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.