Description

Pinnacle Holdings (BIGT $3.70 8/7/01 close) is a REIT that owns/manages 5,000 telecom towers and rooftops generating rent from wireless telecom providers. BIGT trades at 37% of its book value that consists of tower assets generating recurring and growing free cash-flow. The thesis for investing in the stock is that BIGT is significantly oversold in sympathy with other telecom stocks while it has a stable and growing cash-flow stream generated by contractual rents. The stock has some issues, mainly high leverage and a SEC investigation, which will be covered in this report, however I believe that the stock should be at $12.50 by year-end.

BACKGROUND
BIGT was founded in 1994 and had its IPO in February 1999. The stock hit an all time high of $80.50 on 3/10/00 driven by the telecom boom. BIGT hit an all time low of $3.20 at 6/21/01 driven by the telecom bust, which I believe was an overreaction on the downside. The company has grown mainly by tower acquisitions. All of BIGT’s revenues are generated by rent, paid by wireless companies to BIGT. BIGT has been focused on existing cash-flow (with growth opportunities), when acquiring towers, resulting in positive cash-flow from operations for the last three years.

A GROWTH COMPANY WITH SOLID CURRENT CASH FLOW
BIGT has 4.5 tenants per tower, the highest in the industry. In addition BIGT only focuses on leasing its towers and receiving rent versus servicing. As a result BIGT has the highest margins (currently the company has an approximately 50% EBITDA margin) among its peers. Currently the company’s cash flow is approximately $1 per share (the company has negative earnings due to massive D&A charges which do not reflect economic reality), and there is virtually no maintenance capex in the tower industry. As available capital for external growth has dried up BIGT is currently focused on internal growth. Even in the current environment, tower industry revenues are expected to almost double in five years driven by wireless companies continuing to build-out their networks. While BIGT has 4.5 tenants per tower, this could be increased to 6 tenants per tower over time. In addition, the company has scheduled rent increases of 3-5% per year from existing tenants. These revenue increases plus the reinvestment of free cash flow should result in an EBITDA growth rate of approximately 15-20% and an even higher cash flow from operations growth rate. Please see the calculation of BIGT’s growth rate and the discounted cash flow analysis at the end of the report.

WHAT IS BIGT WORTH
Book value of BIGT is approximately $10 per share. The cost basis of the company’s tower investments (adding back D&A) is approximately $14 per share (after subtracting the debt). The company has an approximate $1.6 billion investment base (before depreciation) and its return on that investment next year should be 7.5% (based on next years EBITDA estimate of $120 million). Remember that there is virtually no maintenance capex and BIGT is a REIT so it does not pay taxes. This return on invested capital is increasing approximately 12% per year so that in five years (2006) return on invested capital is approximately 11.5%. On a discounted cash flow bases the stock is worth $12.50 by year-end. At my price target of $12.50 the stock would be trading at 15x this year’s EBITDA of $100 million and 12.5x next year’s EBITDA of $120 million (conservative estimates). Currently, at $3.70, BIGT trades at 10.8x this year’s EBITDA and 9x next year’s EBITDA. Next year’s implied yield on BIGT’s total enterprise value is approximately 11%.

My price target of $12.50 is based on a very conservative discounted free cash flow calculation because I believe that some issues, (which I believe are overblown) which are described below, have to be taken into account. In my analysis I only use a five year time horizon, a 17% EBITDA growth rate, a 15% discount rate, a 9x terminal EBITDA multiple and no additional financed growth. These assumptions are very conservative and I believe the company should do a little better. If the company were going to resume external growth, BIGT’s valuation could improve dramatically from $12.50. Please see the discounted cash flow analysis at the end of the report.

ISSUES
CHURN-BIGT is experiencing churn (loss of revenues) of paging/messaging providers. However, churn appears to have peaked in 3Q2000 at 2.2% of revenues. Churn in 4Q2000 was approximately 1.8% and appears to have normalized in 1Q2001 at 1.3% of revenues. Churn is taken into account in my growth projections.
SEC INVESTIGATION-On 9/11/00 the SEC initiated an investigation into BIGT about certain accounting practices and the independence of their former auditors. On 6/20/01 the SEC registered BIGT’s 5.5% Convertible Subordinated Notes due 2007, which essentially concludes the first part of the SEC investigation. Currently the SEC investigation is mainly focused on BIGT’s former auditor and I would be surprised if BIGT gets more than “a slap on the wrist.”
LIQUIDITY-On 5/30 S&P downgraded BIGT’s senior unsecured debt to CCC, which was followed by Moody’s on 8/3. In addition, the covenants on BIGT’s $520 million credit facility is tight, but the company believes this year it will remain within their covenants. Because of BIGT’s internal growth the company’s liquidity situation should substantially improve in 2002.

CONCLUSION
So yes, there are issues, but I believe as time progresses they will have been resolved and the company will get a better valuation. Because of the asset value of the company’s towers, (private market values are 12-15x EBITDA) I do not believe there is a lot of downside, especially in the longer term. Even if the SEC investigation turns out nastier or if the company would have a problem with their covenants, two events I believe are unlikely to happen, I believe the asset value protects the shareholders from permanent losses. Monday August 13th the company reports Q2 earnings and I believe we will get a good idea of the progress the company is making increasing its cash flow thereby increasing its liquidity. If the company is making some real progress the stock could bounce pretty quickly. In addition the SEC investigation should be resolved soon, which I believe is a positive catalyst, even if the company gets a slap on the wrist.

HOW TO GET TO BIGT’s 15-20% EBITDA GROWTH RATE
Tenants per tower should increase from 4.5 to 6 over 10 years, which represents a 33% (approximately 3% per year) increase with minimal capex. The company has scheduled rent increases of 3-5% per year from existing tenants. Thus with 6-8% same tower (“same store”) revenue increases, 50% EBITDA margins and inflationary (2%) cost increases, same store EBITDA increases are approximately 10-14%. Currently, BIGT generates approximately $50-$60 million is cash flow from operations ($1.00-$1.25 per share) and there is virtually no maintenance capex. Thus $50-$60 million can be used to pay off 9% debt or for new investments, which yields another 4.5-5.5% EBITDA growth. In total BIGT’s EBITDA growth should be approximately 15-20% for the foreseeable future. Because of BIGT’s financial leverage, cash flow from operations should be growing at a much faster rate than EBITDA.

BIGT’s DISCOUNTED CASH FLOW ANALYSIS
Five years of 17% (mid range) EBITDA growth produces $219 million of EBITDA in 2006 (without leveraging up). I use a year-forward terminal EBITDA multiple of 9x. 9x $219 million is $1.97 billion. $1.97 billion - $900 million of debt is $1.07 billion. $1.07 billion divided by 48.4 million shares is $22 in 2005. Discount $22 back four years at 15% and BIGT should be trading at approximately $12.50 by year-end 2001.

Catalyst

Because the shares are depressed, the company just showing it is growing cash flow and executing its business plan could already serve as a catalyst (Monday August 13th the company reports Q2 earnings). In addition I believe the resolution the SEC investigation is going to be a positive catalyst. Finally, while I believe a worst case wireless telecom scenario is priced in the stock, any sign of stabilization of the wireless telecom sector could be a catalyst for the stock.