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Could This Move Help Zayo Make More Money?

By Dan Caplinger - May 4, 2018 at 9:29AM

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Find out what the communications infrastructure specialist is considering.

Every successful business has to focus on its fundamentals. Yet even once you've identified a lucrative market and done everything you can to profit from it, there are often some additional things you can do to squeeze out even better results. Zayo Group Holdings (ZAYO) has done a good job of building a promising business in communications infrastructure, and now, Zayo is considering a conversion to a more favorable tax status that could put more money into investors' pockets.

Coming into Thursday's fiscal third-quarter financial report, Zayo investors had modest expectations for the company, anticipating good sales growth but tepid performance on the bottom line. Zayo wasn't quite able to live up to all of those expectations, but it did say it's looking more seriously at potentially converting to a real estate investment trust in the future.

Building with Zayo Group sign with mountain landscape and partly-cloudy sky in background.

Image source: Zayo Group.

Zayo sees mixed performance

Zayo Group's fiscal third-quarter results slowed down from the more encouraging numbers it posted three months ago. Revenue was up 18% to $649.4 million, slowing by more than 10 percentage points from its fiscal second-quarter growth rate and coming in slightly below projections among investors for 19% growth. Similarly, net income was down 13% to $23.4 million, and the resulting $0.09 per share in earnings fell just short of the consensus forecast for $0.10 per share.

Zayo still pointed to some favorable fundamental elements that went well during the quarter. Net bookings jumped to $9.5 million on $8.1 million in gross installs, both of which were record numbers. Churn levels dropped slightly to $5.8 million, and although 1.1% is still a bit high, it's improving from recent levels. However, net installs of $2.3 million are still growing at just a 5% rate, which is below Zayo's long-term 6% to 8% target for that metric.

Various other initiatives are continuing apace at Zayo. The company made an organization transition to five key vertical clusters, with global markets focusing on carriers; finance and professional services; media, content, and commerce; cloud, software, and infrastructure; and public, health, and utilities businesses. That framework should help sales personnel work more effectively with customers. At the same time, investment in new sales staff is gaining speed as new hires gain experience.

Zayo is also seeing quick paybacks on much of its newly booked business. As Zayo has grown, it's been better able to lever its fiber network assets, and that makes it easier to generate sales that become profitable faster for the company. At the same time, though, Zayo has also been able to afford taking on larger projects with longer payback times because of its growth and financial capacity.

What's next for Zayo?

In addition to the numbers, CEO Dan Caruso focused on Zayo's efforts to find good complements through acquisitions. Recent purchases of Spread Networks, Optic Zoo, and Neutral Path have all fleshed out Zayo's capabilities in key areas, with Spread offering assets on the Chicago to New Jersey route, and Optic Zoo having dedicated exposure to Vancouver, British Columbia. Neutral Path has the less-obvious Minneapolis to Omaha fiber route, but that actually fits well with Zayo's existing Midwest exposure.

Yet perhaps the most interesting thing for investors that Zayo discussed was its ongoing efforts to investigate whether it makes sense to try to convert to a REIT. Typically used by companies with more of a real estate focus, Zayo could have the option of doing a conversion to a real estate investment trust if it can argue successfully that data centers and associated fiber assets can be included in the tax-law definition of real estate for REIT purposes. Zayo believes that a path toward a conversion does exist, but it will need to consult with the IRS to get support for a position before pulling the trigger. The benefit for investors would be greater dividend income, while the company would avoid corporate-level taxation. That's less of an issue with lower corporate tax rates, but it still could produce impressive savings for the company and its shareholders.

Zayo shareholders didn't seem entirely happy with the sluggish fiscal third-quarter performance, and the stock was down 3% in pre-market trading Friday following the Thursday afternoon announcement. Nevertheless, if Zayo can gain REIT status to boost its profits and give shareholders more income, it could have a transformative impact on how many investors view the communications infrastructure stock in the future.

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