CommScope (COMM) made its public debut on Friday, October 25th. Shares of the global provider of connectivity and infrastructure solutions for broadband networks ended their first day with minuscule losses of $0.1% at $14.99 per share.
It is easy to see why investors pass on this debt-loaded public offering. The debt load is too high, placing high risks on investors in CommScope's equity if headwinds may arise.
The Public Offering
CommScope is a provider of connectivity and infrastructure solutions, to be used in wireless, business enterprise and residential broadband networks.
The company provides critical radio frequency solutions, connectivity, cabling platforms and broadband access solution. Continued growth of smart phones, tablets and intra-device communication continues to fuel demand for these services.
The company has quite diverse operations in terms of product offerings, each targeting different target markets, focusing on both residential and business customers.
CommScope sold 38.5 million shares for $15 apiece, thereby raising $578 million in gross proceeds. Some 30.8 million shares were sold by the company which thereby raised $462 million. The remaining 7.7 million shares were being offered by selling shareholders.
Initially, bankers and the firm set an initial price range of $18-$21 per share. Shares were eventually sold far below the low end of the initial public price range.
Some 21% of the total shares were offered in the public offering. At Friday's closing price of $14.99 per share, the firm is valued at $2.78 billion.
The major banks that brought the company public were J.P. Morgan, Deutsche Bank, Credit Suisse, Bank of America/Merrill Lynch, Goldman Sachs, Barclays and Morgan Stanley, among many others.
CommScope has quite diverse operations and can count both small and medium businesses, as well as many Fortune 500 names as a client. Key communication clients include AT&T (T), Verizon Communications (VZ), Comcast (CMCSA) and T-Mobile US, among others.
The company's solutions are based on RF technology and other technological expertise, backed by some 2,700 worldwide patents and patens applications. Some 12,500 workers, serve CommScope's customers in over a 100 countries across the globe.
Besides increased adoption of smart phones and tablets, consumers and businesses continue to increasingly use Big-Data, cloud-based services and streaming media, all putting a strain on existing networks.
To accommodate all of this, wireless infrastructure providers are investing in 4G wireless infrastructure, building LTE networks. CommScope also aids its customers by dealing with peak capacity demands, growth in data centers and infrastructure in smarter buildings.
For the year of 2012, CommScope generated annual revenues of $3.32 billion, up 1.5% on the year before. The company reported operating earnings of $238.2 million compared to a $188.4 million loss the year before. On the back of the high leverage employed, and the consequent higher interest payments to service that debt, net profits came in at just $5.4 million. In 2011, CommScope reported a $392.4 million loss driven by asset impairments and the amortization of intangible assets.
For the first six months of 2013, CommScope generated annual revenues of $1.75 billion, up 10.4% on the year before. The company reported net earnings of $17.0 million compared to an $11.4 million loss last year. This is despite asset impairments of $34.5 million and amortization charges of $87.0 million.
The company operates with $223.6 million in cash and equivalents and $3.02 billion in total debt, for a net debt position of around $2.8 billion.
Factoring in the gross proceeds of $462 million from the offering, and CommScope will operate with a net debt position of around $2.4 billion. Proceeds of the offering, combined with cash at hand will be used to repay $525 million in notes expiring in 2019, paying a coupon of 8.25% per annum. Such a move will save CommScope some $43 million per annum in interest expenses.
With the equity in the business being valued around $2.8 billion, CommScope is valued at 0.85 times annual revenues and a non-meaningful earnings multiple based on 2012s earnings.
As noted above, the offering of CommScope has been quite a disappointment. The company priced the offering at $15 per share, some 23.1% below the midpoint of the original preliminary offering range.
Clearly the market has not been enthusiastic about this debt-loaded offering. Note that ownership following the offering will still be tightly controlled with the Carlyle Group LP (CG) holding a roughly 79% stake. CommScope's net debt position of $2.4 billion following the offering is large due to the acquisition by Carlyle back in 2011. Following the deal, CommScope took on a lot of debt, partially to pay itself a $750 million dividend. Note that Carlyle is still being represented on 9 out of the 11 board seats, possibly creating a mis-alignment between all investors.
Actually, CommScope is quite a well-established business operating in a range of industries in many countries. Yet current profitability is sub-optimal due to the debt position, which prevents the company form paying a dividend a the moment.
Even when striping out the $34 million in impairment charges and $87 million of amortization of intangible assets, earnings in the first half of this year would only have come in around $138 million, when added to reported earnings of $17 million. Annualizing these earnings and relating them to a $2.8 billion valuation of the equity, and the price-earnings ratio seem reasonable.
That being said, the current valuation is still too high given the large debt outstanding on the balance sheet, even when deleveraging results in quite some accretion to the income statement.
I'll pass on this one. The debt position is still too high for me, to warrant the current valuation despite the discounted offer price. I might reconsider if shares were to fall further and operating cash flows have reduce the net debt position.