New Stock Pick: Fibernet Telecom (FTGX)
Posted on October 26, 2006
FiberNet Telecom (Nasdaq: FTGX). FTGX, is a highly-leveraged, micro-cap company, based out of New York City, that provides broadband transport and co-location services to over 240 clients. The company’s stock currently trades at about $4.30, down from a five-year high of over $100, and a two-year high of nearly $10. We believe the company is in the midst of a successful and sustainable turnaround in operations, and given the low valuation of its shares relative to recent M&A multiples in the sector, we think investors should be aggressively buying stock at current price levels or lower.
Financials Are Improving Dramatically
We’ve been following FTGX for quite some time, and we finally became interested in the company following the last quarterly earnings report. In the quarter, EBITDA was $1.2 million, up 207.2% from $0.4 million reported in second quarter of 2005 and up 30.6% from $0.9 million for the first quarter of 2006. Furthermore, in looking at the company’s 10Q, it appears that FTGX broke even on a cash-flow basis, after taking into account capital expenditures and interest expenses. We saw what happened to Internap’s stock when the company started turning the corner on a cash-flow basis, and we think that FTGX is now in a similar position to where Internap was about a year ago.
Valuation is Cheap
What makes FTGX even more interesting is that the company’s market valuation is still low when one takes into consideration industry valuations based on the recent M&A activity in the company’s industry and valuations given to FTGX’s competitors. With the stock trading at an over 50% discount to our expected value, we think the shares are very attractive at these levels, despite a recent run-up from $2. It is also worth noting that the company’s tangible book value on a fully diluted basis is about $6.00 per per share. It’s not often that we find a company in a hyper-growth industry, with improving company-specific financials, trading beneath tangible book value.
Upside Potential Far Exceeds Downside Risk for the Shares
Overall, we think that the supercharged industry backdrop, including recent acquisition activity, a generally positive outlook for bandwith transport pricing over the next year, and the continued financial improvements that we forecast at the company over the coming quarters, more than compensate for FTGX’s high debt level and dismal past operating performance.
We believe that as the company continues to report increasing EBITDA and cash-flow growth over the coming twelve months, Wall Street will finally wake-up to this developing turnaround story, and send the stock soaring. In a worst case, should the stock remain at low levels, we would expect management to put the company up for sale to a larger competitor. Any sale would likely be at significantly higher prices, making the stock a worthwhile investment at current levels or lower.
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Please note that we have updated some our figures on FTGX, following the company’s recent earnings release. Fully diluted shares go to 8.5 million, from 7.8 million to reflect additional options and restricted stock, which we had failed to include in our initial report. Importantly, these additional options do not much concern us, as a large portion are still out of the money, and in addition, when assuming these shares in an Enterprise Value, you must also take into account the cash that these options would bring to the company. This additional cash offsets debt, and therefore makes negligible impact on enterprise value.
Furthermore, we have reduced our debt level by about $5 million since our initial report included debt from the company’s letters of credit to cover operating leases. This debt is “undrawn” and should not have been included in our estimates. Overall, our fully-diluted book value goes to $5.50 per share. Our revenue for 2006 goes to $40 million with EBITDA of $5.2 million. For 2007, we expect at least $48 million in revenue and $7 million in EBITDA.