In fibeReality’s opinion, a kind of “shell game” seems to be conspicuously occurring at times in the telecommunications market, without always the precisely nefarious connotations frequently associated with the term, including not only temporarily involving Zayo Group, but WindStream Communications in the past, as well as currently AT&T. While the exact details of the plans of the three entities have been dissimilar, the intended outcomes have a lot of commonality — asset divestitures to maximize profit in one group versus the other. In other words, it is about making the individual part of a company really profitable, while the other tends to assume the losses, and then getting a better multiple in the overall valuation. We have recently touched on AT&T’s apparent plan to shift as much of its excess infrastructure as possible from the wireline side, including central offices, dark fiber, old copper, etc., to the wireless portion of the operator, which at a minimum, will evidently result in impressive tax savings. Clearly, Windstream’s rearranging of assets has become notorious, as it was ruled by a court that the service provider inappropriately did so with the REIT spin-off, Uniti, ultimately resulting in the former declaring bankruptcy. In focusing on Zayo, after going on a consolidation binge between 2009 and 2011, and then over the next several years later, increasingly dealing with the fact that there were not that many appealing fiber candidates to purchase anymore, there became a problem with growth. A little while before the announcement of its acquisition, Zayo’s leadership was not confident about such a prospect (at the price it was seeking), which had been its goal for a long time. Thus, the player publicly stated that it was moving in the direction of reshuffling its assets. In this article, we will also provide some intelligence we gathered on this firm, which, if nothing else, may help to partially explain why taking the concern private proved to be the most attractive exit option (as we have contemplated for Infinera), as well as even perhaps clarify the appearance of reluctance on the part of the two investment firms to have a sooner, more targeted closing date.
Zayo’s idea was to divide up the company. The supplier was hoping for a recapitalization through a new IPO in spinning out one of the entities. Additionally, the supplier wished to get an inflow of cash from the sale of the other asset that would get distributed back to the shareholders, and the dream was that the valuation of the entity left standing would go up to an attractive level.
However, despite the CEO’s reputation for being a “finance machine,” there was the fundamental problem with the equity market not pulling cash, especially in the dark fiber space, like it did seven or eight years earlier. The Street did not react kindly to the plan, and a prominent shareholder, Starboard Value, wrote a critical letter. Subsequently, Zayo abandoned the proposal.
Hopefully for the two new owners, it will turn out that we are correct that CenturyLink just needs some time to get to a better place financially before it will purchase the vendor. At the same time, we believe that Starboard’s denunciation of Zayo’s “management turnover,” is worse than it sounds, in that it was ostensibly self-inflicted to a large degree. We understand that Zayo purposely only kept people in the same leadership roles for short periods of time with the justification that they should not get comfortable, and the policy created havoc with a lot of people getting disenfranchised very quickly, as they could have a different boss about every nine months.
Also, Zayo’s “stark contrast to industry trends” may be explained as well, as we have heard that its business model is completely different than other enterprises in the sector. There has been a great deal of blending of margins across the operation, along with a propensity for the “synergy thing” in which there was overpayment for acquisitions (often already at saturation points), combining them together, eliminating half the staffs, and then hiring inexperienced millennials to run the departments.
As always, fibeReality does not recommend any securities, and this writer does not invest in any companies being analyzed by us.
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[written by Mark Lutkowitz]