May 9, 2019

Breakingviews: Buyout firms download promising $14 bln data deal

by Breakingviews.

Buyout firms EQT and Digital Colony Partners have downloaded a promising $14 billion data deal. They are buying serial acquirer Zayo on the cheap. The fiber and data center firm’s subdued growth and hefty need for capital made for an uncomfortable five-year ride as a public company. A brighter future, helped by 5G growth, awaits as a private firm.

At the turn of the millennium, companies like WorldCom, Global Crossing and a slew of smaller firms went on an investment rampage laying fiber-optic cable to transmit data. The result was a tsunami of bankruptcies. Zayo was formed a few years later to snap up fiber and data centers at cheap prices, and rent out capacity as data traffic steadily grew.

The company’s idea to go public in 2014 seemed sensible. Stock provided another form of currency for the deal-hungry outfit. The ride proved bumpy, however. The company’s stock has underperformed rivals Equinix and Cogent Communications since its IPO.

The company disappointed shareholders – revenue growth has fallen short of analyst projections in multiple quarters. And the need to upgrade infrastructure meant the company had to spend a lot on capital investment. Worst of all, management seemed confused about its next strategic step. Just six months ago, Chief Executive Dan Caruso unveiled a plan to split the company in two and was considering converting it into a tax-efficient real estate investment trust. Zayo later walked back those plans.

The buyers are getting the company relatively cheaply, at about 11 times EBITDA over the next year, according to Refinitiv estimates. Cogent and Equinix are valued at 15 and 18 times respectively. However, analysts think the company will only throw off less than $600 million of operating profit over the next year. After standard corporate tax, that’s a return of less than 4 percent on the $14 billion price, which includes debt.

Yet Zayo’s acquisitive history and subpar performance means there’s room for cost cuts. Moreover, the rollout of the 5G standard in phones and other mobile devices means revenue growth should accelerate for the next several years, as this data needs fiber to travel on. Zayo has already invested the high fixed costs of building networks, which mean much of the new income should end up as profit. That means its new private-equity owners have a good chance of making an attractive return.


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