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Tuesday, April 13, 1999

Data Transmission Network
(Nasdaq: DTLN)
Phone: 402-390-2328
Website: www.dtn.com
Price (4/12/99): $23 3/4


We live in a world where everyone seems to depend on digitally delivered time-sensitive data. So it seemed natural that Data Transmission Network (Nasdaq: DTLN) decided to try to maximize shareowner value and, eventually, hire Salomon Smith Barney to "present the company to potential buyers." Yet, a year later, nothing's come of it.

Though the shares popped to a high of $46 on the news, they've been slumping ever since. On May 20, 1998, PanAmSat (Nasdaq: SPOT) lost control of its Galaxy IV satellite, leaving most of Data Transmission's subscribers temporarily without service. Since then, falling commodity prices have further weakened the farm economy, DTN's bread and butter market.

In addition, low-priced -- or simply free -- data feeds via the Internet have raised questions about whether Data Transmission's business model remains viable. Short-sellers have piled on, with some 2.78 million shares shorted as of March out of a reported float of just 4.7 million shares.

On March 18, the board announced it had "not received an offer for the whole [company] that we believe is equal to the parts." So DTN said it would take down the "For Sale" sign and refocus on aggressive growth. The stock slumped 20% to $16 1/8 on the news.

A week later, though, longtime Chairman and CEO Roger Brodersen resigned, passing the baton to hedge fund manager Peter Kamin, a director and 4.7% shareowner who had instigated last year's move to find a buyer. Kamin has promised to re-examine the firm's strategic alternatives, indicating the new board may again hire an investment banker to seek a buyer. The stock has popped back into the low $20s on hopes that this time may be different.

Yet, given Data's Transmission's heavy debt burden and its negative book value (after backing out $64 million in intangible assets), the skeptics remain skeptical.


Data Transmission provides comprehensive, time-sensitive information, including weather, news, quotes, market analysis, and commentary. It has more than 159,000 subscribers in the U.S. and Canada.

DTN supports several different information distribution technologies, including small dish Ku-band satellite, the Internet, FM radio side-band, cable TV, and DIRECTV. DTN provides the equipment that subscribers need to receive services using FM, Ku, or cable technologies.

As of December, nearly all of DTN's subscribers (144,800) relied on Ku-band satellite delivery, while just 4,700 used its Internet service. About 80% of revenues were derived from basic subscription products.

In 1998, agricultural services accounted for 59% of revenue and 72% of the subscriber base. Other revenues came from weather (17%), energy (11%), and financial services (9%). Agricultural services declined from 69% of 1997 revenues as the subscriber base fell by 5.6% to 113,800 (just 2,500 via the Internet), after rising 3.7% in 1997.

Meanwhile, weather services increased from just 8% of sales in 1997, as weather-related revenues soared 141% last year on top of a 91% gain in 1997. The company has made numerous acquisitions in recent years, including six deals during FY98, which included the July purchase of Kavouras, a provider of meteorological data services, for $22.7 million in cash.

Insiders own 27.6% of the company. Funds run by respected value investor Ralph Wanger control 13.2% of the stock while funds connected to esteemed value investor Wally Weitz, including the market-beating Weitz Hickory fund, own a 10% stake.


Income Statement*
12-month sales: $149.0 million
12-month income: ($2.66 million)
12-month EPS: ($0.24)
Profit margins: N/A
Capitalization: $276.2 million
Enterprise Value: $384.1 million
(*Before charge for debt extinguishment. Includes a $3.7 million after-tax charge related to the loss of control of the Galaxy IV Satellite by PanAmSat.)

Balance Sheet
Cash: None
Current Assets: $19.0 million
Current Liabilities: $36.4 million
Long-term Debt: $100.6 million

Price-to-earnings: N/A
Price-to-sales: 1.85


At $46, DTN traded for 242 times FY97 earnings, while sporting a negative book value after backing out intangible assets. The satellite glitch raised questions about the reliability of its main service in an environment where competition for data has perhaps never been more intense. In addition, the part of the economy DTN depends on most heavily continued to slump.

These negatives were arguably just reinforced by the company's failure to attract a buyer. Though Kamin has argued that the overall market's troubles simply closed doors to acquisition financing, skeptics think the company was and still is overvalued.


Though the company hasn't yet hired an investment banker, it probably will shortly. However, in the March 25 conference call, Kamin refused to say whether the company had received any bid at all during the year-long search. With well-known short-sellers Rocker Partners among those following the company, the professional shorts appear to be settling in for the next act.

However, DTN did announce February 1 that it attained a $122.9 million revolving credit facility to replace an existing $80.8 million line, which had $55.5 million outstanding at year end.

While DTN spent $8.4 million on interest expenses last year, depreciation and amortization accounted for a substantial $48.9 million, or roughly a third of operating expenses. That means the company's cash flow is much greater than its reported net income and can easily cover the interest expenses.

Indeed, in the recent conference call, chief operating officer Greg Sloma made the bull case for DTN by referring to cash flow and subscriber metrics. He said cash flow rose 8% last year from $54.7 million to $58.8 million, or from $4.52 to $4.74 per share. He expects cash flow to increase by about 5% this year.

Sloma said free cash flow -- defined here as EBITDA (earnings before interest, taxes, depreciation, and amortization) minus capital expenditures, minus interest expenses -- should soar to $37 million this year, after inching ahead just 4% to $21.9 million last year.

Though subscriber retention rates dipped to 81% last year from 88% in 1997 due to the satellite mishap, rates are now climbing back toward 83% to 84%. Sloma suggests a key figure is the economic payback per new subscriber. He said new subscribers generate $77 per month in revenue, or $924 per year. Subtracting operating expenses for customer service, delivery, and advertisements, DTN is said to generate 41.5% marginal cash flow, or about $383 per subscriber. (This excludes the Galaxy IV charge and the Kavouras customers.)

Back out $50 per year in maintenance capital expenditures, and each new customer generates $333 in cash per year. With equipment per subscriber costing $1,100, customers become profitable after 3.3 years. The 83% retention rate suggests the average customer stays around for 6 years.

DTN will also shift from developing and utilizing proprietary hardware to using new electronic delivery systems like the Internet. About 20% of new agricultural customers are opting for Internet delivery, while two-thirds of new financial services customers are signing up for Internet distribution. The company says about 60% of Internet-based DTN.IQ streaming real-time quote and full-text news service trial users are now becoming subscribers.

This shift is important because increased adoption of the Internet could reduce DTN's expenses, further increasing profitability and cash flow, which are now expected to lag the 10% to 15% revenue growth management expects this year.

Yet, the dynamics that would drive this move are the same dynamics that intrigue short-sellers. After all, real-time quotes are a commodity. Indeed, the Internet really ought to make all such data delivery into an ultra low-margin affair. Falling prices could simply destroy the upbeat per-subscriber payback model outlined by Sloma.

If we assume DTN should trade at an EV-to-sales ratio of no more than 1, then we get awfully close to the $10 price target mentioned by some shorts.

Yet, if the shorts turn out to be wrong -- and some pretty smart value investors seem to think they are -- the stock could rocket on a squeeze. With so many shares shorted, all it would really take is a well-worded press release and some daytrader attention to create another plot twist in the DTN saga.

-- Louis Corrigan

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