Description

Tucows (TCX)

   Share Px (7/12/24): $21.72

      TSO: 11M

   Market Cap:$238M

       Cash:$66M

       Debt:$544M

   EV: $716M

Intro:

Tucows is well known to the VIC community, no need for elaborate introductions. The prior 2019 short report was spot on, aided by a different interest rate environment. We believe now is a good time to get back in (high teens was a better entry point - should have posted this a day or two earlier!). Why now? The value in the assets is there, saddled by an ugly capital structure thanks to the continued investments in Ting Fiber. Elliot Noss has decided that the public markets are not the place for a fiber capex play and is therefore planning some kind of transaction (sale, spinoff, go-private, re-financing, etc.). From his recent commentary and flaccid stock price over an extended period, we believe the catalyst will be announced this year, resulting in a nice return from current stock prices.

Quick Business Overview

Tucows has three distinct growing businesses: Domains, Wavelo, and Ting.

1. Domains is utility-like with about $240million of revenue growing low single-digits with 17-18% EBITDA margins, approx $43million EBITDA’24

2. Wavelo is a software business for telecom customers, providing subscription/billing management and other services. Wavelo is growing nicely (~30% in Q1-24 but 2024 is forecasted to be lower growth) with approx $40million run-rate revenue and $8-10million EBITDA’24

3. Ting is a FTTH business with approx 20%+ revenue growth, $53million revenue, and unprofitable due to continued investments in fiber (flowing through capex and operating). Ting has been the problem-child from a funding perspective, saddled with $340million of debt (inclusive of term notes and expensive preferreds).

Tucows also has a drying EBITDA stream of a few million dollars (‘corporate’) that we will ignore in this write-up.

Ting Value:  If management transacts Ting (which is the key part of thesis) how much is it worth?

Management is obviously, not content with the current situation (see commentary further below) and believes the business is worth at LEAST the debt pertaining to Ting and probably wouldn’t transact if worth less than the cumulative capex of $365million..

The financing market for FTTH has improved significantly since Tucows securitized part of Ting’s subscriber-base April 2023, with several actual/proposed transactions: Frontier/Stonepeak, T-Mobile/Lumos, Uniti/Windstream, Shentel/Horizon, WideOpenWest (take-under), etc. Table below highlights some transactions/comps/valuations. Ting has 124K owned serviceable addresses and partners with local entities totaling another 33K serviceable addresses. We valued the partner addresses at half of fully owned (Ting shares in the economics with partner).

The table above omits some transactions, including NelNet partially selling its fiber business at the end of 2020 for approx $7,700 per sub (equivalent of $350 million which covers Ting debt), given the age. 

Also, some other (proposed) transactions were not fiber pureplays so harder to do apple-to-apple e.g. WOW recent bid by Crestview, a cable overbuilder with a nascent fiber business (launched in 2022). Seems to us this is a take-under and at least one shareholder is fighting Crestview.

CNSL acquired by Searchlight in October 2023 for 9.6XEBITDA - napkin math with current Ting sub-base and $650 EBITDA/sub = $30million EBITDA = $290 million valuation ($50million below Ting debt). As penetration improves with current serviceable addresses, sub-base is comfortably 60-75K (including owned and partners) valuing Ting easily at debt or higher.

Uniti/Windstream merger jives with the CNSL multiple. In a recent TDCowen conference, management laid out financing and transaction multiples: ABS financings were done at 9X-12X EBITDA and M&A transacted at 10x-20x. Both of those would value Ting easily above its debt on normalized EBITDA.

It will be interesting to see Frontier and Stonepeak finalize their fiber JV, rumored to be $500million to $1billion.

The key takeaway is that once Noss transacts Ting, he should be able to get at least Ting’s current debt but probably considerably higher. There is also a good chance (and history of) Tucows obtains a Wavelo contract from Ting once it has spunoff/transacted, giving Tucow’s an additional stream of income. Noss consistently distinguishes between the infrastructure and the ISP parts of Ting - inferring that the ISP part is under-appreciated and why he would want to retain some of the economics of the ISP (again, probably through Wavelo).

RemainCo Value:

The remaining business carries $205million of debt with $66million of cash and generates about $52million of EBITDA (growing). Below are the various multiples one is paying for RemainCo once Ting has been transacted depending on valuation:

Domains’ value >10X EBITDA due to its stability and slow growth. Comp GoDaddy trades at a substantial premium (18XEBITDA) given its slightly higher growth.Conservatively valuing Wavelo at 10XEBITDA (one could value the growing Saas business higher, easily at 5X revenue). Domains+Wavelo valued at $520million. Our base assumption is that Ting will be sold for cumulative capex, leaving a $37/sh value for the remaining business, or a ~70% upside.

Why Now?

We believe Noss is just fed up with the current TCX stock situation. It has been a slow grind lower over the quarters/years and shareholders patience has a limit. One can see Noss’s patience run thin through his commentary.

To finance Ting fiber expansion, Tucows issued pretty expensive preferreds back in 2022 (partially redeemed in 2023 at usurious rates). Subsequently, in 2023, Tucows issued term notes backed by Ting assets at reasonable rates. Thereafter Noss hired Goldman Sachs to seek alternative financing which didn’t go anywhere. After all this, we believe Noss has decided to transact Ting (could be a go-private but probably more creative). Below are relevant excerpts from Noss over the last 12 months (apologies for the extensive copy/pasting but we think it is relevant).

Noss 2Q23 earnings call:

“...my brief comment on the process we engaged in with Bank Street and Goldman Sachs. In that process we were looking to sell a minority equity stake in the Ting business. We believe that we could have sold a majority stake and we certainly could have received another pref. Neither of those were of interest.”

“I am now well into my 22nd year running this public company and I am not sure there has ever been a time where I felt the value of the business was so disconnected from the stock price. The stock is 78% off its high at the end of 2021.”

Noss 3Q23 earnings call:

“TCX has a tight cap table and thin public float, making the disconnect between the value of our three businesses and the TCX stock price the greatest I have seen in my time running a public company”

“There are two other specific trends in fiber particularly to discuss — the move to asset-backed securities (ABS) and the trend towards taking the benefit of a fiber build out of the public market and into private hands. …The second trend is the privatization of the economic returns of a fiber build. We have seen that twice this quarter: an activist shareholder with an existing telecom backer taking a stake in Frontier as well as the privatization of Consolidated Communications. 

In each case, the thesis is that the public market will not allow a company to go through the cash burn of a fiber cycle. In each case, the company needs capital to fully take advantage of the opportunity in front of them. In each case, the public market has not been terribly receptive.”

“In closing, in 22 years running a public company, I have never spent more of my time on capital allocation. These are dynamic times, and as I said last quarter, we have a demonstrated ability to take advantage of them.” 

“Providing further detail prior to announcing anything would compromise our ability to keep all our options open.”

Noss 4Q23 earnings call:

“With Ting, I find myself thinking about time and timing. Time in the sense of the pace of the coax-to-fiber transition in the US. Timing in the sense that when one engages in anything dealing with the balance sheet or the cap table, “when” is often more important than “what”.”

Noss 1Q24 earnings call:

“Both items are further reminders that the long-term nature of building and operating infrastructure like fiber assets is not rewarded in the public markets. In fact, it is clearly viewed negatively. And the latter item* is the first large deal that validates the split between infrastructure and operating assets that we have been pursuing since 2015. We have every indication that the public markets are not the right place to source that capital.

If you look at TCX, the market is saying that if we turned over the keys of the Ting fiber business to its lenders for nothing that our stock price would likely skyrocket. That is market inefficiency.

Inefficiencies create opportunities. We have a good sense of what the inefficiencies are and a track record of exploiting them. We are looking forward to the rest of 2024 and to the long-term future.”

Noss 1Q24 Earnings Q&A:

“Frankly, the statement speaks for itself. We have the two non-Ting businesses and the mobile tail generating well over $50 million in EBITDA. We have the Ting business, and we have the current stock price. My statement feels accurate. And of course I know I am just like every public company CEO who thinks his stock price is too low. Again, we think we have a clear sense of how to approach this.”

“....as we sort out the long-term capitalization of the Ting business we will be much better able to tailor the operations appropriately.”

* related to TMobile-EQT joint-venture to acquire Lumos fiber assets, April 2024

Key Risks

The thesis is based on some catalysts vis-a-vis Ting in 2024. Obviously, a lack of catalyst would delay the revaluation. The cash burn will continue in the near-term but Noss has already somewhat addressed it by workforce reductions at Ting and is well aware of limited timing. 

The biggest risk from a capital structure perspective is no transaction, cash eventually runs low so Ting taps expensive financing through the preferreds again (paying 15%+ for IRRs in the mid/high-teens doesn't make sense).

Conclusion

We believe Noss will transact Ting in 2024, de-risking the balance sheet, revaluing the whole business to at least the mid $30s but probably higher.

Notes:

https://www.t-mobile.com/news/business/t-mobile-eqt-jv-to-acquire-lumos

https://www.lightreading.com/finance/a-frontier-stonepeak-jv-could-be-worth-7-5b-analyst

https://investor.uniti.com/news-releases/news-release-details/uniti-merge-windstream-creating-premier-insurgent-fiber-provider

LB Partners letter to WOW re: Crestview bid:

https://www.sec.gov/Archives/edgar/data/1701051/000110465924066724/tm2415985d1_ex1.htm

Windstream/Uniti TDCowen conference deck, p.9 for comp multiples:

https://investor.uniti.com/static-files/2580b450-ceb9-47f2-b5a1-8838ad6fcd2c

Catalyst

Noss transacting Ting in 2024, de-risking the balance sheet, revaluing the whole business to at least the mid $30s but probably higher.