Investors really pummeled Cincinnati Bell (NYSE:CBB) following its recent earnings report. It seems shareholders weren't too fond of the company's plan to reinvest cash flow into its Fioptics and commercial businesses and not initiate a dividend instead. In just a few days, more than 50% of shares traded hands, and the stock dropped precipitously.
But with major value-creating catalysts, CinBell could trade much higher in the next two years. So my Special Situations portfolio is buying $2,000 in stock on the next business day.
CinBell owns and operates wireline and wireless operations in the Cincinnati area. It also owns a 69% stake in CyrusOne (NASDAQ:CONE) after having spun off the remainder of the datacenter operator in an IPO earlier this year.
CinBell's wireline operations are a cash generator, though like other fixed-line telecoms, it's shrinking. The company is attempting to increase revenue here by investing in its Fioptics and commercial businesses, and management sees the opportunity to get attractive returns on capital.
The wireless segment is shrinking rapidly, and management has already stated that it's trying to figure out what to do with the unit, including a sale. It has spectrum assets that hold some value as well as a cash-generating business that could be even more valuable to an operator who could cut costs more than CinBell is able to.
Finally, its CyrusOne stake could be its greatest asset. The company grew the unit inside CinBell and then converted it into a REIT before spinning it off to the public in January. With operations centered heavily in Texas, the company boasts relationships with the top energy players, and it aims to be the preferred data center provider to the Fortune 1000. It already counts more than 100 of them as clients.
CyrusOne can take advantage of a projected 63% annual growth rate in data production to 2015. With just 10% of large U.S. companies outsourcing their datacenters, there's a runway for growth. The company is also moving internationally, trying to take advantage of its energy connections to move into Brazil, a growing energy player. CyrusOne expects around 20% revenue growth this year.
The special situation
CinBell is heavily leveraged, and the company is working to unload some of that debt. CinBell used about $500 million in proceeds from a CyrusOne debt offering to deleverage, and the plan going forward is to monetize its stake in CyrusOne sometime after the one-year lock-up period ends and pay down debt to 2-3 times EBITDA. That would indicate deleveraging of at least $1 billion, with interest savings from $80 million on up. That should drastically improve free cash flow.
CinBell's 69% stake in CyrusOne is worth $980 million right now. You wouldn't know that from the public finance sites that show all of CyrusOne worth around $450 million. That's because CinBell owns partnership units in CyrusOne that aren't counted in the share count, but it still has the economic interest in the business, which also entitles it to CyrusOne's 2.8% yield. Those partnership units are later convertible to actual shares. And with the high multiples afforded to REITs and the swiftly growing business, CyrusOne could be worth much more in a year or two than it is now. For context, its CyrusOne stake ($980 million) is valued more highly than all the equity of CinBell ($660 million).
Based on these factors, it looks reasonable for CyrusOne to be worth $32 per share – upside of 40% -- within two years, making CinBell's stake worth nearly $1.4 billion. That would substantially improve the parent's balance sheet. Marcato Capital, which owns 8.4% of CinBell, has said that CyrusOne could be worth $35 this year. Bully, if it happens, and all the better for CinBell.
In addition to the deleveraging, CinBell has another catalyst, the potential sale of its wireless unit. That unit could fetch over $300 million, a sizable chunk of the company's market cap. Any proceeds would probably go to deleveraging, but CinBell needs to determine how it's going to move.
Based on deleveraging and other smart capital allocation decisions, I see upside here of over $10. A further catalyst could be the initiation of a dividend when free cash flow returns.
The key risk here is that management makes poor capital allocation moves. The market really did not like the decision to invest in the wireline business, sending the stock down 22% on the day of the announcement. But I think management has made smart capital allocation decisions with its CyrusOne unit, and I think they need to have some time to see if the wireline investment works.
Plus, I like that management stepped up to buy shares on the open market recently. CEO Ted Torbeck purchased 100,000 shares at $3.33, while CFO Kurt Freyberger snapped up 15,000 shares at the same price. That's a very favorable sign.
The price decline over the last few months really resets the clock on this stock. While the market ran the stock up last year as it awaited the REIT conversion and IPO of CyrusOne, CinBell now sits at a price that reflects almost none of that news, but yet the catalyst has now been realized with public market pricing. We have another opportunity to buy at a very attractive price with few, if any, expectations built in. In addition, the actual deleveraging is ever closer. With so much of the public float turned over in the last month, there's a new group of shareholders who aren't anchored to the prior expectations.
Other risks remain. Investors may decide not to pay high multiples for REITs' cash flow, or margins may compress in the data center sector. The wireline and wireless businesses could crumble much faster, or competition may erode what management thinks it can achieve with its wireline investment.
Foolish bottom line
So on the next market day, I'm buying $2,000 of Cincinnati Bell in my Special Situations portfolio.