PART II: WHO IS CINCINNATI BELL
For those looking for a more complete analysis, we have included Appendix A: Overview of Wireline Industry. Here we introduce the competing technologies, the number of subscribers per technology, and its relative market share.
In Appendix B: Industry Map, we take a high-level view of the industry and look at how the various parties exchange product/services with one another. It is not meant to be exhaustive, but rather to set to stage in [i] explaining why competitive advantage exist and, [ii] to propose what we think is a pragmatic growth strategy.
We follow the industry map with a look at the sources of competitive advantage that exist in the wireline industry (Appendix C). Despite the escalated competitive environment, it is worth noting these key sources that drive steady profitability remains intact.
The above table shows various wireline providers in the United States. It is in no way a rigorous list but provides a quick sense of various players, their relative sizes, sales and margins. The first observation worth noting is Cincinnati Bell’s relative size. Although it appears relatively small and may lack scale advantages, this is not the case. In actuality, its concentrated presence in Ohio, Indiana and Kentucky gives it more scale economics than larger peers in the context of its own states. This can be seen from its more efficient operating expenses.
The second observation is the relative multiples appropriately reflect maturity and growth potential of the technologies. Telcos predominately own copper DSL technology and are attempting to grow their fiber network. Cablecos predominately own coaxial cable technology with a hybrid fiber/coax network. IP Transit providers are predominately fiber. One part of any telco wireline thesis relates to the probability they can transition from their legacy copper network to a fiber network. Moving on, we will very briefly glance over some multiples of Telus, a Canadian telco/wireless carrier.
Although this is not an apples-to-apples comparison, it offers what we feel is a good relative sense of the industry. You will want to model out a dozen wireline peers yourself, but the general characteristics of this industry can be seen using Telus as an example. Note, you would have to adjusted accordingly given Telus’ dominant wireless assets. Having built a base-line sense of the industry, we will shift focus back to Cincinnati Bell and look at how it’s different from its peers. We will start by looking at Cincinnati Bell’s recovery efforts over the past 5-years.
Over the past few years Cincinnati Bell has been patiently deleveraging its balance sheet from 5.2x Net Debt / EBITDA in 2012 down to 4.2x in 2016. One key event was the sale of its wireless segment to Verizon in 2014, which was bleeding cash. More notably was its gradual sale of CyrusOne which completed in the first quarter of 2017. To provide some context, this data center business grew revenue from $74mm in 2009 to $529mm by the end of 2016.
We think the recent changes have positioned it to have a more natural equity investor base. Specifically, its debt pay down, 1-to-5 reverse split in 3Q 2016, diversification of non-core assets for easier understanding of business segments, and option to institute a dividend. Additionally, its balance sheet has gradually improved. Expenses have been eliminated around its wireless segment, pension obligations, and maintenance from legacy copper operations.
We think Cincinnati Bell is positioned favorably in a horizontal market. Counter to AT&T’s strategy to vertically integrate, we believe the industry is and should be moving horizontally. The industry is in a multi-decade cycle to break apart vertically with niche verticals such as: data centers, IP transits, content delivery networks, tower operators, communication platform providers, security platforms, and various OTT offerings. For a firm operating in a dynamic vertically integrated market like Salesforce.com, top line growth is important. The firm with more resources will more likely create that fully-integrated solution. We want our CRM to be fully integrated to connect our sales department to support department. We want all data centralized and marketing and analytics already tied into the same system. The opposite is true for a firm operating in a horizontal maturing market with low growth like wireline. In a horizontal maturing market, we would like to see non-core assets diversified, and an opportunity to be easily acquired. If not acquired, we want to see the firm positioned to compete well against peers because it holds regional scale advantages. We want the firm to have relatively newer fiber technologies, while also having nimbleness in relative size. These two factors will help it navigate the future of SD-WAN, IP Elastic cores, OTT, and more.
For those looking for a deeper dive into the industry structure, we have a section titled Revisiting the Computer Industry included in Appendix E. Here we look at how the telecom industry has matured and why it is flattening in a horizontal structure. We discuss what the requirements are in order to succeed in such a structure, and Cincinnati Bell’s alignment to this. We end off by proposing how we think the near-future will look and why we think Cincinnati Bell will be acquired.