Towerstream Trading Below Cash

The 12% surge in the Dow over three trading sessions was certainly welcome but has hardly alleviated the level of anxiety felt by most investors as it could easily turn out to be a bear market rally. It is interesting to see from the adjacent table by Paul Kedrosky that out of the 13 biggest two day advances in the Dow Jones Industrial Average that have occurred going back to the stock market crash of 1929, 11 of them took place during the great depression and 5 of these occurred before the Dow hit its bottom in July 1932.

In this uncertain environment it is easy to find companies not only selling at low single digit P/E ratios (with earnings in jeopardy, investors are looking at low P/E ratios with a wary eye), but often below tangible book value. A quick stock screen I ran brought up 2,181 companies that are trading below book value. However there are only a handful of companies that are trading below book value, have little or no debt and are actually trading below the cash they hold on their balance sheet.

One such company is our portfolio holding Towerstream (TWER), a provider of commercial wireless internet service, which we featured in the July 2008 edition of our investment newsletter.

The stock has lost nearly half its value since then but interestingly enough the story has hardly changed and if anything has gotten better. The stock with a market cap of $23.5 million not only sells for below book value of $35 million, it is selling at a discount to the $25.4 million in cash it holds on its balance sheet after removing $2.6 million in debt.

Towerstream reported third quarter 2008 results earlier this month and almost every single metric improved year-over-year with the exception of average revenue per user (ARPU) for new customers, which decreased from $748 in Q3 2007 to $733 last quarter. Gross margins increased from 63% to 64%, ARPU per customer increased from $694 to $827 and churn rate dropped from 1.26% to 1.22%. Towerstream has consistently maintained low churn rates and from what I have heard, customers who have initially purchased an internet line from them as a backup or load balancing solution have often made it their primary internet connection. While operating expenses dropped from $6.26 million to $6.09 million on a sequential quarter basis, they increased significantly from $3.96 million in Q3 2007 due to the company entering new markets and expanding its sales force.

Shortly after results were announced, Canaccord Adams upgraded the stock from a hold to a buy with a $1.50 price target over a 12 month period. While I think that price target is conservative, it still represents the potential of over 100% gains from these levels. Obviously the key concern with Towerstream is its ability to scale the business while at the same time reducing or eliminating cash burn. Cash burn in the third quarter was $3.9 million after falling for two consecutive quarters. Anyone who has been involved with start-ups can tell you that attempting to scale a business while preserving capital is a tough act.

I got a chance to talk to Towerstream's CEO Jeff Thompson last week and he reaffirmed the company's outlook of becoming EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization) positive by the end of Q1 2009. He also addressed my concern about an economic slowdown affecting small businesses and in turn impacting Towerstream's business by letting me know that a majority of Towerstream's customers are mid to large size businesses. The company's 8 MBPS solution at a very competitive price point has also been received well by customers. Having priced a 1.5 MBPS T1 internet line and periodically looking through Towerstream's offerings, I can personally attest to their competitive pricing.

In light of the roll out of WiMax in countries like South Korea where wireless access is available in subways and buses as well as Australia's plan to spend nearly AUD $1 billion to provide wireless access to rural areas, the United States has been slow to adopt WiMax. Since Towerstream has been one of the early members of the WiMax forum, I asked Jeff his opinion about the ramp up of WiMax in the U.S and competing technologies. Jeff mentioned that with Clearwire shareholder approval in place of the ClearWire, Sprint, Google, Intel, Comcast and Time Warner deal (could there be any more companies collaborating on this deal?), WiMax adoption will hopefully increase. He also mentioned that LTE, a technology that is being touted as a WiMax alternative, is probably 3 to 4 years away.

According to Jeff, one of their equipment providers is another portfolio holding Alvarion (ALVR) and they have been happy with their experience with Alvarion as it does not take "10 engineers to get their stuff working". However they have the option to use various other manufacturers and expect equipment prices to come down next year, helping reduce cash burn even more.

The stock has been under $1 since October 22nd and would normally get a delisting notice from Nasdaq as the stock has been under $1 for 30 consecutive days. Given the number of stocks that are currently trading below $1, the Nasdaq has temporarily suspended this rule and hence delisting is not an immediate problem.

Companies usually have a six month period after violating listing requirements to meet those requirements again. Some companies opt for a reverse merger to accomplish this but with a few exceptions like Priceline (PCLN), stocks of companies using reverse mergers generally tend to drop after the merger. As I was mentioning to a friend, Sun Microsystems (JAVA) was trading in a $3 to $5 range for quite some time before its 4 to 1 reverse split, that pushed its price all the way up to $20 post split only to see the stock meander back down to a little over $3 today. Had the reverse split not occurred, Sun's stock would have been trading under $1 right now. Please note that beyond stock price, there are also other requirements related to market cap, shareholder equity and net income. You can find all the Nasdaq listing requirements here (pdf).

Overall management sounded very confident on the call and while Towerstream has all the risks associated with start-ups, it certainly feels like the company is at the point of proving out its business model while posting impressive year-over-year growth even in this difficult environment. I am going to add 3,000 shares of Towerstream to our existing position in the model portfolio and also plan on adding to the position in my personal portfolio after this blog entry is published. The closing price of the day will be used for the model portfolio.

Disclosure: Author holds a long position in Towerstream.

Comments

[ej1234:]

This stock has every right to be trading below net cash value. They continually report losses, are cash flow negative and issue shares at a rapid pace. Broadvision and Sycamore Networks are two more in the same boat.

2008 Dec 03 11:42 AM

[MMS2728:]

I heard in the news that Towerstream was forced to lay-off over half of it's employees yesterday and yet they still claim to be increasing revenue by 33%. In the Rhode Island area where this company is based, there have always been rumors of reporting false numbers and concealing their true financial position. Is this mass lay-off proof that the rumors are true and is this stock just a sinking ship?

Jun 11 05:12 PM

[Asif Suria:]

I saw the filing about 35 employees getting laid off and also talked to an ex-employee yesterday.

Since the second quarter has not yet ended and sales in first quarter of 2009 grew 64%, I am not sure where you are getting your 33% growth number from. In face for full year 2008, revenue grew 54% when compared to 2007.

From my understanding, the growth has been driven by offering lower priced products such as the $500/month 5 MBPS product. I have been approached by Towerstream sales about this product in my role as the Director of IT for a small company and have seen companies switch to Towerstream within the last year.

The allegation of false numbers is very serious and it would benefit everyone if you can back up these allegations with some details.

Jun 13 03:26 PM

[MMS2728:]

As a Rhode Islander who lives and works in the area where this company is based, much of the information I have of this company comes from locals and the relationships I have with Towerstream employees I have met in social arenas. As a casual investor I have always had my eye on Towerstream and for a long time heard a lot of good things about the company. But for the last year or so, I have heard much more negative feedback than positive.

Much of what I have heard as far as reporting false numbers relates to reporting the same revenue more then once or withholding revenue from a month in which they have already met their quota and reporting it as revenue for the following month to ensure that month's goal is met.

Whether this is "fudging" the numbers or just common business practice is something as a casual investor I am unsure about which is why I asked for your opinion. But whether this is common business practice there is much about this company that raises red flags to me.

For one, I have spoken to many Towerstream employees and now ex-employees and they all put the numbers of laid off employees closer to 60 and yet the company claimed in the Providence Journal that they had only made minor layoffs. Even if it were only 35, for a company their size, that would seem to me to be more than just minor layoffs which makes me question the validity of all of their statemnts. I have also heard from many past employees that have been laid off and had their unemployment disputed only to have it reinstated because Towerstream was unable to provide any evidence to support their claims, which makes me question their ethics. These employess have all told me that these accusations were completely without merit.

And with these new layoffs coming just months after Towerstream paid for several employees and management to go to a resort in Puerto Rico in a time when Rhode Island already has one of the highest unemployment rates in the country, it again makes me question their ethics as well as their managerial decisions.

And finally, for a company that claims to be doing so well and showing such astounding growth to be forced to layoff such a large number of employees makes me question how these number can be true.

I admit that I am only a casual investor and that rumors and hear-say should not be your basis for investing decisions, but as someone who has considered putting my hard earned money into a company like Towerstream, I have to give these things consideration. I don't know if these things are true which is why I would like your opinion on the matter. Thank you.


On Jun 13 03:26 PM Asif Suria wrote:

> I saw the filing about 35 employees getting laid off and also talked
> to an ex-employee yesterday.
>
> Since the second quarter has not yet ended and sales in first quarter
> of 2009 grew 64%, I am not sure where you are getting your 33% growth
> number from. In face for full year 2008, revenue grew 54% when compared
> to 2007.
>
> From my understanding, the growth has been driven by offering lower
> priced products such as the $500/month 5 MBPS product. I have been
> approached by Towerstream sales about this product in my role as
> the Director of IT for a small company and have seen companies switch
> to Towerstream within the last year.
>
> The allegation of false numbers is very serious and it would benefit
> everyone if you can back up these allegations with some details.

Jun 14 06:59 PM

[BuhBye:]

As of 6/15/09 towerstream is now down to 40 salespeople compared to 150 at a point in mid-2009. Their marketing strategy is putting juvenile "viral" spots on YouTube where they have employees doing bad shtick and generally making themselves look small-time.

As a former employee, I can say the talent in towerstream lies in it's technical staff headed by Arthur Giftakis and Brent Petersen. While this technology is promising, the installation and customer service sectors are abhorrent. The equipment they place on rooftops is NOT aerodynamic as the would have you believe and that contributes to many outages. They opened in Miami on the premise of "bandwidth when disaster strikes" and nobody cares.

As far as the leadership goes, there is none. Blaming others has worked well to this point, but who is left to fire now?

Some of their best salespeople have flown the coop. Jeff Thompson will sell the infrastructure to Sprint and have a new start up company, mark my words.

This company went public on a back-door merger to begin with. They arrived on NASDAQ at $8 and today 85 cents. Their CFO Mel Yarborough couldn't find his ass with a flashlight in a room full of mirrors and their HR and customer service departments are very subpar. The window for this company to have any major presence passed in 2008. Halfway through 2009 they look like they are still on the field with the time expired and the scoreboard says:

TOWERSTREAM LOST

Jun 15 08:39 PM

[BuhBye:]

In that first sentence, I meant a point in mid-2008 when they overhird massively. There is no edit feature, so *correction*

Jun 15 08:59 PM

[Asif Suria:]

@MMS2728, thank you for adding to the discussion and providing additional insight into some of your earlier comments.

I cannot comment to the Puerto Rico trip as I was not aware of it until you mentioned it.

Without a doubt the size of the layoffs was large. However based on the size of the company and the revenues generated, it was clear to everyone that they had ramped up very quickly in terms of employees.

With the focus shifting to reaching break even instead of growth at any cost, this seems like a logical step. It will be interesting to see what management says about it during the next conference call.

Jun 17 06:28 PM

[TheSnail:]

Asif,

Any hints as to what is going on today?

Jul 23 01:55 PM

[Asif Suria:]

No idea why the stock popped 40% yesterday. I did post a blog entry this morning about Towerstream based on my conversation with their CEO last week.

www.sinletter.com/blog...

Jul 24 03:10 PM

[freddee:]

am also a former employee. I left recently on my own for a better company recently, but I was around the day they made the 35 layoffs. While these 35 people cleaned their desks, Jeff took the surviving employees to an expensive catered lunch up the street with free drinks for all and speeches about the company becoming "leaner and meaner". They definitely take advantage of the poor RI economy by forcing their low salaried, understaffed NOC and customer care reps to work ridiculous hours supporting a completely unstable network.

The concept of using unlicensed 5.4 band equipment to market 5-10Mb links sounded cheap and easy 2 years ago, but now they've exhausted the usable frequency in markets like NY but continue to sell links with no respect to the engineering side. Keep in mind sales is in a different building and are taught Jeff Thompsons sugar coated view of how the technology works (ex: not affected by weather at all). There are countless outages everytime it rains in Chicago, NY, Miami, and Boston, which leads to the poor customer service they're best known for. There's only so many angry phone calls a lone on call customer care rep can take at 2 in the morning before they snap back.

Now they are looking to get 120 million in broadband stimulus money. Jeff is on Fox business saying this will lead to jobs. Half of their markets are actually completely unmanned and installs are outsourced. The network and customer base has grown substantially over the last few years and they have lost more engineers and customer care than they have hired.

BuhBye's comments above are right on the money. Jeff has made it clear to all that the intent is to grow the customer base without profitability until Sprint/Clearwire finally buys the company. Read his blog. Sprint/Clearwire is all he talks about

Oct 09 01:27 AM