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ThreeSevenOff
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I am an individual investor with managing personal investments as my full-time occupation. My investing style is fundamental-driven. I am not a technical trader and do not typically daytrade.
  • CBEY - Reported churn rates hide more than they reveal. 7 comments
    Jan 6, 2010 1:54 PM | about stocks: CBEY
    My attention was first drawn towards CBEY when it was first profiled in the Citron Research “Hall of Shame”. Not content with taking Citron's research at face value, I decided to dig into the numbers myself. Upon scratching below the surface, my conclusion is that their operational metrics are far worse than they appear at first glance.
    The key data point here is the churn rate i.e their ability to retain their customer base. Their current reported churn rate of 1.4-1.5% per month implies that their average customer will last 5.5 to 6 years. Once you factor in the $750 per month ARPU, their historical 18-22% cash profit margin (pre-capex) and a 10% discount rate, the math will tell you that their average customer should be worth around $8,000. The market is valuing their 49,000 or so customers at $8,700 today. It seems a little pricey but not horrible given that they have been growing their subscriber base by entering new markets.
    But this is where the numbers begin to get misleading. It seems that most of their customers are locked into 3 year contracts, which means customers have no way of getting out before 3 years unless they want to pay material penalties. So a more accurate way to look at the churn rate would be on a 3 year lag basis. By analyzing the subscriber data from their public filings, it is my estimate that 75-80% of their customers do not renew their contract after 3 years. First, that speaks something about the value proposition of their business and second, even if the remaining 20-25% of their customers stay with them for 6-8 years, it gives them an average customer life of 3.6 to 4.2 years. Assuming a customer life of 4 years, the implied “static pool” churn rate is 2.1% and the valuation per customer is $5,700. In reality, even this valuation is generous  as the company will need to spend capex even if it stops growing, so a more accurate valuation would be $4,000-$4,500 per customer.
    CBEY has been burning up pretty much all free cash flow to enter new markets. This keeps fattening its customer base which keeps the reported churn rate low due to an ever increasing denominator. This masks the issue of concern that a very high percentage of customers are choosing to go away once their contract expires. In the short term the company may continue to grow their subscriber base by burning more cash, but they will run out of growth opportunities sooner rather than later and the churn rate will catch up. I don’t believe that the current business model will ever be able to generate the kind of free cash flow needed to justify today’s valuation. If you layer on top of that (i) the ongoing economic pressures on small businesses and (ii) declining ARPU due to commodity like product and fierce competition from much larger providers, then nothing seems positive for the company.
    In my view, this business is worth no more than $200-$225 million today, implying a $8-$8.5 stock price.


    Disclosure: Short position paired with a protective call, at the time of original writing 1/6/10. Currently, no position.
    Stocks: CBEY
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Comments (7)
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  • User 390533
    , contributor
    Comment (1) | Send Message
     
    Please take time and look at cbeyonds public filing. If you do all the necessary analysis, and consider the 3 year lag associated with churn rate, what you will see is that cbeyond usually retains 65% of its customers which is higher than at&t and Verizon
    16 Feb 2010, 12:08 AM Reply Like
  • Maklo
    , contributor
    Comments (58) | Send Message
     
    In your analysis, you are not factoring in involuntary churn, i.e. churn that is from companies going out of business. This is not an insignificant number, particularly for CBeyond's small customer base, a segment of the market that still has not seen any recovery and has been hurt disproportionately in this recession. CBeyond management has consistently reported that the increase in overall churn was due almost entirely to increases in involuntary churn and that voluntary churn has stayed consistent at about 40-50 bps per month.
    31 Aug 2010, 11:07 AM Reply Like
  • ThreeSevenOff
    , contributor
    Comment (1) | Send Message
     
    Author’s reply » In response to Maklo,

     

    1. My analysis covered the mid-2006 to mid-2009 period. During the first half of this period, small businesses were doing pretty well actually. So any downtick in the 2nd half should have been cancelled out by boom time in the 1st half.

     

    2. Is there a reason to believe that small businesses will go back to their prosperous ways in the next few years or will the creation of new small businesses increase?

     

    3. Could you point me to a few instances where the management has claimed or implied that "churn has stayed consistent at about 40-50 bps per month"? Even if this is true, isn't it the case that small businesses continue to operate in a very harsh environment and the "involuntary churn" will likely stay the same or even go up as contracts end?
    1 Sep 2010, 09:19 AM Reply Like
  • Maklo
    , contributor
    Comments (58) | Send Message
     
    1. Your analysis is using CBEY's peak churn rates, not a blended average. In any case, the point is that you cannot assume all the churn is related to people coming off contracts on a three-year lag which is how you presumably calculated the 25% figure. This is because the majority of churn is actually involuntary, ie people who re-neg on their contracts b/c of bankruptcy or other similar reasons.

     

    2. Yes, I believe that the economy will eventually go back to normal. Small businesses have traditionally been the engines of job creation in the US and I don't know why the future would be any different.

     

    3. Check out slide 15 in their q3 2009 presentation on their website.
    3 Sep 2010, 02:47 PM Reply Like
  • aduaks
    , contributor
    Comments (2) | Send Message
     
    How do you figure out that a churn rate of 1.4%-1.5% implies a customer lifetime value of 5-6 years? A little insight would be appreciated.
    21 Feb 2012, 11:08 AM Reply Like
  • aduaks
    , contributor
    Comments (2) | Send Message
     
    "Their current reported churn rate of 1.4-1.5% per month implies that their average customer will last 5.5 to 6 years" - could you please explain how you arrive at 5.5 to 6 years for the average customer lifetime? A little insight would be much appreciated. Thank you.
    21 Feb 2012, 11:09 AM Reply Like
  • jzcambs
    , contributor
    Comment (1) | Send Message
     
    Divide 1/annual churn rate (0.1 for 10%) and that will give you the customer lifetime
    14 Sep 2012, 03:39 PM Reply Like
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