MULTIBAND CORP MBND
October 21, 2011 - 8:38pm EST by
Lukai
2011 2012
Price: 2.70 EPS $0.30 $0.00
Shares Out. (in M): 19 P/E 8.9x 0.0x
Market Cap (in $M): 52 P/FCF 3.7x 0.0x
Net Debt (in $M): 23 EBIT 16 0
TEV ($): 75 TEV/EBIT 4.8x 0.0x

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Description

MBND's core business generates a level of EBITDA that justifies more than 100% upside in the equity while growth opportunities will potentially more than double EBITDA. If you think we're being too aggressive we'll refer you to management who has guided to quadrupling EBITDA. In fact, MBND's management team has articulated a $90m EBITDA target in 3-4 years, nearly four times greater than 2011's $23m level. At a 6x multiple, the equity would be worth 9x more than today's close. This of course seems crazy so while we contemplate a value that represents a double, we're comfortable that the probability-weighted reward/risk is substantially skewed in favor of a long position. UNTK, an MBND competitor seems to side with us in being conservative as they bid a paltry $4.50 per share (67% above today's price) for the company 10 weeks ago but were denied. At $2.70, one can buy the shares for 3.8x this year's free cash flow.

INVESTMENT STORY
At its core, MBND has a workforce of over 2k field employees that provide technical installation and fulfillment services to 5k residential and commercial properties per day. MBND's business is split into two distinct buckets: HSP and MDU.

Home Service Provider (HSP)
The HSP segment is the second largest fulfillment service provider for DirecTV (DTV) in the United States. If the owner of a single family home orders/moves/adds/changes DTV service and lives in one of MBND's 36 exclusive DMAs there is a 100% probability that it is an MBND technician performing the service.  The HSP segment is the result of MBND's acquisition of DirecTech (DTHC) through a series of transactions prior to fiscal 2010. The net purchase price paid for this acquisition was $46m and it generated EBITDA of $25m in 2010 (1.8x). DTHC Transaction Breakdown:

 

      Initial   Net
Date Subsidiary Percent Value Adjusted Value
Mar-08 MMT 51% 6.1   6.1
Jan-09 MMT 29% 1.7   1.7
Jan-09 Sub-Group 80% 38.7 -10.7 28.0
Dec-09 All Rmaining 20% 10.0   10.0
Total 45.8


MBND's two public peers trade for 5x and 7x EBITDA. If we were to apply the median multiple to MBND the stock would be worth $6. Further, MBND's EBITDA is understated relative to its peers. One year after the in-service date of its vehicles, MBND has the option to renew the lease or surrender the leased vehicle to the lessor. Therefore, the company characterizes leases as operating rather than capitalizing them and fully expenses them accordingly. MBND's comps capitalize their fleets and so the expense (depreciation and interest) is added back to their EBITDA number. If we were to capitalize MBND's leases, we'd add $10m to EBITDA and $10m to enterprise value, equal to their annual commitment. After making these adjustments, MBND's EBITDA is $33m and their current EBITDA multiple is 1.9x. Apply the adjustments and a median multiple of 6x and MBND's equity is worth more than 3x today's close.

Adjusted EBITDA        
"GAAP" EBITDA 23.3      
Operating lease payments 10.0      
Adjusted EBITDA 33.3      
         
Enterprise value 52.1      
Operating lease liability 10.0      
Adjusted enterprise value 62.1      
         
Adjusted EV / EBITDA 1.9x      
         
Valuation Sensitivity        
EBITDA = $33m        
EV/EBITDA Ent. Val. Mkt. Val. / Share % Upside
4.0 132.0 102.3 5.30 96%
5.0 165.0 135.3 7.01 160%
6.0 198.0 168.3 8.72 223%
7.0 231.0 201.3 10.42 286%
8.0 264.0 234.3 12.13 349%
9.0 297.0 267.3 13.84 413%

Again, the valuation begins to get out of hand and one can make varied assumptions with respect to years' worth of lease payments to add to EV so we just keep a 6x on "GAAP" EBITDA (125% upside) in mind noting that EBITDA is obviously not GAAP to begin with. Additionally, DTV took out one of their largest fulfillment partners (180 Connect-84% DTV revenue) with a massive looming debt maturity in the death throes of the 2008 market at 6.2x EBITDA.

 DTV's 180 Connect, Inc. Acquisition
   
Closed: Jul-08    
     
  Mar-08  
Price 1.80 Irony?
Shares 25.5  
Mkt. Val. 45.9  
     
Net Debt 54.4  
Ent. Val. 100.3  
     
  LTM EV /
Sales 382.4 0.3x
EBITDA 16.1 6.2x
     
DTV Revenue % 84%  

We believe that MBND's core HSP segment will generate more than $20m of EBITDA per annum assuming DTV's US subscriber growth slows; we model 2011 EBITDA of $23m. As the MDU segment is breakeven, this equates to EBITDA for the overall company. The HSP segment's meteoric EBITDA increase in 2010 was not dependent on sales growth - sales actually declined by roughly 1%. Also, two-thirds of this segment's business is related to moves/adds/changes for existing subscribers vs. new service orders. MBND has 36 exclusive DMAs and this has remained stable for years. Though DTV fulfills roughly 40% internally, this is primarily due to taking out financially strained fulfillment partners. As such, DTV is appreciative of the difficulties this business entails. DTV has some promotional programs such as NFL Sunday Ticket for free but those haven't yet shown up in the $23.5m TTM EBITDA; a level achieved during the NFL lockout. Additionally UNTK, another large DTV fulfillment partner, tried to acquire MBND for $4.50 per share 10 weeks ago. We assume that UNTK has as much insight into DTV's business as MBND and wouldn't attempt to more than double their business with DTV if they viewed it as falling apart.

DTV initiated an incentive payment structure in 2009 in order to improve customer satisfaction numbers. MBND's management team calculated that they could generate more income if they maximized incentive payments rather than squeeze the business for profitability and treat incentive payments as a bonus. As such, they staffed-up and instituted an ongoing top-to-bottom Disney Institute customer service training program which brought the HSP business to breakeven. Management also instituted a real-time dashboard to monitor the seventeen key performance metrics. It worked - the HSP business generated record EBITDA under the new structure. In addition we know firsthand that DTV awarded MBND the status of #1 fulfillment partner over 90% of the time in the last two years. This is just one example of the perspicacity of this management team.

HSP EBITDA
2008: 2.4m
2009: 4.0m
2010: 25.4m

Through discussions with management and past performance, we don't believe that they'll risk the HSP segment cash flow investing in growth initiatives; rather they'll use HSP cash flow to pay down debt or expand the segment and look for other initiatives to self-finance.

Multi-Dwelling Unit (MDU)
The MDU segment is a system operator for DTV. If an apartment building offers DTV pursuant to an agreement with a system operator, tenants order DTV service from them, pay them monthly, call them for moves/adds/changes, and are billed by them. This is in contrast to the HSP segment which simply fulfills orders placed directly with DTV. The MDU segment also provides customer support and billing for other DTV system operators around the country. MBND's MDU segment has been bumping along at breakeven for awhile but is poised to grow significantly beginning in the next 2-3 quarters. MBND has spent years and $millions positioning themselves to be DTV's largest system operator partner and, given emerging details from a new DTV program yet to be announced, MBND may be the only choice going forward.

Roughly one-third of Americans live in MDUs representing a large opportunity for pay-TV operators. DTV commands a 20% market share of US single family homes but less than 1% of MDUs. This is because for most of the last decade, satellite operators were effectively locked out of the market due to cable companies' exclusive agreements. Cable companies had a strategy similar to legacy RBOCs - they owned the wiring and so owned the customer. In late 2007 (later upheld in 2009), the FCC banned such exclusivity clauses paving the way for satellite operators, including DTV, to begin marketing to MDUs.

There remained however, technological difficulties. MFH2 has emerged as a viable solution to provide services to all units in a building and substantially reduce the capital cost of buildout. MFH2 allows a system operator to offer all DTV programming and services in all units through one centralized dish using single-wire technology through existing coaxial cabling. Additionally, MFH2 integrates with high-speed data services allowing operators to bundle services at reduced cost. Given the heterogeneity of MDUs (contract terms, building architecture, system infrastructures, locations, etc.), DTV relies partly on system operators to deliver content and service to buildings. At 100k subscriptions, MBND is already DTV's largest system operator and handles client servicing for another 50k units acquired by other system operators.

The FCC ruling and technology advancements have paved the way for system operators to penetrate MDUs. Sensing this trend, MBND's management began expending significant resources to further develop proprietary customer service and billing platforms in order to position the company to take advantage of the MDU opportunity. The software that MBND has developed is something that nobody else in the industry has - they developed it internally and have 10 dedicated programmers continually enhancing it. We view this complete solution as a large barrier to entry. The platforms seamlessly manage individual unit programming data, room-by-room inventory, billing, paperless statements, account history, automatic account credit and debits, credit scores, receivables aging, etc. On the customer interaction front it answers the call, transfers to relevant personnel and scripts the interaction. The platform allows MBND to offer a triple play to MDU residents including DTV video.

DTV's Chairman has made several public comments that MDUs represent a focused area of growth for them:

"In apartments, we have changed our business model. We've lowered the cost of our MDU, multiple-dwelling unit product - the cost of it to us - by a third, which opens up the ability to grow our MDU business more."
-Michael White, Chairman, Mar-2011, MSCO's TMT Conference

"So frankly there are some non-traditional segments like commercial and apartments. We think MDU, we call them multiple-dwelling unit, is a big opportunity."
-Michael White, Chairman, Sep-2010, GSCO Communacopia Conference

"...looking for selected channels and strategies where we might grow our business, and MDU is a good example of that."
-Michael White, Chairman, May-2010, 1Q10 Earnings Call

Emerging details of DTV's restructured system operator program reveals the requirement that system operators handle their own customer support and billing. If this is imposed as management expects in the near-term, MBND's strategic platform investment is going to pay off big. MBND is focused on A and B type properties (higher end) totaling roughly 7m units. If DTV is able to penetrate this market to the same extent that it has single-family homes, that's 1.4m units. With MBND's sophisticated platform and existing status as DTV's largest system operator, we think that MBND can get a big chunk of this business through newbuild and inexpensively replacing existing system operators. With roughly 300k total DTV MDU units, MBND already owns or services half of them. If MBND held onto their DTV share that's 700k units at maturity. Additionally, MBND is in a position to take out other system operators that can't service/bill the customer on their own. These system operators will be compelled to hand their business over to MBND, likely at a very attractive price to MBND because they have no choice as existing contracts run their course. This is one source from which we expect MBND can grow their owned unit base. Management also claims to have a backlog of over 100k MDU units desiring DTV installs.

Once the new structure is in place, the unit economics, superior margins, and recurring nature of revenue makes MDU quite attractive relative to HSP. We contemplate a double play for the average unit because MBND plans to only pursue Local/Long-Distance for buildings exceeding 150 units.

 

      % of Bill /
Average MDU Unit Per Month Per Annum Gross Margin
DirecTV 77 924 69%
Internet 30 360 27%
Protection Plan 5 54 4%
Revenue 112 1,338 100%
       
DirecTV 22 259 28%
Internet 12 144 40%
Protection Plan 5 54 100%
Gross Profit 38 457 34%

As tends to be the case with this story, the numbers get out of hand. Applying the above numbers to 700k units results in $210m of revenue and $64m of gross profit. Management expects that the cost per unit to build out a property is $250. At a 1/3 take-rate, subscriber acquisition cost is $750. At gross profit of $457, the payback period is less than 2 years.

Management has guided to 150k primarily owned units under the restructured DTV program in the near-term. Backing into the numbers, 150k units / .333 take rate = 450k units built out * $250 = nearly $115m. When walking him through this logic, CEO Jim Mandel didn't even flinch and believes the company can get there with a $50m lease facility collateralized by specific MDU channel assets rather than recourse to the parent company (in-line with their mentality to not risk the solid HSP business). Cash flow from the MDU units will finance the rest. He mentioned they already have some term sheets and is something they plan to announce once all the pieces are in place.

Insofar as the aforementioned pieces are concerned, this may be a good time to talk about the secondary and recent announcement of the tuck-in WPCS acquisition.

FINANCING AND M&A
MBND's acquisition of DTHC was pursuant to a stock purchase agreement with the former owners that put significant restrictions on management's ability to expand the business. Specifically, section 6.1.2 (l) specified that any acquisition of assets, operations, businesses or securities could not exceed $1m in the aggregate. Therefore, management had to get the former owners of DTHC out of the stock in order to pursue their MDU strategy. The original S-1 was filed in September 2010 which included only the shares of the former DTHC owners. Within a month on the back of QE2 the shares nearly doubled. Following the Craig Hallum initiation (the only bank that covers MBND), the stock doubled again to $6. Management had already struck a $10m agreement with Lincoln Park Capital which would trickle out shares as MBND needed the capital but with the stock at $6 they decided to sell some primary shares all at once and cancelled the agreement with Lincoln Park. When the amended S-1 was filed and management hit the street to place the shares, the stock was sold down hard to get the deal at a lower price (according to management anyway). The deal ultimately went off at a disappointing $3. What's done is done.

Subsequent to the financing and with the restrictions lifted, management went after WPCS - a micro cap engineering company focused on wireless technology and specialty communication systems. Before closing on the acquisition however, management accelerated the acquisition of certain WPCS operating entities. We were scratching our heads on this one a bit and spoke with management about it. The two operations MBND initially purchased are design houses. WPCS has expertise in combining technologies to deliver close-range wireless internet. In an effort to make the economics work on MDU service bundling, MBND's management intends to serve customers with high-speed internet by delivering it wirelessly (short-haul 5km or less) to the rooftop and over MFH2 to the unit. This setup is a significant cost savings for MBND as rather than leasing circuits from the local phone company, they can buy wholesale backhaul from the phone company and deliver their own internet wirelessly. The product that they have is already developed and is already delivering wireless internet at speeds of 10 to 30 megs and the technology roadmap targets 50 to 100 megs.

CAPITAL STRUCTURE AND MULTIPLES
With a $2.70 share price and 19.3m diluted shares outstanding, MBND has a $52.1m market cap. Net debt and preferred of $22.6m bring the enterprise value to $74.8m. Prior to the recent financing, the balance sheet was messy with 7 classes of preferred stock. The impact of preferreds is now a couple hundred thousand shares and a $3m liquidation preference. Roughly $30m of debt matures in January 2013, bears 8.25% interest and is owed to former DTHC holders. As this is a big source of income for the holders, management believes they want to extend the maturity date. Nonetheless, cash on hand and cash generation can cover the maturity.

We model $283.3m revenue, $23.3m EBITDA, $14.0m FCF and $0.30 EPS. This results in the following multiples:

 

Multiples 2011E
P/E 8.9x
P/FCF 3.7x
EV/S 0.3x
EV/EBITDA 3.2x

CONCERNS
Customer concentration is obviously a concern but we estimate that MBND fulfills somewhere around 20% of DTVs service installs/moves/adds/changes. This is not an easy business to run profitably and DTV has already had to acquire fulfillment partners facing financial difficulties. MBND's MSAs have remained stable and MBND is their number one performing fulfillment partner.

There's speculation that DTV's subscriber growth is going to slow and it will be difficult for MBND to maintain profitability. As we've outlined, the HSP segment's 2010 EBITDA increase was achieved even as sales declined slightly. Additionally, 2/3 of revenue comes from existing subscribers. Further, a large competitor with insight into DTV's business recently bid $4.50 for the company. Management believes that if subscribers just remain flat that they'll sustain this level of EBITDA. JPM initiated recently and still expects DTV to grow subs even as cable loses video subs.

The largest concern on the growth story is a lack of financing. We expect that equipment leases will be expensive. Nonetheless, we expect that MDU can have a significant contribution to EBITDA, collateral for financing will be insulated by specific building assets AND we're not formally including significant value for the MDU in our valuation.

Leverage could be a concern but MBND is trading at 1.1x net debt to EBITDA and debt service is 5:1.

Auditors are Baker Tilly Virchow...who? Also, such a small company is not required to have auditors express an opinion on the company's internal control over financial reporting.

TARGET PRICE
Ultimately we value the shares at $6 (125% upside) primarily based on putting a 6x multiple $23.4m of EBITDA. Though MBND has higher customer concentration from DTV (>90%) vs. UNTK's 48% and MTZ's 24%, MBND has leading margins and EBITDA is understated due to differences in accounting which makes us comfortable with the multiple. Further, DTV bought out a similar company (180 Connect-84% DTV revenue) about to blow up at more than 6x. What's more we're not ascribing any value to the MDU segment which could ultimately be larger than the core HSP business. Net/net, we think $6 is fair especially as it only represents roughly 8.3x P/FCF. We note that our ultimate longer-term target price is quite substantially higher.

We use EBITDA because it's industry standard. We could use cash flow or a DCF. If we assume no growth from 2011's $14m FCF, a simple perpetuity discounted at 10% renders a $140m value and this number includes cash interest; an expense that would be removed in a DCF analysis. Our target price of $6 results in a $140m EV. Again, we're comfortable here but note that there's significant room for upside.

As this report is somewhat long and verbose, we left out a discussion of other growth initiatives but figured to include a sentence at the bottom. Management believes they can add another $100m of revenue by leveraging their super-regional footprint and strong technical capability for other installation services (Home Security, Digital Signs, Big box retail electronics home install, etc.) As HSP has a largely fixed cost structure, management envisions boosting earnings by keeping their crews busier. They've already added several million dollars of revenue in this area.

Catalyst

We believe many of the sub-catalysts have quietly occurred and that the stage is set for MBND to outperform. On the MDU side, these include the FCC's ban on exclusivity clauses in MDUs, the advancement of MFH2 as a viable distribution system, MBND's development of a sophisticated purpose-built billing/provisioning/customer support system, the lifting of restrictive covenants in the DTHC stock purchase agreement, the acquisition of two WPCS engineering shops and the signing of a four-year MDU extension agreement with DTV. Near/mid-term MDU catalysts include the announcement of an equipment lease facility to begin building out MDUs and the announcement by DTV of their restructured MDU program which MBND has strategically positioned themselves to benefit from. We believe that MDU buildout will begin in earnest by 2/3Q 2012. Meanwhile, HSP will continue to perform and Q3 will be especially strong.
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    Description

    MBND's core business generates a level of EBITDA that justifies more than 100% upside in the equity while growth opportunities will potentially more than double EBITDA. If you think we're being too aggressive we'll refer you to management who has guided to quadrupling EBITDA. In fact, MBND's management team has articulated a $90m EBITDA target in 3-4 years, nearly four times greater than 2011's $23m level. At a 6x multiple, the equity would be worth 9x more than today's close. This of course seems crazy so while we contemplate a value that represents a double, we're comfortable that the probability-weighted reward/risk is substantially skewed in favor of a long position. UNTK, an MBND competitor seems to side with us in being conservative as they bid a paltry $4.50 per share (67% above today's price) for the company 10 weeks ago but were denied. At $2.70, one can buy the shares for 3.8x this year's free cash flow.

    INVESTMENT STORY
    At its core, MBND has a workforce of over 2k field employees that provide technical installation and fulfillment services to 5k residential and commercial properties per day. MBND's business is split into two distinct buckets: HSP and MDU.

    Home Service Provider (HSP)
    The HSP segment is the second largest fulfillment service provider for DirecTV (DTV) in the United States. If the owner of a single family home orders/moves/adds/changes DTV service and lives in one of MBND's 36 exclusive DMAs there is a 100% probability that it is an MBND technician performing the service.  The HSP segment is the result of MBND's acquisition of DirecTech (DTHC) through a series of transactions prior to fiscal 2010. The net purchase price paid for this acquisition was $46m and it generated EBITDA of $25m in 2010 (1.8x). DTHC Transaction Breakdown:

     

          Initial   Net
    Date Subsidiary Percent Value Adjusted Value
    Mar-08 MMT 51% 6.1   6.1
    Jan-09 MMT 29% 1.7   1.7
    Jan-09 Sub-Group 80% 38.7 -10.7 28.0
    Dec-09 All Rmaining 20% 10.0   10.0
    Total 45.8


    MBND's two public peers trade for 5x and 7x EBITDA. If we were to apply the median multiple to MBND the stock would be worth $6. Further, MBND's EBITDA is understated relative to its peers. One year after the in-service date of its vehicles, MBND has the option to renew the lease or surrender the leased vehicle to the lessor. Therefore, the company characterizes leases as operating rather than capitalizing them and fully expenses them accordingly. MBND's comps capitalize their fleets and so the expense (depreciation and interest) is added back to their EBITDA number. If we were to capitalize MBND's leases, we'd add $10m to EBITDA and $10m to enterprise value, equal to their annual commitment. After making these adjustments, MBND's EBITDA is $33m and their current EBITDA multiple is 1.9x. Apply the adjustments and a median multiple of 6x and MBND's equity is worth more than 3x today's close.

    Adjusted EBITDA        
    "GAAP" EBITDA 23.3      
    Operating lease payments 10.0      
    Adjusted EBITDA 33.3      
             
    Enterprise value 52.1      
    Operating lease liability 10.0      
    Adjusted enterprise value 62.1      
             
    Adjusted EV / EBITDA 1.9x      
             
    Valuation Sensitivity        
    EBITDA = $33m        
    EV/EBITDA Ent. Val. Mkt. Val. / Share % Upside
    4.0 132.0 102.3 5.30 96%
    5.0 165.0 135.3 7.01 160%
    6.0 198.0 168.3 8.72 223%
    7.0 231.0 201.3 10.42 286%
    8.0 264.0 234.3 12.13 349%
    9.0 297.0 267.3 13.84 413%

    Again, the valuation begins to get out of hand and one can make varied assumptions with respect to years' worth of lease payments to add to EV so we just keep a 6x on "GAAP" EBITDA (125% upside) in mind noting that EBITDA is obviously not GAAP to begin with. Additionally, DTV took out one of their largest fulfillment partners (180 Connect-84% DTV revenue) with a massive looming debt maturity in the death throes of the 2008 market at 6.2x EBITDA.

     DTV's 180 Connect, Inc. Acquisition
       
    Closed: Jul-08    
         
      Mar-08  
    Price 1.80 Irony?
    Shares 25.5  
    Mkt. Val. 45.9  
         
    Net Debt 54.4  
    Ent. Val. 100.3  
         
      LTM EV /
    Sales 382.4 0.3x
    EBITDA 16.1 6.2x
         
    DTV Revenue % 84%  

    We believe that MBND's core HSP segment will generate more than $20m of EBITDA per annum assuming DTV's US subscriber growth slows; we model 2011 EBITDA of $23m. As the MDU segment is breakeven, this equates to EBITDA for the overall company. The HSP segment's meteoric EBITDA increase in 2010 was not dependent on sales growth - sales actually declined by roughly 1%. Also, two-thirds of this segment's business is related to moves/adds/changes for existing subscribers vs. new service orders. MBND has 36 exclusive DMAs and this has remained stable for years. Though DTV fulfills roughly 40% internally, this is primarily due to taking out financially strained fulfillment partners. As such, DTV is appreciative of the difficulties this business entails. DTV has some promotional programs such as NFL Sunday Ticket for free but those haven't yet shown up in the $23.5m TTM EBITDA; a level achieved during the NFL lockout. Additionally UNTK, another large DTV fulfillment partner, tried to acquire MBND for $4.50 per share 10 weeks ago. We assume that UNTK has as much insight into DTV's business as MBND and wouldn't attempt to more than double their business with DTV if they viewed it as falling apart.

    DTV initiated an incentive payment structure in 2009 in order to improve customer satisfaction numbers. MBND's management team calculated that they could generate more income if they maximized incentive payments rather than squeeze the business for profitability and treat incentive payments as a bonus. As such, they staffed-up and instituted an ongoing top-to-bottom Disney Institute customer service training program which brought the HSP business to breakeven. Management also instituted a real-time dashboard to monitor the seventeen key performance metrics. It worked - the HSP business generated record EBITDA under the new structure. In addition we know firsthand that DTV awarded MBND the status of #1 fulfillment partner over 90% of the time in the last two years. This is just one example of the perspicacity of this management team.

    HSP EBITDA
    2008: 2.4m
    2009: 4.0m
    2010: 25.4m

    Through discussions with management and past performance, we don't believe that they'll risk the HSP segment cash flow investing in growth initiatives; rather they'll use HSP cash flow to pay down debt or expand the segment and look for other initiatives to self-finance.

    Multi-Dwelling Unit (MDU)
    The MDU segment is a system operator for DTV. If an apartment building offers DTV pursuant to an agreement with a system operator, tenants order DTV service from them, pay them monthly, call them for moves/adds/changes, and are billed by them. This is in contrast to the HSP segment which simply fulfills orders placed directly with DTV. The MDU segment also provides customer support and billing for other DTV system operators around the country. MBND's MDU segment has been bumping along at breakeven for awhile but is poised to grow significantly beginning in the next 2-3 quarters. MBND has spent years and $millions positioning themselves to be DTV's largest system operator partner and, given emerging details from a new DTV program yet to be announced, MBND may be the only choice going forward.

    Roughly one-third of Americans live in MDUs representing a large opportunity for pay-TV operators. DTV commands a 20% market share of US single family homes but less than 1% of MDUs. This is because for most of the last decade, satellite operators were effectively locked out of the market due to cable companies' exclusive agreements. Cable companies had a strategy similar to legacy RBOCs - they owned the wiring and so owned the customer. In late 2007 (later upheld in 2009), the FCC banned such exclusivity clauses paving the way for satellite operators, including DTV, to begin marketing to MDUs.

    There remained however, technological difficulties. MFH2 has emerged as a viable solution to provide services to all units in a building and substantially reduce the capital cost of buildout. MFH2 allows a system operator to offer all DTV programming and services in all units through one centralized dish using single-wire technology through existing coaxial cabling. Additionally, MFH2 integrates with high-speed data services allowing operators to bundle services at reduced cost. Given the heterogeneity of MDUs (contract terms, building architecture, system infrastructures, locations, etc.), DTV relies partly on system operators to deliver content and service to buildings. At 100k subscriptions, MBND is already DTV's largest system operator and handles client servicing for another 50k units acquired by other system operators.

    The FCC ruling and technology advancements have paved the way for system operators to penetrate MDUs. Sensing this trend, MBND's management began expending significant resources to further develop proprietary customer service and billing platforms in order to position the company to take advantage of the MDU opportunity. The software that MBND has developed is something that nobody else in the industry has - they developed it internally and have 10 dedicated programmers continually enhancing it. We view this complete solution as a large barrier to entry. The platforms seamlessly manage individual unit programming data, room-by-room inventory, billing, paperless statements, account history, automatic account credit and debits, credit scores, receivables aging, etc. On the customer interaction front it answers the call, transfers to relevant personnel and scripts the interaction. The platform allows MBND to offer a triple play to MDU residents including DTV video.

    DTV's Chairman has made several public comments that MDUs represent a focused area of growth for them:

    "In apartments, we have changed our business model. We've lowered the cost of our MDU, multiple-dwelling unit product - the cost of it to us - by a third, which opens up the ability to grow our MDU business more."
    -Michael White, Chairman, Mar-2011, MSCO's TMT Conference

    "So frankly there are some non-traditional segments like commercial and apartments. We think MDU, we call them multiple-dwelling unit, is a big opportunity."
    -Michael White, Chairman, Sep-2010, GSCO Communacopia Conference

    "...looking for selected channels and strategies where we might grow our business, and MDU is a good example of that."
    -Michael White, Chairman, May-2010, 1Q10 Earnings Call

    Emerging details of DTV's restructured system operator program reveals the requirement that system operators handle their own customer support and billing. If this is imposed as management expects in the near-term, MBND's strategic platform investment is going to pay off big. MBND is focused on A and B type properties (higher end) totaling roughly 7m units. If DTV is able to penetrate this market to the same extent that it has single-family homes, that's 1.4m units. With MBND's sophisticated platform and existing status as DTV's largest system operator, we think that MBND can get a big chunk of this business through newbuild and inexpensively replacing existing system operators. With roughly 300k total DTV MDU units, MBND already owns or services half of them. If MBND held onto their DTV share that's 700k units at maturity. Additionally, MBND is in a position to take out other system operators that can't service/bill the customer on their own. These system operators will be compelled to hand their business over to MBND, likely at a very attractive price to MBND because they have no choice as existing contracts run their course. This is one source from which we expect MBND can grow their owned unit base. Management also claims to have a backlog of over 100k MDU units desiring DTV installs.

    Once the new structure is in place, the unit economics, superior margins, and recurring nature of revenue makes MDU quite attractive relative to HSP. We contemplate a double play for the average unit because MBND plans to only pursue Local/Long-Distance for buildings exceeding 150 units.

     

          % of Bill /
    Average MDU Unit Per Month Per Annum Gross Margin
    DirecTV 77 924 69%
    Internet 30 360 27%
    Protection Plan 5 54 4%
    Revenue 112 1,338 100%
           
    DirecTV 22 259 28%
    Internet 12 144 40%
    Protection Plan 5 54 100%
    Gross Profit 38 457 34%

    As tends to be the case with this story, the numbers get out of hand. Applying the above numbers to 700k units results in $210m of revenue and $64m of gross profit. Management expects that the cost per unit to build out a property is $250. At a 1/3 take-rate, subscriber acquisition cost is $750. At gross profit of $457, the payback period is less than 2 years.

    Management has guided to 150k primarily owned units under the restructured DTV program in the near-term. Backing into the numbers, 150k units / .333 take rate = 450k units built out * $250 = nearly $115m. When walking him through this logic, CEO Jim Mandel didn't even flinch and believes the company can get there with a $50m lease facility collateralized by specific MDU channel assets rather than recourse to the parent company (in-line with their mentality to not risk the solid HSP business). Cash flow from the MDU units will finance the rest. He mentioned they already have some term sheets and is something they plan to announce once all the pieces are in place.

    Insofar as the aforementioned pieces are concerned, this may be a good time to talk about the secondary and recent announcement of the tuck-in WPCS acquisition.

    FINANCING AND M&A
    MBND's acquisition of DTHC was pursuant to a stock purchase agreement with the former owners that put significant restrictions on management's ability to expand the business. Specifically, section 6.1.2 (l) specified that any acquisition of assets, operations, businesses or securities could not exceed $1m in the aggregate. Therefore, management had to get the former owners of DTHC out of the stock in order to pursue their MDU strategy. The original S-1 was filed in September 2010 which included only the shares of the former DTHC owners. Within a month on the back of QE2 the shares nearly doubled. Following the Craig Hallum initiation (the only bank that covers MBND), the stock doubled again to $6. Management had already struck a $10m agreement with Lincoln Park Capital which would trickle out shares as MBND needed the capital but with the stock at $6 they decided to sell some primary shares all at once and cancelled the agreement with Lincoln Park. When the amended S-1 was filed and management hit the street to place the shares, the stock was sold down hard to get the deal at a lower price (according to management anyway). The deal ultimately went off at a disappointing $3. What's done is done.

    Subsequent to the financing and with the restrictions lifted, management went after WPCS - a micro cap engineering company focused on wireless technology and specialty communication systems. Before closing on the acquisition however, management accelerated the acquisition of certain WPCS operating entities. We were scratching our heads on this one a bit and spoke with management about it. The two operations MBND initially purchased are design houses. WPCS has expertise in combining technologies to deliver close-range wireless internet. In an effort to make the economics work on MDU service bundling, MBND's management intends to serve customers with high-speed internet by delivering it wirelessly (short-haul 5km or less) to the rooftop and over MFH2 to the unit. This setup is a significant cost savings for MBND as rather than leasing circuits from the local phone company, they can buy wholesale backhaul from the phone company and deliver their own internet wirelessly. The product that they have is already developed and is already delivering wireless internet at speeds of 10 to 30 megs and the technology roadmap targets 50 to 100 megs.

    CAPITAL STRUCTURE AND MULTIPLES
    With a $2.70 share price and 19.3m diluted shares outstanding, MBND has a $52.1m market cap. Net debt and preferred of $22.6m bring the enterprise value to $74.8m. Prior to the recent financing, the balance sheet was messy with 7 classes of preferred stock. The impact of preferreds is now a couple hundred thousand shares and a $3m liquidation preference. Roughly $30m of debt matures in January 2013, bears 8.25% interest and is owed to former DTHC holders. As this is a big source of income for the holders, management believes they want to extend the maturity date. Nonetheless, cash on hand and cash generation can cover the maturity.

    We model $283.3m revenue, $23.3m EBITDA, $14.0m FCF and $0.30 EPS. This results in the following multiples:

     

    Multiples 2011E
    P/E 8.9x
    P/FCF 3.7x
    EV/S 0.3x
    EV/EBITDA 3.2x

    CONCERNS
    Customer concentration is obviously a concern but we estimate that MBND fulfills somewhere around 20% of DTVs service installs/moves/adds/changes. This is not an easy business to run profitably and DTV has already had to acquire fulfillment partners facing financial difficulties. MBND's MSAs have remained stable and MBND is their number one performing fulfillment partner.

    There's speculation that DTV's subscriber growth is going to slow and it will be difficult for MBND to maintain profitability. As we've outlined, the HSP segment's 2010 EBITDA increase was achieved even as sales declined slightly. Additionally, 2/3 of revenue comes from existing subscribers. Further, a large competitor with insight into DTV's business recently bid $4.50 for the company. Management believes that if subscribers just remain flat that they'll sustain this level of EBITDA. JPM initiated recently and still expects DTV to grow subs even as cable loses video subs.

    The largest concern on the growth story is a lack of financing. We expect that equipment leases will be expensive. Nonetheless, we expect that MDU can have a significant contribution to EBITDA, collateral for financing will be insulated by specific building assets AND we're not formally including significant value for the MDU in our valuation.

    Leverage could be a concern but MBND is trading at 1.1x net debt to EBITDA and debt service is 5:1.

    Auditors are Baker Tilly Virchow...who? Also, such a small company is not required to have auditors express an opinion on the company's internal control over financial reporting.

    TARGET PRICE
    Ultimately we value the shares at $6 (125% upside) primarily based on putting a 6x multiple $23.4m of EBITDA. Though MBND has higher customer concentration from DTV (>90%) vs. UNTK's 48% and MTZ's 24%, MBND has leading margins and EBITDA is understated due to differences in accounting which makes us comfortable with the multiple. Further, DTV bought out a similar company (180 Connect-84% DTV revenue) about to blow up at more than 6x. What's more we're not ascribing any value to the MDU segment which could ultimately be larger than the core HSP business. Net/net, we think $6 is fair especially as it only represents roughly 8.3x P/FCF. We note that our ultimate longer-term target price is quite substantially higher.

    We use EBITDA because it's industry standard. We could use cash flow or a DCF. If we assume no growth from 2011's $14m FCF, a simple perpetuity discounted at 10% renders a $140m value and this number includes cash interest; an expense that would be removed in a DCF analysis. Our target price of $6 results in a $140m EV. Again, we're comfortable here but note that there's significant room for upside.

    As this report is somewhat long and verbose, we left out a discussion of other growth initiatives but figured to include a sentence at the bottom. Management believes they can add another $100m of revenue by leveraging their super-regional footprint and strong technical capability for other installation services (Home Security, Digital Signs, Big box retail electronics home install, etc.) As HSP has a largely fixed cost structure, management envisions boosting earnings by keeping their crews busier. They've already added several million dollars of revenue in this area.

    Catalyst

    We believe many of the sub-catalysts have quietly occurred and that the stage is set for MBND to outperform. On the MDU side, these include the FCC's ban on exclusivity clauses in MDUs, the advancement of MFH2 as a viable distribution system, MBND's development of a sophisticated purpose-built billing/provisioning/customer support system, the lifting of restrictive covenants in the DTHC stock purchase agreement, the acquisition of two WPCS engineering shops and the signing of a four-year MDU extension agreement with DTV. Near/mid-term MDU catalysts include the announcement of an equipment lease facility to begin building out MDUs and the announcement by DTV of their restructured MDU program which MBND has strategically positioned themselves to benefit from. We believe that MDU buildout will begin in earnest by 2/3Q 2012. Meanwhile, HSP will continue to perform and Q3 will be especially strong.
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