Description

Currently, Lexent is a lousy business in a lousy industry...and its price still may not have hit bottom because its about to get tossed out of the Russell 2000 this month.


The company describes itself as an infrastructure services company that designs, deploys and maintains fiber optic, electrical and life safety systems for telecommunications carriers and enterprise organizations in some of the largest national metropolitan markets. Lexent provides a full spectrum of project management and specialized maintenance services. Representing various industries such as utility, telecommunications, real estate, government and large enterprise, Lexent's key customers include AT&T Local Services, Cablevision, Con Edison Communications, WorldCom, Level 3 Communications, IBM and the Dormitory Authority of the State of New York. The company has offices in New York, Boston, Washington D.C., Philadelphia, Long Island, White Plains and the state of New Jersey.

I describe it as a broken company that has no choice but to change its business (at least temporarily). It actually was an electical contractor for over 5 decades before it IPO'd as a "company that offered a complete, outsourced turnkey solution to meet its clients "last mile" requirements and provided customer support 24 hours a day, seven days a week." In other words, it heartily hitched its fortune to the telecom bandwagon, and has been decimated in the process. The original founding family of the firm made way for the new hotshot telecom execs to take their electrical contracting business to new levels. The company IPO'd in July of '00 at $15/share and quickly shot up to $38 share based on the wonderful promise of the company. The new CEO gave a breathless interview in The Wall Street Transcript in November of that year...which in hindsight, seems like a lifetime ago. They were about to expand their 15 markets in the US to 40, and contemplating an international footprint. Earnings and margins were enjoying heady growth and the employee rolls were growing even faster.



Well, most of us know that this ended badly. In 2001, one-time rock-solid customers like ATT, Level 3, Sprint, Global Crossing, and Worldcom dramatically curtailed their capex, and even worse some couldn't pay their old bills. It was a crummy year and the company could never gain any traction. They couldn't cut expenses as fast as revenues were shrinking, and it culminated in a horrendous Q1 in 2002. Gross margins sank to 6% and revenues dropped to $31M as they de-emphasized telecom services. This isn't a one-quarter or even a one-year transitioning event. They will become more of a specialty electrical contractor than a communications oriented firm, but there will be continued pain but also continued improvement all year.



During the past quarter, telecommunications customers represented 65% of revenues versus 85% in 4Q01 and the company has stated they think it will be down to 35%-50% by year's end. They have taken big one time hits (repeatedly) in the last 5 quarters---shutting down offices, laying off employees, selling equipment, and reserving for their telecom receivables. Going from expansion mode to contraction mode is very expensive...and Lexent's stock price now fully reflects it. The company has stated that margins will slowly climb every quarter as their business mix changes, and they plan on being at break even in Q4.




I'm attracted to the company because I think they will turn it around, but it's really the strength of the company's balance sheet that's providing my margin of safety and comfort level. They had a backlog of $85 million at the end of the quarter and employee headcount was down to 606 from 747 in 4Q01, which is about where they'd like to stabilize it. It's difficult predicting the timing of a rebound in their business, but with almost no debt, net working capital per share of $2.99, and cash per share of $1.97, Lexent's business is being assigned negative value in the marketplace. The company had indicated they will be burning cash in the next 2 quarters but they are also expecting a $6M tax refund that will more than cover those needs. So they should be heading into next year with improving margins, revenues, and profitability...and selling at 54% of net current assets, and 82% of cash. There is no enterprise value here, but it's fair to say they are selling at less than half of peer comp multiples.




Risks and other Unpleasant Factors:

(1) They reside in NYC. If and when their business turns, local city taxes are an additional cost.

(2) They reside in NYC. Dealing with powerful unions is a way of life. The telecommunication's union has sued several contractors who employ the electrical union workers. Lexent is one of several being sued.

(3) Options are way out of the money, but they have repriced 1.7M options that were $13.50 down to $3.03. It stinks but we can't do anything about it.

(4) The owner/managers own 53% of the company. They have leased property to the company and have given family members some nice perks (e.g., increased dad's pension and brother gets to lease a new car every 3 years).

Catalyst

Volume has increased quite a bit over the last several weeks, and I think a lot of the recent selling is dumb selling. A couple of brokerage houses recently dropped coverage, and it's being tossed from the Russell 2000 next week, but arbitrageurs and indexers now don't bother waiting for the official announcement. If the company can show any improvement at all this year, I think the price drifts upward. If that doesn't happen, I look for the insiders to take the company private at $3-$5 a share.