x this number equals a stock price of $11.00. If investors ever start valuing it on actual earnings or FCF (perhaps in a bear market) this thing goes back to the single digits.

Risks

• Signing and ramping up Verizon and/or T-Mobile for WiFi offload

• Further acquisitions that muddy the organic growth picture

• Russell 2000 continuing to appreciate at 200% annual rate

Disclosure: The fund I work for is short shares of WIFI and we may buy or sell WIFI at any time without notice.

Catalyst

• Continued weak DAS bookings flowing through to lower revenue growth
• 2019 revenue guidance potentially short of consensus
• Investors focusing on cash EBITDA instead of fake EBITDA