XO Holdings: Turning the Corner

Nov.13.07 | About: XO Holdings, (XOHO)

On Friday, XO Holdings (OTC:XOHO) reported the 2007 Q3 with the highest revenue of $359.4 million in two years, $29 million of adjusted EBIDTA, and a net loss of $4.5 million – helped by some special items.

The increase in revenue was driven primarily by growth revenue from the Company's in Data and IP Services, which increased 12% from the prior quarter and 27% from the same period in 2006. The Company continued strong growth in its collocation, commercial VoIP, dedicated Internet access, Ethernet, IP-VPN and high-capacity private line network services.

While all the growth looks like baby steps, under the hook, there are some numbers and reveal making the report interesting.

Excluding the $6M settlement, real revenue only increased $3.5 million sequentially. Given SunRocket’s going-under event that probably contributed to the majority of the $2.4 million decrease in VoIP revenue, the number in revenue growth is not bad. In terms of operations, SO&A increased about $8.5 million sequentially and $13 million over 2006Q3, and percentage-wise as well, caused by growing marketing and sales effort, which may be beneficial to future development, but it still needs to be brought down.

Another disappointed is that NextLink – the fixed wireless business did not grow – yet.

On the bright side, in addition to the improving gross margin, new wholesale network transport business signed 55 new carriers, content providers and Internet-centric customers in the 2007Q3. The expansion of backbone and Inter-City network with the 800Gbps increased capacity built on XO’s own fiber, along with faster time to market and better customer intelligence under the re-structured OSS/BSS in August, including the newly announced “10G in 10 Days” fulfillment, XO may speed up the growth trend soon shown in future quarters. In addition, with the recently announced partnership with Global Crossing, NextLink with the presence in 75 markets may start to join the force, hopefully more than making up the possible losses due to the regulation change in UNE-P/L.

Then, in 2007 Q3, the company’s cash burn rate was about $23 million worsened by a doubling CapEx and helped by a special item.

As of September 30, 2007, our balance of cash and cash equivalents was $90.9 million, a decrease of $77.7 million from December 31, 2006.

Therefore, the struggling company may still keep running for another 2-3 quarters with the cash in hand, but definitely needs more funding for future growth soon.

Based on the 10-Q, “for the twelve-month period ended September 30, 2007, the Company was required to achieve a minimum consolidated EBITDA of not less than $470.0 million.” This number may reach $500 million by the end of 2008 to comply with the covenant, which sounds impractical based on the current progress and capital investment level. However, with a closer look, the company’s Data Services + Xoptions FlexIP revenue increased to $142.8 Million (122.375+20.418) from $112.1 million (102.161+9.962) a year ago. That indicates that with about $30 million additional CapEx, the company realized about $30 million increase of revenue in Data and IP revenue in the same quarter a year ago. That was an impressive execution and ROI number of dollar for dollar.

If, a big assumption, the company could get $500 million additional finance for future growth, in an ideal situation, the company may, arguably, realize $500 million revenue increase with the additional CapEx in data and IP services, be it from bandwidth services, high-capacity private line network services, Ethernet/VPN, dedicated Internet access, collocation, content delivery services; excluding additional interest payment of $60 million for the new debts and other costs, the company may gain $200 million EBIDTA and make the total EBIDTA $300 million with the absence of a run away SO&G. The company would be profitable, too!

Finally, among the 10Q’s fine prints, there is a small revelation about the Litigation Relating to the Wireline Sale – XO vs. Carl Icahn:

The Amended Complaint reasserts the claims of various alleged breaches of fiduciary duty and corporate waste in connection with the proposed transaction and seeks, on behalf of XOH, damages in the amount of professional fees and expenses incurred in connection with the proposed sale of the wireline business, rescission of a voluntary prepayment of $100 million of amounts outstanding under the Company’s Credit Facility and lost business and business opportunities relating to the uncertainties associated therewith. The plaintiffs also claim unspecified damages, interest and costs, including reasonable attorneys’ and experts’ fees in connection with these lawsuits. On October 29, 2007, the parties notified the court that they had reached a settlement in principle in this case.

Investors may read from the 10-Q another encouraging sign regarding the long-waited refinance:

The Company is soliciting refinancing proposals from a number of major investment banks in order to raise additional capital to fund the Company’s working capital requirements and capital expenditure plan. As part of the refinancing process, the Company may also replace or renegotiate the Company’s existing Credit Facility. On September 28, 2007, the Company’s Board of Directors established a Special Committee to assist the Company in evaluating these financing alternatives and the Special Committee has retained Cowen and Company, LLC as its financial advisor.

This seems to be an indication of not only some compensation for the damages to XO, but also the desperately needed $100 million that could be coming back. Even though the transfer is from the Chairman’s one pocket to another, this is at least a gesture showing “I promise I won’t do it again.” – removing some uncertainty and making the Chairman sound less shareholder-unfriendly.

Reading the 10-Q carefully, one could feel that the still struggling big ship is turning the corner with a better footing on business and improving finance while moving slowly towards the right direction.

How about the worries over economy slowdown and lower consumer confidence? Well, in a less optimistic economy environment, people will stay home and spend more time to download and listen to more music, download and streaming more video/TV/movies from the Internet, thus consuming much more bandwidth. With a conceivable EBIDTA and EV/EBIDTA ratio similar to TWTC ($300 million and 14 respectively) in 4 quarters or slightly more, the company’s Enterprise Value would become about $4 billion but would have a higher market capitalization thanks to its lower debts level!

Undoable? Unless you believe Mr. Icahn is a regular Joe on the street. About three months ago, Carl Icahn took his $7 billion hedge fund operation public by selling it to American Real Estate Partners, a public company he also controls (90%) and renamed it to Icahn Enterprises (NYSE: IEP). Now IEP trades about 45% higher than before the acquisition.

Disclosure: Author has a long position in XOHO.OB