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Zayo Group Contemplates Split as Sales Growth Flatlines

By Dan Caplinger - Updated Nov 8, 2018 at 9:09AM

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Lower bookings and installations led to a big strategic decision.

Data management has become essential for enterprises to make the best use of the information they collect. Zayo Group Holdings (ZAYO) has long hoped that its emphasis on meeting communications infrastructure needs would lead to impressive growth, but things haven't worked out that way for the company as of yet. Amid slowing revenue gains, Zayo has had to contemplate larger moves that would transform the face of the business.

Coming into Wednesday's fiscal first-quarter financial report, Zayo investors didn't have especially high expectations for the company's key results. But Zayo wasn't even able to get over that low bar, and investors seem even more concerned about a big strategic move that the company sees itself making late next year.

Storefront with Zayo Group signage with a mountain and sky view in the distance.

Image source: Zayo Group.

Zayo's slowdown continues

Zayo Group's fiscal first-quarter results didn't produce the growth most people wanted to see. Revenue of $641.1 million was down a fraction of a percentage point from year-earlier levels, missing expectations among those following the stock for very modest gains. Net income eased lower by 5% to $22.1 million, and the resulting earnings of $0.09 per share fell short of the $0.12 per-share consensus forecast among investors.

However, there was an unusual item that affected earnings. Income tax provisions nearly quadrupled from the year-ago quarter, likely in connection with Zayo's sale of its Scott-Rice Telephone unit in July. Pretax income was up by nearly half, with operating income of 29% pointing to slightly better performance than the headline numbers suggested.

Even so, Zayo had a lot of headwinds to overcome. Net bookings of $7.3 million were down from $7.6 million in the first quarter of fiscal 2018, and numbers were well below what Zayo itself had anticipated. The company insisted that there's still strong demand across its target areas, but the business simply hasn't come in the way investors had hoped. Gross installations were up $300,000 from year-earlier figures to $7.6 million, but that number was also less than Zayo had anticipated, with the fiber and transport areas not living up to expectations. Net installation figures point to anticipated growth rates of just 2%, slower than at any point over the past year.

Some other fundamental indicators also remained unfavorable. Churn levels remained at 1.2%, climbing by $400,000 over the past 12 months to $6.5 million. Zayo said it expects churn to remain close to 1.2% for the next several quarters despite efforts to get the number lower.

The next stage for Zayo

Rather than lingering on the numbers, CEO Dan Caruso made a big strategic announcement that shows a different direction for Zayo. The company now expects to break itself into two publicly traded companies, one focusing on infrastructure and the other on enterprise solutions. Caruso hopes the move will let the infrastructure business focus on developing the best network available, while freeing up the enterprise business to concentrate on serving specific customers with solutions tied to their individual needs.

The move will achieve a couple of strategic goals. First, it will let Zayo Infrastructure be a pure play in fiber-focused communications infrastructure. Second, Zayo Infrastructure should be able to qualify for favorable tax status as a real estate investment trust, avoiding corporate taxation and appealing to a different set of investors. Zayo hopes to get the move done by late 2019.

Zayo also expressed a massive vote of confidence in bulking up repurchases of its own stock. Despite making almost no buybacks in the quarter, the company said that in October and the first week of November, it spent more than $402 million to buy back almost 13 million shares of stock. Zayo even used $200 million in borrowing to support the buyback in a move that some might think of as reckless.

Zayo shareholders weren't happy with the news overall, and the stock plunged 18% in pre-market trading Thursday following the Wednesday evening announcement. Zayo is trying hard to get itself moving back in the right direction, but it's unclear whether corporate restructuring will get the communications infrastructure specialist's sales moving higher.

Dan Caplinger has no position in any of the stocks mentioned. The Motley Fool recommends Zayo Group. The Motley Fool has a disclosure policy.

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