Description

Summary

TeraGo holds strategic wireless spectrum in Canada. The ongoing buildout of 5G networks, the upcoming auction of 38 and 39 GHz mmWave spectrum (likely in 2022), and the potential divestiture of Freedom mobile to a fourth player should catalyze strategic interest in the company over the next couple years. Though spectrum valuations can vary depending on the idiosyncrasies of a particular auction or acquisition, TeraGo should be at least a double based on precedent US transactions. Meaningful downside appears unlikely because the market is implying a spectrum value of less than half US comparables and would only materialize in the event of an unfavourable regulatory decision on flexible use licensing for 24 GHz spectrum or significant investment by management in 5G trials/buildout, neither of which appears likely.

Background and Analysis

TeraGo is the largest holder of mmWave spectrum in Canada. The company also owns two low-quality businesses – a connectivity division serving SMBs and a data center operation. TeraGo was written up on VIC twice before, in 2017 and 2019. The stock has not performed well since these write-ups because the operating businesses have continued to grind lower and there was no catalyst to daylight the spectrum value. At current prices, I think TeraGo represents an asymmetric risk/reward opportunity on a two-year view with upside potential of 100% against limited downside.

TeraGo holds 9.1B MHz-Pops of 24 and 38 GHz spectrum across Canada. The bulk of the value (80%+ on my math), is in the 24 GHz holdings. These are concentrated in Canada’s largest cities – Toronto, Montreal, and Vancouver. 24 GHz spectrum has commanded a premium value relative to higher-frequencies at US auctions. In general, mmWave spectrum has high bandwidth but poor propagation characteristics. The ultimate use case is still evolving, but it has been deployed in the US to densify 5G mobile networks (eg. in stadiums or urban centers) and for fixed wireless broadband.

To use the spectrum in a mobile network, TeraGo requires flexible use licensing approval from the Canadian regulator (ISED). The company received flexible use approval for its 38 GHz spectrum as part of a June 2019 decision. Flexible use licensing for TeraGo’s 24 GHz spectrum holdings has yet to be addressed by ISED. Management indicated on the latest conference call that ISED will likely first complete the auctioning of some higher-frequency mmWave spectrum (38, 39 GHz) and then turn its focus to 24 GHz. TeraGo is currently utilizing its spectrum within the connectivity business and all of the spectrum was purchased, either at auction or through acquisition.

I think it is likely that we will see the spectrum value crystallized in the next couple years and corporate actions support the notion that TeraGo is preparing for a sale. 5G network buildouts are in motion in Canada driving the incumbents to secure spectrum holdings. An ISED auction for mid-band spectrum is currently underway and I would expect the auction of 38 and 39 GHz spectrum to occur some time in mid-to-late 2022.

TeraGo appointed Chairman Matthew Gerber as CEO in February 2021 rather than hire an outsider. This feels like a temporary appointment. The company also completed a $15 million financing with EdgePoint in April which included warrants struck at $7, $7.50, and $8 expiring 24-36 months after issue. EdgePoint appointed Martin Pinnes to the TeraGo Board, a former Canada Pension Plan PM.

There are three obvious bidders for TeraGo’s spectrum – Rogers, Bell, and Telus. Regulators will likely force the sale of Freedom mobile (currently owned by Shaw) as a condition of the Rogers/Shaw merger, opening up the possibility of a fourth bidder for the TeraGo spectrum (Quebecor? New foreign entrant?). This would be positive for TeraGo and could serve to accelerate strategic interest in the asset and heighten the competitiveness of the bidding. As it sits today, the incumbents appear content to wait for ISED to rule on TeraGo’s 24 GHz spectrum prior to making a bid for the company – an acquisition in advance of a ruling would increase the risk that ISED could claw back a portion of TeraGo’s spectrum. A fourth player could change this calculus as the incumbents might be more willing to assume clawback risk to prevent TeraGo spectrum falling into the wrong hands and ISED would look more favourably on an acquisition of TeraGo by a smaller player.

Precisely valuing spectrum is a fool’s errand. The price paid for spectrum in any auction or acquisition is a function of the dynamics at that particular time – how many bidders, the level of desperation, the available alternatives? Here are some precedent US transactions courtesy of the TeraGo corporate presentation:

I value TeraGo’s 24 GHz holdings at $0.023 per MHz Pop by using the June 2019 top 10 market average of US$0.018 x 1.25 exchange rate. I value the 38 GHz spectrum at $0.016 per MHz Pop by using the January 2020 top 50 market average of US$0.0125 x 1.25 exchange rate.

At the end of March, the company had $11 million of net debt and will likely burn some cash conducting 5G equipment trials over the next 1-2 years. From a public messaging standpoint, it is important that TeraGo not post a “for sale” sign and simply wait for a buyer. The company must present a viable go-it-alone business strategy to both increase competitive tension in any auction of the company and to make its case to ISED to grant flexible use licensing for the 24 GHz spectrum (ie. they are not just spectrum squatting). This creates tension for management from an investor communications perspective as they must balance the desire of investors to avoid dilution against the need to present a potentially expensive go-it-alone network buildout strategy. In other words, there may be a disconnect between what management says they are going to do and what they actually plan to do.

The data center business could be separated and sold. TeraGo does not own the real estate underlying the data centers, but the company does have significant excess capacity at its centers driving the potential for high incremental margins if another owner could grow revenue. I would guess the business could sell for $20-$40 million based on revenue of $17 million ($1.00-$2.00 per share). Cogeco sold its Peer 1 data center business in 2019 for 2.6x revenue/~9x EBITDA.

The connectivity business would likely go to the buyer of the spectrum. With $28 million of revenue, assume it sells for 1x ($1.50 per share).

To see downside from the current price, I think we’d need to assume either significant ISED clawbacks on the 24 GHz spectrum when licensing for flexible use or large amounts of capital invested in 5G trials/buildout (with no return). I don’t see either as especially likely. TeraGo purchased all of its spectrum through auction or acquisition and has deployed it in the connectivity business. The US has already approved 24 GHz spectrum for flexible use. At the current share price, I estimate the market-implied value of TeraGo’s spectrum is about $70 million or less than half the value in my base case, implying valuations over 50% below those realized in comparable US auctions.

Catalyst

Completion of mid-band spectrum auction may drive more investor awareness of 5G spectrum in Canada

Sale of Freedom to fourth player

Sale of data center business