Description

Investment Overview: GTT is an asset-light, low cap-ex growth compounder with a high FCF, predictable and differentiated business model, with healthy competitive barriers. The company is run by a knowledgeable management team with a lot of skin in the game, with an outstanding ~10 year track record of successfully deploying cash to acquire/integrate various acquisitions, achieving multiple financial targets and rapidly expanding EBITDA (56% 5-year CAGR) and intrinsic value. Management targets 10%-20% revenue growth from the combination of organic growth (high single digits) and accretive acquisitions, and with deal synergies EBITDA growth should exceed 30% over at least the next 3-years. The recent acquisition of Hibernia Networks has accelerated management’s timetable for achieving its next financial goals of achieving adjusted EBITDA of $250 million (compared with $125 million reported in FY16) by about a full year to FY18. The shares screen poorly due to temporary timing issues and we believe are mis-priced due to investor misunderstanding of the company’s business model and how it compares with other comp’s. Based on pro-forma Hibernia run rate adjusted EBITDA (including cost savings) of $228 million, the shares are trading at 9.1x multiple of EV. Valued on our 3-year adjusted EBTDA forecast of $310 million, the shares are trading at an EV/EBITDA multiple of only 6.7x. This valuation is significantly below the multiples accorded other slower growing asset-owned comp’s, which trade on average at 14.6x ttm and 12.0x 2017 estimates. Additionally, GTT’s current valuation is well below the ~14x ttm multiple that a smaller private competitor was acquired for in December and highlights that the company itself could be an attractive target for either a strategic acquirer or a PE firm. Based on the company achieving our profitability forecast and a re-rating to a 10-11x multiple, we believe the shares should double or more over this period, translating into a healthy 25%+ IRR.

Key Investment Points

Cap-ex light, high FCF, predictable and differentiated business model: GTT is a tier-1 global telecom network services provider. Focused on multi-national enterprises, GTT offers offer a broad portfolio of global services including: wide area network ("WAN") services; Internet services; managed network and security services; and voice and unified communication services. A more detailed review of the company’s products can be found in the company’s latest investor presentation; a link to which is: https://www.gtt.net/wp-content/uploads/2017/03/GTT-Investor-Presentation-March-2017-.pdf

The company signs long-term contracts with its customers and given low customer churn of ~1.5%/month, translates into a predictable +90% monthly recurring revenue business. About 75% of incremental sales come from existing customers, highlighting the value proposition GTT offers and its ability to grab a greater share of wallet once a relationship is established.

A key element of the company’s competitive differentiation is GTT’s status as a leading tier-1 ISP and its asset-light, low cap-ex, business model. GTT’s IP backbone is consistently ranked a top five network in terms of internet routes. The company has +300 points of presence ("PoPs") in top data centers around the world, trans-oceanic access and being a tier-1 ISP, gives GTT access to the entire global Internet routing table through their peering relationships ("settlement-free" interconnection with other global ISP’s). This positions GTT on par with the leading global telecom service providers and gives the company various scale benefits that enable the company to differentiate itself against a number of smaller competitors.

Differentiating the company from some of the leading telecom service providers, who own their own fiber global networks, is GTT’s asset-light, low cap-ex business model. With the exception of its recent acquisition of Hibernia Network’s transatlantic modern fiber network, GTT leases capacity from the major asset-owned ISP’s through its peering relationships. GTT has a proprietary software platform that matches the optimal and low cost routes for a customer’s communications needs among the various ISP’s and contracts capacity on other networks. While most of GTT’s legacy competitors are primarily focused on less complex sales, GTT specializes in more complex/customized solutions, including “off-net” buildings (those not already equipped with fiber, networking equipment and a third party connection to an IP backbone) and last mile services. As illustrated in the table below, GTT has the lowest cap-ex/revenue among the major public telecom service providers.

This low cost business model coupled with its peering privileges to multiple networks, gives GTT the flexibility to go after lower margin business that most asset-owned competitors, with higher cost structures, avoid. Notably, GTT focuses on “off-net” communications, which are viewed as the dirty word in the industry, due to the complexity and low margins associated with connecting them. Conversely, most of GTT’s larger customers are more focused on higher margin sales associated with filling up capacity on their own networks allowing them to gain gross margin scale efficiencies.

As illustrated in the following tables, while GTT has lower EBITDA margins than its asset-owned competitors, its unlevered cash flow (as defined by EBITDA – cap-ex) to revenue ratio is among the leaders in the network telecom services business.

Separately, GTT both competes with and is a customer to other asset-owned telcos’ like Level 3, Cogent and Zayo. For example, GTT may work with Zayo to provide a “dark fiber” (dedicated fiber strands) as part of creating a custom client network.

Healthy & Sustainable Competitive Barriers: GTT’s business model helps gives the company healthy and sustainable competitive advantages relative to both smaller and large legacy telecom competitors. On one hand, GTT competes with a number of smaller regional companies. However, GTT status as a tier-1 ISP and its peering privileges gives it access to global networks that smaller competitors would find more challenging to replicate. Additionally, GTT’s large relative scale, with +300 points of presence worldwide and its buying power, provide additional advantages that smaller competitors cannot match. Finally, the breath of GTT product portfolio and services offerings, garnered through various acquisitions over the last decade, provide further competitive advantages, allows the company to garner a greater share of wallet and makes the customer relationship more sticky.

Relative to larger legacy ISP’s (like AT&T and Verizon), GTT’s “off-net” focus, provides certain competitive advantages and has been a major reason behind the company’s market share gains. In addition to better service, as “off-net” tends to be a lower margin more complex sale, larger legacy telecom providers with higher cap-ex cost structures tend to focus more on higher margin “on-net” sales opportunities. Consistent with their own business models, these legacy telco’s are also more incentivized to sell capacity on their networks to help offset the initial costs associated with laying fiber and are more reluctant to route traffic to competitive networks or spend time helping customers with their “off-net” communications. Conversely, GTT can provide a more customized solution by picking and choose the best network routes among all the leasing asset-owned ISP using its proprietary software, create matching contractual agreements at competitive prices with these ISP using its scale advantages and provide last mile and additional services.

Organic growth driven by favorable secular trends, mining the customer base, market share opportunities and investments in the sales force: Management targets organic revenue growth in the high single digits over the next few years. This growth is being fueled by favorable secular trends, including such factors as: the insatiable appetite for bandwidth, movement of SaaS and apps to the cloud, growth of web services (i.e. AWS, GCP & Azure) as well as mobile enabling everything. GTT has roughly 6,000 multi-national customers, however only about 700-800 of which provide about 90% of revenues. Historically GTT has been successful in bringing on a new customer for only a small piece of their business, building a relationship and proving themselves, and then getting more share of wallet over time. Customer churn is a relatively low 1.4%/month, with the majority being unpreventable (client downsized, closes a facility or files bankruptcy) and management focused on reducing this number. With roughly 70% of incremental sales coming from existing customers, there is a significant opportunity to generate organic growth, just from the existing customer base.

Additionally, GTT has been successful at increasing market share from legacy providers (such as AT&T and Verizon) due to better service and the more flexible and customized solution it offers uses, versus the competitors approach of trying to put all the corresponding customer traffic exclusively on their own network and leaving end users to figure out the remaining connections. Conversely, as GTT is not wedded to any individual network, the company will find the best routes for each individual customer among the various asset-owned ISP and negotiate capacity usage contracts matching their needs as well as working with customers to fulfill a variety of off-net service’s needs, including last mile agreements. GTT’s customized approach saves customers time versus shopping/structuring individual agreements with various ISP, leverages GTT’s buying power and gives network IT managers the comfort of “one throat to choke” if problems arise.

Noteworthy, GTT began making investments to increase its salesforce in early-to-mid calendar 2016. Given the approximate 12-18 months for new sales reps to begin contributing full-quota revenue, this should begin to have a positive impact on internal growth beginning in mid-2017. This should help organic growth going forward from this period.

A proven, highly accretive M&A strategy of adding services, customers and scale to transform the company’s business: GTT has historically redeployed the rich cash flow from its business model to fund accretive acquisitions to grow scale, drive healthy growth in profitability and increase intrinsic value. Over roughly the last decade GTT has successfully completed/integrated a number of accretive acquisitions that have helped transform the company. The following chart from the company’s investor presentation highlights some of the most significant of these acquisitions.

The focus of these deals has been to add new customers, expand the company’s product portfolio and grow its scale. These acquisitions have helped GTT: complete its transformation to a tier-1 ISP network as well as adding a portfolio of managed services, enterprise grade voice services and a trans-Atlantic fiber network (with Hibernia Networks). Additionally, these deals have helped GTT gain a greater share of wallet of their customers, increase gross profit margins as well as adding scale and operating leverage.

GTT has a very disciplined approach to M&A. Every acquisition has to either add: to its global network, product/technology and its base of multi-national clients. Additionally, the company targets a rapid integration within only two quarters to complete and a highly accretive post synergies multiple (normally about 4x-5x EBITDA). The company has historically financed these deals with debt and has targeted a leverage ratio of 3x-4x. The healthy FCF’s from the business are then used to reduce debt.

The recent acquisition of Hibernia Networks adds a number of benefits and is highly accretive: The recent November 2016 acquisition of Hibernia Networks represents GTT’s largest acquisition to date (growing revenues by ~35%) and somewhat differs from past deals in that the acquired company owns its own fiber network. Hibernia operates a trans-Atlantic fiber network, with the lowest latency connection (Hibernia Express) between New York and London, which after the company invested ~$225 million in cap-ex, just opened in September 2015.

GTT has agreed to pay $607 million for Hibernia, consisting of $515 million in cash and the remainder in stock. GTT raised $1 billion in debt to fund the acquisition. With the consummation of the deal, the company’s ratio of total net debt to Adjusted EBITDA is approximately 4.5:1, and management estimates that within one year after closing, this ratio will drop to 4.0:1 or below, reflecting growth in profitability and cash flow.

Consistent with GTT’s acquisition criteria, Hibernia brings to the company a major addition to its product portfolio as well as a base of large multi-national clients.  Additionally, GTT can create revenue and scale efficiencies by selling Hibernia capacity to its legacy base of enterprise customers. Management expects to realize $30 million of cost synergies within three quarters (one more than prior deals, reflecting the size of the deal) with a post synergies EBITDA multiple of <7x’s.

Noteworthy, the Hibernia acquisition differs from GTT’s prior deals in that Hibernia owns its own fiber network. Management has discussed that it would be interested in acquiring an existing (post cap-ex spend) non-metro, long-haul network in selected high usage markets which provide synergistic benefits, which fits Hibernia’s profile. Our understanding is that Hibernia has a significant competitive lead time advantage in this important sub-oceanic market, with the cost to lay new fiber (~$225 million) a major barrier to any new entrant.  

Hibernia will increase GTT’s annual cap-ex from about 4.5% of revenues to 6%-7%, which will still below many other network communications companies. However, the trade-off is that the transaction adds a higher margin revenue stream and another element to the company’s ability to scale its business model. GTT’s previous acquisitions provided the company post synergies operating expense leverage. However, with Hibernia, GTT can now begin to scale its gross product margins as it fills up capacity, especially on its new Hibernia Express network. Hibernia adds a significant amount of high margin revenues and by our estimates increases GTT’s adjusted EBITDA margin from ~24% to a ~28% run-rate return. Noteworthy, a secondary benefit is that investors have accorded higher margin asset-owned revenue streams higher margins, which bodes well for the shares to receive a favorable re-rating.

Knowledgeable management team with a lot of skin in the game and an excellent track record of execution over the last ~10 years in successfully deploying cash to acquire/integrate various acquisitions, achieving multiple financial targets and rapidly expanding profitability and intrinsic value: Noteworthy is the depth and knowledge of the telecommunications industry of senior management and the Board, which is a little unique for a company the size of GTT. The Chairman and founder of GTT, Brian Thompson, is a well-seasoned telecom industry veteran, and was the ex-Chairman of LCI, which he sold to Qwest, and was EVP of MCI, where he headed its Sonus Networks division. CEO Rick Calder has been in his position since 2007, and has been the architect of the company’s growth and M&A activities over the last decade. He has a 22 year background in the telecom industry, including COO of InPhonic (a mobile services/devices reseller) and held senior management positions at Broadwing (acquired by Level 3 in 2006), Winstar and MCI. Mike Sicoli was appointed CFO of GTT in 2015 and was CEO of Sidera Networks (fiber network), CFO of RCN (Cable Co.), and held various positions at Nextel (Wireless).

One of the characteristics we find very appealing in a potential investment is an owner/operator management team, fully aligned with investors, with a lot of skin in the game. Such is the case with GTT, as Chairman Brian Thompson maintains an ownership of about 15%, CEO Rick Calder owns 4.2% and the entire management team and the Board owns more than 25% of the company. Noteworthy, total compensation is heavily weighted in favor of stock and over his tenure at GTT, CEO Rick Calder has for the most part steadily increased his holdings by over four fold.

Management has established an excellent track record of performance over the last decade. The company has hit all its major financial growth targets, demonstrated success in deploying cash in making/integrating a number of accretive acquisitions and has significantly increased intrinsic value. Notable, as illustrated in the following chart, in the 5-year period beginning in FY12, revenues have grown at a 37% CAGR, while adjusted EBITDA and unlevered cash flow (EBITDA – cap-ex) have grown at a 56% and 54% CAGR respectively, while book value has grown from $0.89/share to $3.43/share.

Mis-pricing issues create the present investment opportunity: During the past 5-years the stock price of GTT has on balance done very well as investors have rewarded the company for its strong growth and outstanding execution. However, as illustrated below, the shares have been somewhat volatile over the similar period, creating opportunities for longer term investors to take advantage of a period of share price weakness.  

We believe these are two reasons why the shares are mis-priced and why the current opportunity exists.

Temporary screening issues: The shares do not screen properly due to timing issues associated with the Hibernia acquisition, thereby not properly showing the true profitability of the company. When screening the company on an EV/EBITDA multiple, the company’s EV already fully reflects the incremental shares and debt associated with the transaction while the trailing 12-month EBITDA does not reflect any of the profitability from Hibernia. When screening GTT using such services as Cap-iq or Bloomberg, the trailing-12 month EV/EBITDA multiple shows an unattractive multiple of ~17x. However, adjusting this ratio to include the trailing-12 month EBITDA from Hibernia shows a more attractive multiple of only about 11x (or 9.5x after cost synergies). While such a discrepancy was evident post GTT’s previous acquisitions, none were of the scale of Hibernia and the level of profitability this transaction adds to the company. This discrepancy will begin to alieve itself during the 2017 year as each quarter is reported, which will then illustrate the true profitability of the combined organization.

Investor mis-understanding of GTT’s business model and how it compares with major comp’s: The second issue is that despite having a business model that yields among the highest unlevered FCF (EBITDA - cap-ex) profitability and has been the fastest growing among the major publically held telecom ISP providers, GTT is valued at a significant discount relative to its closest public comps. This disparity is illustrated below:

We believe the cause of this is a mis-understanding among investors regarding the benefits of GTT’s business model. Among the most similar comp’s, GTT is the only asset-light provider, and a quick first level analysis focusing in on just EBITDA margins, shows the company’s profitability to be below its peers. We believe that if investors take the time to better understand the company’s business, they will conclude that a more important metric is GTT’s ability to generate among the highest unlevered FCF profitability. Given the abundance of fiber assets/capacity and the significant annual declines in pricing in the market, we do not see the wisdom in valuing those companies that own fiber assets at a premium to asset-light providers like GTT. Conversely, we would argue that those providers that can generate high ROIC and have the opportunity to redeploy their healthy cash to grow at among the highest rates in the industry (like GTT) should be valued at least on par with the comp’s, if not in excess of them.

By comparison, we find a lot of similarities in the business models that currently exist between the telecom business and the transportation industry. In the transportation industry there are two different business models: asset-owned truckers & freight forwarders (i.e. JB Hunt, YRC and Swift) and 3PL asset-light logistics providers (i.e. CH Robinson, Expeditors International of Washington and XPO Logistics) who purchase capacity from various asset-owned providers at the best prices. Noteworthy, over time the asset-light 3PL logistics companies have exhibited higher FCF and growth dynamics versus the asset-owned truckers & freight forwarders, and as a result, sell at premium valuations on average. Thus, we believe that over time, as investors better understand the economics of GTT’s business model and its sustainable competitive position in the industry, its shares will re-rate to a multiple at least on par with its asset-owned peers.

Hibernia, accretive acquisitions and scaling benefits should translate into further margin increases and a 30%+ CAGR in EBITDA over the next 3 years: Management targets 10%-20% revenue growth from the combination of organic growth and timely accretive acquisitions. Prior to the Hibernia acquisition, management had discussed its next financial goal of achieving a $1 billion target run-rate in sales and $250 million in adjusted EBITDA by FY20. Post the consummation of the Hibernia acquisition, we believe these goals have been accelerated forward by 1-2 years. Noteworthy, as illustrated below, based on the Q4 annualized run rate, GTT’s pro-forma revenues, including Hibernia, are already $714 million and adjusted EBITDA is $198 million, or $228 million after considering the projected $30 million of cost savings. This compares with FY 16 revenues of $521.7 million and adjusted EBITDA of $125.0 million.

Management has indicated that it has a rich pipeline of potential targets and that post the full integration of Hibernia in the second half of 2017, the company will be ready for another transaction. With trying to forecast when M&A will occur impossible, growth could be a little lumpy. Thus, for modeling purposes in the FY18-FY20 period, we have assumed organic growth of roughly 8% and $50 million of acquired revenue (implying roughly a 15% CAGR), yielding ~20% EBITDA, and purchased at a ~9x-10x multiple pre-synergies, and ~6x-7x post synergies, with a 2-3 quarter integration period. Our model shows adjusted EBITDA growing from $125 million in the recently reported FY16 year to roughly $310 million in the 3-year period ending FY19 aide by the combination of organic growth, Hibernia, as well as the profitability and synergies from future acquisitions.

Attractively priced relative to public comp’s, with a healthy IRR: Based on pro-forma Hibernia run rate adjusted EBITDA (including cost savings) of $228 million, the shares are trading at 9.1x multiple of EV. As previously illustrated, this valuation is significantly below the multiples accorded other slower growing asset-owned comp’s, which trade on average at 14.6x ttm and 12.0x 2017 estimates.

Valued on our 3-year adjusted EBTDA forecast of $310 million, the shares are trading at an EV/EBITDA multiple of only 6.7x. Based on the company achieving our profitability forecast and a re-rating to a 10-11x multiple, we believe the shares should double or more over this period, translating into a healthy 25%+ IRR.

An attractive acquisition target in a consolidating industry: A recent private market transaction of a smaller comparable company at a significantly higher multiple suggests that GTT is mis-priced relative to private market valuations and highlights the company as a take-over candidate. In December 2016, privately held Masergy, was acquired by Berkshire Partners at a ttm EBITDA multiple that was reported to be ~14x. The significance of this is that our research suggests that M&A activity in the telecom industry has heated up as organic growth among some of the major players has slowed and many are looking to acquire growth or looking to move into new sectors via acquisitions.  With the acquisition of Hibernia and the company fast approaching its $1 billion revenue goal, the company now has the scale to move the needle for some large global telco providers. Possible acquirers of GTT include:

• global telecom operators (i.e. BT of Deutsche Telecom), looking to increase their US presence;

• cable operators, looking to move up from the SMB market to the enterprise;

• asset-owned telco’s looking to bolster their salesforce to better leverage their fiber investments;

• A PE firm attracted by the company’s healthy cash flows.

Noteworthy in this regard are comments from management indicating that they would not be surprised to be acquired in the next few years.

Risks:

• Acquisitions: As GTT is a serial acquirer that depends on acquisitions to add to its growth, any acquisition, especially in the technology industry, carries a degree of risk relative to the quality of product/technology and the ability to integrate it into its organization and achieve the expected synergistic benefits.  GTT has a highly disciplined approach to acquisitions and a ~10 year track record of successfully completed/integrated a number of accretive acquisitions that have helped transform the company. Additionally, management has indicated that it has a rich pipeline of potential targets and that post the full integration of Hibernia in the second half of 2017, the company will be ready for another transaction.

• Organic growth: GTT operates in a highly competitive market, against a number of large legacy brand name competitors, and is faced with declining price per bit trends. Management targets organic growth in the mid-to-high single digit levels, aided by a number of favorable secular usage trends, which appear to more than offset declining prices, and the ability to continue to take market share from legacy incumbents. The company’s growth is also tied to finding and training new sales representatives and having them become productive in a timely manner, which also carries some degree of execution risk.

   

• Debt: As indicated previously, GTT acquisition strategy is to fund transactions primarily with debt and to use the post synergies rich cash flows in the business to pay down the debt. GTT raised $1 billion from a $700 million term loan and $300 in unsecured notes to fund the Hibernia acquisition. With the consummation of the deal, debt approximates 42% of GTT’s capitalization while the company’s ratio of total net debt to Adjusted EBITDA is approximately 4.5:1. Management estimates that within one year after closing, this ratio will drop to 4.0:1 or below, reflecting growth in profitability and cash flow, while its term loan does not mature until January 2022.

Catalyst

• GTT continuing to report strong EBITDA growth and earnings
• The impact of the Hibernia acquisition flowing thru the company's financials
• The company announcing further accretive acquisitions
• The investments in the sales force having a positive impact on organic growth
• The company being targeted as an acquisition target.