Description

I recommend CTV as a long-term investment opportunity with a timely short-term catalyst: its annual investor day on Monday, December 4^th.  For those interested, it is being held outside of Dallas in Richardson, TX and prepared remarks and Q&A will be followed by a tour of the R&D facilities.  It will run from 11am to 4pm CST.  Please note: this stock has been very volatile – more so than its peers – and there will be other chances to own this stock.  Sales can be lumpy – particularly to carriers as discussed below – and that can create opportunities.

 

Company short overview: CTV has historically been a leader in manufacturing fiber coax for the cable industry, selling directly to the MSO’s (Cablevision, Comcast, etc.) – 30% of sales.  Several years ago, the company engineered a highly-questioned yet brilliant acquisition of the enterprise connector business from Avaya (nee Lucent) that came with an albatross around its neck that built cabinets for the CLECs – now 20% of sales.  Specifically, they make the cages for telecom equipment with the primary customer being the baby bells – or what’s left of them.  ATT’s move to FTTN (fiber to the node) over the past several years has and will prove quite lucrative for CTV – though admittedly lumpy – more on that in risks below.  The rest is structured wiring for office buildings and the like as well as interconnects between servers, routers, etc. – now 50% of sales.  In summary, CTV is the gold standard for every sector in which they operate.  To drive further sales, CTV has also reworked certain aspects of their Enterprise business to reach smaller companies that cannot afford or will not pay for that last bit of performance.  The company likens it to providing both the Lexus and now the Toyota.  Please note that CTV’s components/connectors represent less than 10% of the cost of a network in every sector in which they sell – and though one might think that would make their products less economically sensitive, the decision to re-wire a network often goes hand in hand with an equipment upgrade.

 

What happened in the past 18 months: Frank Drendl is one of the great CEOs in business today and has been at it for over 30 years.  When we entered the stock at $14 about 18 months ago, it was a gift from Mr. Market as everyone decided that Mr. Drendl had suddenly taken stupid pills and bought a monster that would eat up the core business’ profits.  Today, the enterprise business is a rock-star with growth in its nascent stages and the cabinet business (the afore-mentioned albatross) is flying in the right direction and helping lift up the company.

 

What is there to like?: I believe that CTV is the best run of the group and has significant potential as it looks to make accretive acquisitions with its large cash hoard and highly-under-levered balance sheet:

 

1. The factories remain under-utilized – keeping a lid on capex
2. Asia is a virtually untapped opportunity – with the added bonus of cheap manufacturing there now and in the future
3. European and Japanese cable companies are in an arms race
4. U.S. cable market remains stable (significant maintenance revenues – people move, new homes, cables get cut by the gardner, etc.) with the added bonus of the Adelphia properties build-out
5. Data throughputs at corporations are over-taxing the networks to say the least and while first-mover industries like oil and gas (trading operations) and several Wall Street firms have done material upgrades to their infrastructures, many are just getting going and the rest of the corporate world is awaiting.  New commercial construction helps too and the global boom for that will prove fantastic for CTV.  Wireless shows no signs of taking over that business any time soon – for practical reasons: security and reliability.
6. Simply put – you only need to observe the YouTube phenomenon and know that video at home and in the corporation is exploding exponentially.  Further, in efforts to cut back costs, corporations are upgrading their video teleconferencing capabilities and must re-wire to do so.  We are in the nascent stages of a major rewiring of the modern world.  I won’t even assume that China and India will wire up materially for our projections – though you should consider the construction booms in those two countries as optionality.  If you have any questions, I recommend you read “The Singularity is Near” by Ray Kurzweil.  Though a futurist and probably the greatest living inventor, he too is now a hedge fund manager!!!  Network data demand will only go up exponentially – not linearly.
7. Data center consolidation – a one-time boon for the company that should last several years
8. Future acquisitions – company management has a history of intelligently deploying capital.  The recent acquisition attempt for Andrew would have been highly accretive to CTV.  Irrelevant now is the fact that it was ultimately rejected.  What is relevant now is that the market trashed the stock by almost 20% - for what would have been a superb deal.  In other words, if the stock tanks with the next acquisition offer, seriously look at what they are doing and be ready to buy.

  

Valuation: So what is Wall Street missing here

 

1. For starters, the street dings them for the shares from a convert but keeps the debt there.  So the EV is distorted.  Plus, the street does not value the company on an EV/FCF basis – thus not giving management the credit for ultimately deploying the capital in an accretive fashion.  EPS is not reflective of the earnings power of this business.
2. Look at our model below.  With modest growth based on expected demand, the company is trading at between 12-13x 2007 EV/FCF and less than 10X 2008
3. More below in the model

 

Risks:

 

1. Inventory correction – but the company has already lowered guidance for Q4 and is clearly being conservative for 2007
2. Lumpy sales – particularly from the carrier/cage business.  The ATT/Bellsouth merger has slowed spending – though management already guided down for that and only that
3. Slowdown in commercial construction
4. Delays in the Adelphia network re-build
5. Global slowdown in the arms race to wire homes – particularly in Europe
6. Inventory correction for the whole sector – though CTV’s inventories are within 7-8% of their long-term average 

Share Price		$30.17		Cash	333
Shares Outstand (4/24/06)		59		Debt	24
Options		6		Convert	250
Convertible Shares		11		Convert Price	21.75
Total Shares		77
				Pension & OPEB		99.5
Mkt Cap (fully-diluted)		$2,327		Options Out (3/31/06)		6.474
Debt		24			Strike	16.99
Cash		333
Cash from Options		110
Enterprise Value		$1,908
		2003	2004	2005	2006E	2007E	2008E
Revenues						`
Enterprise		402	588	663	808	889	960
Broadband		146	423	460	542	597	626
Carrier		27	144	217	272	304	335
Corporate		(2)	(2)	(2)	(2)	(2)	(2)
Total		$573	$1,153	$1,337	$1,620	$1,788	$1,919
					21%	10%	7%
Adjusted Op Income
Enterprise				67	105	120	134
Broadband				34	52	63	69
Carrier				(4)	14	23	33
Total		$23	$47	$98	$170	$205	$237
Margin		4.0%	4.1%	7.3%	10.5%	11.5%	12.3%
D&A
Enterprise		$7	$30	$33
Broadband		$25	$24	$22
Carrier		$3	$7	$5
Total		$34	$61	$60	$60	$50	$50
EBITDA Adjusted		$57	$108	$158	$230	$255	$287
Assumptions
Enterprise Growth			46.3%	12.7%	22%	10%	8%
Broadband Growth			190.2%	8.7%	18%	10%	5%
Carrier Growth			429.5%	51.5%	25%	12%	10%
Enterprise Margin				10.2%	13.0%	13.5%	14.0%
Broadband Margin				7.3%	9.5%	10.5%	11.0%
Carrier Margin				(1.6%)	5.0%	7.5%	10.0%
EBITDA		$57	$108	$158	$230	$255	$287
Cost Cuts
Pension Contribution					15.0	15.0	15.0
Interest expense		8.6	9.6	8.3	3.7	3.7	3.7
Taxes		(5.2)	(7.0)	21.1	53.3	64.6	74.6
Capex		5.3	13.2	19.9	25.0	25.0	25.0
FCF				$108	$133	$147	$169
EV/FCF				17.6x	14.3x	13.0x	11.3x
EV/FCF (including - money in)						12.0x	9.5x

Catalyst

- ATT/Bellsouth merger gets regulatory approval and cabinet capex kicks back up – then management can move numbers back to expectations
Investor day this Monday gives heightened clarity of just what the company is building
- Major acquisition – could just as easily create a great buying opportunity if the market misinterprets it as in past acquisitions
- Long-term growth – valuation will take care of itself