1Q Post-Earnings

All of my holdings have reported with the exception of AOBC, which should report in mid-June. Everything did OK. CBMX, VICR, WCG and SILC all legged higher on results. My tech picks are all steadily grinding up. Everything else except my cable/infrastructure picks, CHTR, UNIT, and LILA moved in the right direction. Expectations around CHTR were so high that the stock actually sold off despite reporting decent results. I continue to hold and still consider it a solid long-term position. Overall the quarter was a good one. I haven’t opened any new positions, and plan to look internationally when I do. I have highlighted the top 25% of performers in green.

1q-after earnings

I’m currently up 12.6% vs the S&P500 being up 9% over the past 6 months. It’s not bad by any means, but if I can’t get a 15-30% return per anum then I should probably consider simply rolling into a broad market tracking ETF and leaving everything on auto-pilot. I still care more about minimizing losses rather than shooting for the moon, but I also value my time and researching stocks can be time-intensive. My preference is also changing from passively owning parts of companies to full ownership, where I can control the outcomes rather than depending on others to do it for me.

Closed Positions

TWX – I closed out my TWX position to fund other opportunities. The spread had narrowed sufficiently to give me a ~10% gain since November, and I have no desire to hold AT&T after the deal closure.

GSAT – My GSAT call options expired worthless. The stock rallied like 2 days after the expiration and would have been excercisable had I rolled the position over. They still haven’t nailed down a deal and I’m skeptical that they are top of mind for any potential buyer. If I could find cheap LEAPs for GSAT I might buy again, but my broker doesn’t appear to them.

TWLO – I had a nice 21% gain in TWLO heading into earnings then watched it turn into a -15.7% loss as the stock cratered on revelations that Uber might reduce spending. So I closed out the position. Management sounded really down on the business, and then made some open market purchases. I’m torn about where the stock goes from here so I’m back on the sidelines. It sounds like Vonage/Nexmo is getting extremely aggressive on price and that’s never good for competitors.

SBAC – I bought and sold SBAC after a 6% gain. At 7x leverage, when the stock does well it does really well. But you have to watch-out when it turns or flattens and I’m not sure how much room it has to go up from here. It also sounds like they plan to make some additional overseas acquisitions. It’s a good time to do so (I think), and I generally want to be more exposed globally rather than solely to the U.S., but I worry about property rights in emerging markets and the high debt. I like the more mature markets where LILA is focused and I added to my position there.

New Positions

CBMX  – There is a good write-up here on CBMX. I really like the demographics set-up and I feel the stock is underappreciated for two reasons.

  1. Investors are discounting the improvements the new management team has made and their commitment to year-end profitability.
  2. Healthcare stocks in general are still pretty beat-up.

VICR – This Seeking Alpha post has convinced me that 48 volt is going to be the future of hardware, and Vicor owns the space. The author has clearly researched this company intensively and is excited about the prospects. The opportunity in front of VICR is due to an intriguing controlling owner who chose to forego easier research and development avenues for years, which punished the stock. I love finding companies with committed founders who have substantial stakes and plan for the long-term.

I’ve been both a bit too concentrated and a bit too spread out in smaller names for comfort, so I’m working to reduce my portfolio size to something more manageable, under 20 symbols. I don’t regard the U.S. market as particularly attractive, but I also wouldn’t pretend to understand international or emerging company dynamics as well as I know the U.S. It’s something of a conundrum. If domestic valuations stay this high then at some point we are headed for pain, so I am saving excess cash and waiting for a nice fat pitch.





CenturyLink and Corvex – Not All Heroes Wear Capes

Sometimes it is impossible to spot your best catalysts ahead of time. As I noted a month ago, I started a mid-sized position in CenturyLink. In my post I stated that I think management is terrible, but the valuation was too compelling to ignore. I felt an organic rebound would occur into the LVLT acquisition close as investors realized CTL was too big not to own anymore. But then something even better happened, an activist has stepped in. Keith Meister, a Carl Icahn alumn and founder of Corvex Management LP, announced at the Ira Sohn Conference that CenturyLink is now his largest position.

CTL management has been quietly ignored by investors for a long time. Historically, the company has been classified as a Rural Local Exchange Carrier (RLEC). Other RLECs like WIN and FTR are struggling to cope with massive secular headwinds due to the poor quality of DSL copper assets, depopulation of captive rural customer bases, and steady onslaught of cable expansions. CTL’s shares have consequently underperformed the S&P 500 for years.

But CenturyLink is in the process of acquiring Level 3 (LVLT), a strong Tier 1 service provider and Competitive Local Exchange Carrier (CLEC) with a global footprint, primarily to business customers. The acquisition itself is a pretty good idea. CTL can use LVLT’s net operating losses to keep paying out the 9% dividend. It will also result in CTL’s revenue exposure shifting to >70% enterprise, where customers are stickier than residential. There’s no regulatory risk to this deal either. Yet the pro-forma combined company trades at 6.5x EBITDA, below LVLT’s historical 8-10x range. What has kept shareholders on the sidelines is the operational ineptitude of CenturyLink’s team. CTL stock sells off after every earnings report, because no matter how low they set the bar they always miss. Two examples: the current CEO has poured resources into a stadium naming right and Prism TV, an uninspiring video package. It was supposed to be a game-changing customer retention tool, but broadband and access line subs are still rolling off while cable continues to grow overall subs, in spite of continued poor video uptake.

Glenpost_Prism TV
Glen Post Overseeing the Prism TV Rollout

So why own CTL now? The sleepy board, which owns a mere 0.5% of outstanding shares, just got a wake-up call from a reputable activist. Presenting at the Ira Sohn Conference today, Meister announced a 5.5% stake and stated that he wants Jeff Storey, the current CEO of Level 3 to take CTL’s reigns after a year.

Mr. Meister expressed the view that the combination with Level 3 presents the unprecedented opportunity to: (i) drive significant free cash flow accretion and secure the Issuer’s dividend, (ii) enhance its EBITDA outlook including growth through cost synergies, and (iii) improve the Issuer’s long-term revenue trajectory.  However, Mr. Meister also noted that it is critical to the success of the combined company that the Issuer ensure that the Chief Executive Officers of both companies — Glen Post, who is 64 years old and has served as CEO of the Issuer for 25 years, and Jeff Storey — who is 56 years old and has served as CEO of Level 3 for 4 years — have senior executive roles at the Issuer as of the closing of the combination.  Corvex believes that Mr. Post should continue to serve as Chief Executive Officer of the Issuer and Mr. Storey should join the Issuer in a senior role as President of the Issuer for an initial integration period of approximately 1 year after the closing of the combination, and that after such period, as part of the succession plan for the Issuer, Mr. Storey should step into the role of Chief Executive Officer, with Mr. Post becoming Chairman of the Issuer.  Corvex urges the Board of Directors of the Issuer (the “Board”) to promptly consider and then implement a plan consistent with this proposal, and to announce it in the near future.

The excellent slide deck can be found here.

Right now Mr. Meister is keeping the gloves on, but he has been known to be aggressive in the past, and I think shareholders are ready for change here after years of poor execution. Last year the board voted out one of its own members who was advocating for change. Why change anything when you can get paid more than $250k/year to meet a handful of times a year, and rubber stamp whatever the CEO wants to do?

I am no fan of CTL management and would not mind if it came to a shareholder proxy fight, but I think Glen Post has a decent strategic head on his shoulders, and truly would make a much better Chairman than an operator. Eventually I think he will come to the same conclusion. The real question is whether Jeff Storey *wants* to be CEO. He is almost as old as Glen Post and may have no interest in trying to turn CTL around.

Other Risks

  • Rising interest rates could lower the value of the currently high dividend yield and would raise the cost of capital for CTL.
  • The risk of a prolonged proxy battle is real, but CTL management would have to be crazy to believe that they have a strong shareholder mandate to keep doing business as usual. Meister has basically said that the current team sucks in the nicest most polite activist presentation ever.
  • Pension games have been part of the short thesis. In the past, CTL has been accused of robbing Peter to pay Paul. It looks like they cleaned up their act a bit recently due to new pension filing requirements? Perhaps someone else can chime in here.

Short interest is very high in CTL currently at >18%. Investors have been watching Frontier Communications implode and assume that CenturyLink will meet the same grim fate. If Level 3 management takes the reigns I don’t believe that will be the case. The combined company has some great, globe-spanning assets. I added to my position when the news came out. An activist with a mandate to reshuffle the C-suite is exactly what this company has needed.

UNIT Has At Least Two Good Deal Opportunities in 2017

  • Management has hinted at a larger strategic transaction which would lower UNIT’s reliance on Windstream revenue, currently 70% of total revenue.
  • Windstream (WIN) has been aggressively acquisitive recently, and will have to conduct another sale-leaseback with UNIT for ELNK assets within the next year.
  • Frontier Communications (FTR) recently cut the dividend, but will continue to struggle to pay down debt. A sale-leaseback deal could buy management more time to stabilize the business.
  • Other sale-leaseback opportunities could include asset sale-leasebacks from CNSL and TDS, or a merger of equals with ZAYO.

I have a large position in Uniti Group and my ears perked up when I heard this on the earnings call this week.

We’re very encouraged by the quality of the discussions and the assets we are targeting, including specifically fiber and fiber-enabled consumer broadband. We feel very bullish about future M&A prospects. And although not included in our guidance, we’re increasingly that there will be accretive M&A and sale leaseback activity during the balance of the year.

With these opportunities in mind, we pre-funded the Hunt and Southern Light acquisitions with our most expensive sources of capital, which creating maximum financial flexibility for M&A during the balance of the year, including potentially larger, more strategic transactions.

I see at least 3 big sale-leaseback opportunities out there for UNIT in 2017.

Windstream will Eventually Monetize Earthlink Assets

WIN is going to have to sale-leaseback its new ELNK assets. Windstream also reported earnings this week, and along with RLEC peers, posted results which disappointed investors. Thanksgiving is probably going to be awkward around the Gunderman household, but as a shareholder I expect UNIT to drive a harder bargain for these assets because they run counter to UNIT’s plan to diversify its revenue streams. So this seems less likely, especially given management commentary.

Yeah. I’m sorry, David. Yes. On EarthLink, look, the way you phrased the question is appropriate in terms of – we have stated very clearly repeatedly that our mission is to diversify. We’re very, very focused on that. And so, anything that counteracts that diversification requires a high bar for us to cross in order to transact. And so, you start with that. And that hasn’t changed.

Secondly, I think we’ve said that if there’s a discussion to be had with Windstream on EarthLink, we’re happy to have it, but we’re coming at it from a position of the transaction needing to be a positive transaction for us not only financially, but also on market lease terms and also a transaction that has a strategic element to it in addition to just having the financial benefits of being immediately AFFO accretive, like you mentioned.

And, look, as we’ve also pointed out, across the board, in our sale leaseback transactions, there are many creative interesting ways for us to add strategic elements to those transactions that bring benefit not only to our leasing business, but also to Uniti Fiber, the operating business. There are some raw materials there for an opportunity for us that could be attractive, but at the same time, the bar is high.

To be able to refinance debt on more favorable terms, UNIT needs to diversify its revenue away from Windstream. So I think it’s more likely that FTR, CNSL, or TDS do a deal sometime soon.

Frontier Should Be Most Interested

FTR bought an expensive set of wireline assets from Verizon in California, Texas, and Florida (CTF) last year, and it is becoming increasingly apparent that they took on too much debt to do so. Having cut the dividend by only 60%, Frontier hasn’t bought itself a lot of runway to pay down debt. They will have to do more, and management has stated that they will issue more secured debt in 2Q17. This is not the optimal solution to FTR’s problems. The company paid $388m in interest expense this quarter, on $850m of EBITDA. Because FTR management never really proved that the AT&T deal for Connecticut assets was accretive, I think any attempt to access the secure debt markets would be met with skepticism and uncomfortably high interest rates.

What has always bothered me about this management team is that they have historically been intellectually dishonest about their own financials, but I think the new CFO may be changing things. From UNIT’s perspective, a good sale-leaseback deal with FTR gets it below 50% revenue dependence on WIN in a single shot. If I were UNIT’s CEO I would be calling these guys non-stop. The real obstacle here is convincing the thickheads at FTR that a sale-leaseback is in their best interest. If UNIT can get a deal done for FTR’s $14b of fiber and copper assets, it could be a game changer for both companies.

Long-Shots Include CNSL and TDS

Sale-leasebacks have sometimes been referred to as pawn-shop transactions. In that light I think CNSL would be the most interested company to cash-out some assets. CNSL is levered up 4.6x due to a pending acquisition of Fairpoint Communications, and is in the types of markets that interest UNIT. Cash-on-hand could help CNSL either paydown debt to shore up the dividend or fund further acquisitions.

TDS is unlikely but still small(ish) and doable. TDS has an owner who doesn’t seem to see the writing on the wall for USM and consequently does not seem interested in selling anything.

I am not sure what other suitable strategic deals are out there for UNIT at this point, but judging from the tone of the most recent earnings call UNIT has something surprising within it’s cross-hairs.