Saturday, September 11, 2010

Tinet Kickstarts Neutral Tandem's New Growth Initiatives

Maxwell Smart was an idiot that employed cutting edge communications. Mr. Market represents today's idiots that don't understand, and can't differentiate among, telecommunication companies. Intense price competition doesn't always result in Level3 [LVLT] like financial performance. Yet, that is exactly how the market is treating Neutral Tandem [TNDM].

Disruptive technologies and commodity offerings do result in revenue challenges, but all companies aren't affected equally. The downfall of LVLT and most similar companies was severe over capacity and usage of debt, two factors that do not negatively affect TNDM. Neutral Tandem is debt free and asset light, as they have taken advantage of industry over building and leased their fiber at attractive rates. They have also stayed out of the retail business of their customers and also not pursued enterprise business in competition with those same customers. They've remained wholesalers and have, consequently, be able to gain market share of carrier business.

While TNDM has gained share, total minutes are growing 20+ percent, prices are falling. Revenue is flat, but margins remain healthy. Their niche in voice switching remains solid and viable for the forseeable future. But growth is elusive and a company needs to grow. Management has pointed the company in the direction of termination of international calls and ethernet exchange. They have been expensing all of their expansion efforts and have the balance sheet to accomplish the mission.

Thursday the company jump started their international and ethernet plan. They announced the acquisition of Tinet, an Italy based IP transit and ethernet services company. TNDM is paying $95MM in cash or 6.1X post synergies EBITDA; 7X without the synergies. After the all cash transaction, TNDM will still have over $90MM of cash on hand. The balance sheet will remain strong as TNDM continues to project throwing off over $30MM of free cash next year.

Tinet, with sales of $56MM and EBITDA of $10MM, brings a strong presence in wholesale IP transit and about $5MM of ethernet revenue. The combination of TNDM's North American voice business with Tinet's international data networks offers significant new business opportunities within the customer base. The combined network will offer future ethernet customers over 100 locations worldwide, much broader than any of the fledgling ethernet providers. This growth area now looks much more promising and the CEO states that ethernet revenue should be growing nicely in 2011. Additionally, termination of international calls should ramp up revenue as TNDM solicits Tinet's customer base.

The combined company, at 6/30/10, would have had sales of $230MM and $99MM of EBITDA. After deducting $95MM of cash for the acquisition, the enterprise value of TNDM is only $236MM or 2.4X combined EBITDA. TNDM is cheap.

Maxwell Smart, I mean Mr. Market, will eventually accept that TNDM's voice market isn't near-term terminal or become ethernet exchange believers. Short sellers, over 10% of the float, have made a killing on the ride down and must be near the exit point as the bottom must be near for a company with no debt and lots of cash per share. We may be several quarters away, but at $10 Neutral Tandem is a buy. I thought so at $13 and I'm a bigger believer after yesterday's announcement. I bought more shares on Friday and harbor no thoughts that TNDM will follow the path of Level3.


kevin said...

Humor and value stocks don't usually go hand in hand, but you bridged the gap. Good work, thanks and I'm long TNDM. KJM (thedogsmad)

Andy said...

why do you value stuff on the basis of EBITDA? you seem like a smart guy and most other smart guys dont do that.

William F. Kabourek said...

Andy, thanks for the quasi comment about seeming to be smart. I look at P/Es as well, but the EBITDA number is a good measure of value and somewhat akin to the amount of cash a company generates. A simplistic example is you buy a company for all cash and pay 5X EBITDA for it, you've got a 20% pretax return. It's easier to measure against similiar companies as each will have a different debt structure, tax bracket, depreciation method,and accounting policies. Any way you value TNDM it is cheap as long as they can keep minutes growing faster than pricing shrinks; so far so good.

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