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Zayo Group Disappoints With More Red Ink

By Dan Caplinger - Feb 12, 2016 at 12:22PM

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The Internet infrastructure company fell short of expectations on the top and bottom line.

Image: Zayo.

Technology stocks have proliferated in recent years, and the rise in demand for bandwidth has given Zayo Group Holdings (ZAYO) a golden opportunity to profit. The small company provides physical infrastructure related to connectivity to customers, and the success of networking equipment-maker Cisco Systems (CSCO -0.09%) had generated excitement in the industry. Coming into its fiscal second-quarter financial report on Friday, Zayo investors wanted the company to post a bigger profit on strong revenue gains. Yet Zayo wasn't able to deliver, posting a net loss and falling short of hoped-for sales gains. Let's look more closely at the latest numbers from Zayo Group Holdings and what the company sees ahead for 2016 and beyond.

Zayo Group drops the ball
Zayo Group's fiscal second-quarter results didn't get the job done in the eyes of investors. Revenue grew to $369.6 million, which was up less than 1% from the fiscal first quarter and 14% higher than the year-ago period. Investors had wanted to see $374 million. A net loss of $10.8 million was less than the $15.2 million loss Zayo suffered last quarter, but the resulting $0.04 per share loss was far worse than the profit of $0.03 per share that represented the consensus forecast among those following the stock.

Taking a closer look at Zayo's numbers, the biggest impact on operating income once again came from a big boost in overhead expenses stemming from stock-based compensation. Year over year, overhead costs more than doubled, and stock-based comp went from a $6 million reduction in costs to a nearly $43 million addition. The rise dwarfed Zayo's sales growth, causing operating margins to plunge by nearly half to just under 16%.

Zayo continued to expand its network footprint. The company's capital expenditures for the quarter amounted to $172.4 million, and it added 7,905 route miles and 813 buildings to the network.

Zayo's expansion also came from ongoing acquisitions. The company closed on its acquisition of Viatel at the end of December, giving Zayo a greater presence in Europe. Specifically, Viatel will give Zayo access to a dozen new metro networks, as well as an eight-nation network that spans 8,400 kilometers and includes seven data centers and connectivity to more than 80 buildings. Zayo also spent $16.7 million to acquire a 36,000 square foot data center in Dallas.

More growth ahead
Yet Zayo has also kept moving aggressively to start 2016. In January, Zayo acquired Canadian network provider Allstream for $298 million. Just as Viatel gives Zayo access to Europe, Allstream will open up Canada's network market to Zayo. The acquisition will add more than 18,000 route miles to the Zayo network, including 12,500 miles of long-haul fiber connecting markets across the nation and 5,500 miles of metro fiber connecting about 3,300 buildings in Canada's five biggest metropolitan markets.

Zayo is also taking steps to support its share price. In the most recent quarter, Zayo bought back more than 726,000 shares of its stock, with about half that amount coming from a six-month $500 million repurchase program authorized in November. After the purchase, Zayo still had $491 million remaining under the deal, raising the question of whether the company will accelerate its repurchases in the remaining months of the program authorization.

The big question Zayo faces is how well network demand holds up. Cisco Systems' most recent report sent its stock up sharply, but Cisco did say that it saw signs of weakness in the global economy that had direct implications on the technology sector. If Zayo sees the sluggishness that Cisco was talking about, it could limit its expansion plans.

Zayo shareholders weren't happy with the news, sending the stock down as much as 15% within the first half hour of the trading day before rebounding to cut its losses somewhat. If the industry manages to stay healthy, then Zayo has put itself in a good position to bolster its growth and build a strong foundation for the future.

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