Lumos Networks (LMOS) has not had much luck after it was spun-off NTELOS (NTLS) last year in November. The stock, at $8,66, is down almost 40% from its IPO. However, investors would be wise to take a second look at this busted spin-off.
Lumos is a “fiber-based network service provider in the Mid-Atlantic region.” It has a 5,800 route-mile fiber-optic network presence. The network is not fully owned by Lumos. “83% of our approximately 5,800 route-mile network is under long term leases or Indefeasible Rights to Use, or IRU, agreements that provide us access to fiber owned by other network providers.”
The company has two sources of revenue:
- Legacy Voice and Network Access
- Strategic Data
Legacy Voice and Network Access
The Legacy Voice and Network Access source provides “wireline communications services to residential and enterprise customers”. Network Access charges are fees charged to other telephone companies by Lumos for the use of its local network. As you can guess, with the proliferation of cell phones and VoIP enabled services like Vonage, this source of revenue is in a free fall. To make things worse, this July, FCC reduced network access rates and has plans to entirely eliminate them over time.
This source of revenue comprised over 49.7% of total revenue in the third quarter of 2012. Of that Network Access’s revenue was 18.7% and Legacy Voice was 30%.
Revenue from this source declined 11.3% and will fall at a faster rate due to FCC’s reduced rates. Unfortunately, this segment has the highest margins. So, there should be overall margin compression.
The Strategic Data source has three segments: Carrier Data, Enterprise Data, and IP Services. See Figure 1 below.
Figure 1: Strategic Data (Source Lumos Networks)
The Strategic Data contributed to over 50% of overall revenue and grew 16.7% in the third quarter.
The growing consumption of data by cell phone users is putting a heavy burden on the nation’s wireless networks. The Carrier Data segment helps alleviate that problem by directly connecting the Lumos fiber optic network to cell towers. It is a very profitable investment. See Figure 2 below.
Figure 2: Fiber to Cell Site Economics (Source: Lumos)
Lumos has an existing contract to double the number of connections to cell towers from 150 to 300 by the end of 2012. According to the original spin-off filing, it approximated that its fiber network was near 1,000 cell towers. In early 2012, Lumos estimated that 2,000 cell towers within 3 miles of their network. More recently, it estimated that 5,000 cell towers within a 10 mile network. It wants to double the number of cell sites every year.
This segment is the most important as it is not only profitable, but grew 25% in the third quarter and contributed almost 50% of Strategic Data’s revenue.
In the third quarter, Enterprise Data’s revenue grew 12% and contributed to 36% of Strategic Data’s revenue. The enterprise data revenue will grow as it connects more buildings to the fiber network. The number of on-network buildings grew over 20% to 1,150 from 949 last year. Lumos also has opportunity to up-sell to its existing enterprise customers.
IP Services grew 8% in the third quarter, and contributed to only 18% of Strategic Data’s Revenue.
At Friday’s closing price of $8.66, here are some of Lumos’s financial facts:
- Market Capitalization of $186 million.
- Enterprise Value of $486 million. It has a debt of around $300 million.
- Adjusted 2012 forecast of EBITDA of $88 million.
- 2012 forecast Capital Expenditure of $60 million.
- Dividend of $12 million or $.56/share or 6.5% yield.
Obviously at a 2.1 ratio of Market Cap/EBITDA or 5.5 EV/EBITDA, the stock looks cheap. Also, most of the $60 million capital expenditure goes to future growth with very good return on capital. The big question that needs to be answered is that can the Strategic Data keep growing at a double digit rate to offset the decline in the Legacy Voice and Network Access revenue.
The growth largely depends on the Carrier Data segment. It has steady cash flow (5 to 10 year contracts with wireless carriers), and great return on capital. If it can grow the number of cell sites like it plans to, then this is a very cheap stock. However there are a couple of concerns:
- The company has a contract to add up to the 300 cell sites. It has added 261 sites at the end of the third quarter. However, it has made no mention of any additional contracts after the 300 cell sites.
- It does mention that there are 2,000 cell sites within 3 miles and 5,000 cell sites within 10 miles. So, as it adds more sites, the return on capital will be possibly less and less as it is cheaper to add cell sites which are closer.
- If it adds all 2,000 cell sites, and has EBDITA of $40,000 per cell site, the annual EBDITA would be $80 million/year. Although this would make the stock cheap, it is assuming the very best scenario.
As a result, I am keeping on the sideline with this stock to see what management says in the fourth quarter with regards to the cell sites. It wants to double the cell sites every year. So, the expectations will be that will add an another 300 sites next year. I will add a position if this is the case.
One thing to note that I did not mention is that this is a very competitive industry and Lumos Networks is a very small player. So, I will be very cautious with this company.
Here is the latest investor presentation.
Disclosure: I do now own LMOS