Seeking Alpha

Buy The Cincinnati Bell's Bidding War

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About: Cincinnati Bell Inc. (CBB), Includes: BIP, CBB.PB
by: Wang Financial Research
Wang Financial Research
Arbitrage, small-cap, mid-cap
Summary

Cincinnati Bell Inc. offers integrated communications and IT solutions including video, high speed data, and voice solutions.

I would expect Brookfield to be able to pay more than $12. The implied EV/EBITDA of the deal is below. In my opinion, this is the beginning of the story.

The implied EV/EBITDA of the deal is below 7x EBITDA. A few years ago, the shares traded at 10x EBITDA.

Competitors trade at a median of 8.24x EBITDA with an EBITDA margin of 23%-132%.

After the announcement of the deal with Brookfield Infrastructure, another fund offered $12.00 per share in cash. In my view, Cincinnati is a buy.

Cincinnati Bell Inc. (CBB) signed a $10.5 deal with Brookfield Infrastructure Partners L.P. (BIP). The implied EV/EBITDA of the deal is below 7x EBITDA, which I believe is a low ball. Very recently, another infrastructure fund offered $12 for the company. I still believe that we will see new bids. In my opinion, there is a significant upside in the stock price. Additionally, with two bidders, we could see a bidding war. Smart money managers are betting on the company.

Business Model And Most Recent M&A Activity

Founded in 1873 and Ohio-based, Cincinnati Bell Inc. offers integrated communications and IT solutions including video, high speed data, and voice solutions:

Source: Cincinnati Bell’s Website

The company’s long term goal is transforming its business from a legacy copper-based telecommunications company into a tech corporation with state-of-the-art fiber assets. Right now, Entertainment represents 60%-64% of the total amount of revenue, and IT Services comprise of 40%-35% of the total amount of revenue. As shown in the chart below, revenue from Entertainment is increasing:

Source: 10-k

Source: 10-Q

The company may be acquired by Brookfield Infrastructure Partners. Thus, I researched whether the company has expertise in the M&A markets. Cincinnati Bell is an old corporation, which has gone through several corporate transactions. Readers may remember the acquisition of IXC Communications, which occurred in the 1990s. Most recently, in 2018 and 2017, the company acquired Hawaiian Telcom Holdco, Inc., SunTel Services LLC, and OnX Holdings LLC. As a result, in my opinion, Cincinnati’s employees understand what an acquisition is. It will help during the merger integration.

Brookfield Would Buy Network Equipment, Goodwill And Intangible Assets

I believe that investors would appreciate understanding what Brookfield Infrastructure Partners is buying. As of September 30, 2019, the amount of cash in hand is not significant. The company’s most valuable assets are its PP&E, which is worth $1.796 billion, and goodwill and intangibles valued at $317 million:

Source: 10-Q

Most of the PP&E consists of network equipment. Before taking into account D&A, network equipment comprised of 85% of the total gross PP&E. Taking into account this fact, I would not expect financial buyers to be very interested in CBB. The company does not own buildings or any other asset, which can be sold. Cincinnati Bell Inc. may be targeted by other players in the industry, which understand the company’s business model and may present cost synergies.

Source: 10-Q

Growing EBITDA

The company’s acquisitions in 2018 and 2017 as well as the investments in the expansion of high-speed internet and video products pushed the EBITDA up. As shown in the plot below, from 2017 to 2020, the market is expecting EBITDA growth of 36%. I don’t think many companies founded more than 100 years ago can report the same growth. It is a pity, in my view, that retail investors may not profit from it when CBB gets bought out:

Source: Market Expectations

In my opinion, Brookfield Infrastructure Partners is about to buy the company at the best point in time. Right now, the company’s strategy is working properly, and the most recent acquisitions seemed succesful. I hope that shareholders and the Board of Directors will obtain a good price for the company’s shares.

The Company’s Debt/EBITDA Is Not Much Larger Than That Of Peers

As of September 30, 2019, the company’s balance sheet includes $1.904 billion in long-term debt and $220 million in pension and post retirement benefit obligations. Taking into account total liabilities of $2.746 billion, the company’s debt appears very significant. With that, the company’s Debt/EBITDA level is in line with other competitors. Thus, I am not that worried about the company’s financial risk:

Source: Ycharts

Source: 10-Q

Investors should also not worry much about the company’s contractual obligations. The company has to pay most of its debt and other contractual obligations from 2025. In the light of this fact, I would not expect that the company’s leverage would decrease the company’s EV/EBITDA.

Source: 10-k

Hawaiian Telcom Was Acquired At 1.9x 2018 Sales

In 2018, Hawaiian Telcom brought sales of $175 million and was acquired for a total of $339.5 million. Thus, the company was acquired for 1.9x 2018 sales:

Source: 10-k

Consolidated revenue totaled $1,378.2 million for the year ended December 31, 2018, an increase of $312.5 million as compared to the same period in 2017, primarily due to the acquisitions completed in 2018 and 2017. The acquisition of Hawaiian Telcom contributed $175.0 million of revenue in 2018. Source: 10-k

Taking into account the multiple paid in this transaction, in our view, shareholders should expect to sell the company at a larger ratio. Notice that Cincinnati Bell is larger than Hawaiian Telcom. Usually, the larger the company, the larger the multiple.

Source: Ycharts

Standard Conditions And Low Termination Fee

I did not see any condition that is very difficult to meet. It’s very relevant. In my view, with this merger agreement, other buyers would be interested in signing a new deal:

  1. The waiting period (including any extension thereof) applicable to the merger under the Hart-Scott-Rodino Antitrust Improvements Act of 1976.
  2. The receipt of CFIUS Approval.
  3. Certain FCC consents and state regulatory consents required in connection with the merger shall have been obtained, shall not be subject to agency reconsideration or judicial review.
  4. The receipt of the Company shareholder approval.
  5. The consummation of the merger is not conditioned upon Parent’s receipt of financing. Source: Merger Agreement

The break up fee is also low, equal to $17.97 million. If the company’s enterprise value is close to $2.5 billion, a termination fee of $17.97 million is not significant. In the light of this fact, in my opinion, buyers will not mind paying the break up fee. I saw several seeking alpha users giving, by mistake, misleading information about the breakup fee. Thus, I believe that I am doing good by pointing it out in the article:

Source: Seeking Alpha Comments

With the exception of the termination fee of $17.97 million to be paid by the Company to Parent under certain circumstances, all fees and expenses incurred in connection with the merger and the other transactions contemplated by the merger agreement will be paid by the party incurring such fees and expenses, whether or not such transactions are completed. Source: Merger Agreement

Brilliant Shareholders Bought Shares

Most institutional investors don’t care about what other institutions do. Having said that, I do like checking who bought shares. In this particular case, I could identify two well-known smart money managers among the shareholders. Check the table below for more details on the matter:

Source: Merger Agreement

The $12.0 Non-binding Proposal And The Market Reaction

After the announcement of the deal with Brookfield Infrastructure, another fund offered $12.00 per share in cash:

Cincinnati Bell Inc. today announced that on January 22, 2020 it received a non-binding proposal from an infrastructure fund (the “Fund”) to acquire all of the outstanding shares of common stock of Cincinnati Bell for $12.00 per share in cash Source: Press Release

Investors did not care about the fact that the new bid is non-binding. The market reacted by pushing up the share price from $10 to more than $12. Clearly, many investors believe that Cincinnati Bell Inc. is worth more than $10. I do agree with the market’s vision:

Source: Seeking Alpha And Author’s

Let’s take a look at the valuation of other competitors. They trade at a median of 8.24x EBITDA with an EBITDA margin of 23%-132%:

Source: Ycharts

As shown in the chart below, the company’s valuation is in the lower end of the valuation range. In the light of this fact, in my opinion, the buyers could pay a bit more for the company. Also, the valuation of peers doesn't include the control premium. Taking into account this fact, bidders should pay a bit more than the median of 8.24x EBITDA.

Source: Ycharts (Does Not Include The Control Premium)

Let’s use 2020 EBITDA of $413 and 8.5x EBITDA, which make an enterprise value of $3.510 billion. With debt of $2 billion, the market capitalization is $1.51 billion. With convertible preferred stock of $129 million, I get a valuation of $1.38 billion. If we use a share count of 50 million shares, my target share price would be $27 per share.

Don’t you believe that the company could trade at 8.5x EBITDA? Have a look at the plot below. In 2000, the company traded at 30x EBITDA. Besides, a few years ago, the shares traded at 10x EBITDA:

Source: Ycharts

Risk Assessment And Downside Risk

The company has two clients, which represent a significant amount of Cincinnati’s sales. Investors should understand that losing these clients will result in a significant sales decline:

As of December 31, 2018 Verizon comprised 18% of consolidated accounts receivable. As of December 31, 2017, GE comprised 10% of consolidated accounts receivable. During 2016, GE contributed 11% to consolidated revenue. As a result of these concentrations, the Company's results of operations and financial condition could be materially affected if the Company lost these customers or if services purchased were significantly reduced. Source: 10-k

The company represents an interesting buying opportunity. Brookfield Infrastructure Partners offered $10.50 in cash. Thus, if the other buyer does not pay $12, the share price would decline back to $10.5. As a result, investors would suffer a loss of 12%-15%. In my opinion, the loss is limited, which most investors would appreciate.

My Takeaway

In my opinion, $10.5 per share is a low ball for Cincinnati. Clearly, the infrastructure fund, which offered $12 per share, understood it. Brookfield Infrastructure Partners L.P. reports a revenue of more than $3.5 billion. Thus, I would expect Brookfield to be able to pay more than $12. In my opinion, this is the beginning of the story. There is a significant upside potential in the stock price and limited downside. In my view, Cincinnati is a buy.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.