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A Case for Fairpoint Communications

June 01, 2011 | About:

mo77

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When looking at individual stock issues, one of the many common themes of value investing is that the uglier a business appears on the surface, the more truly beautiful it is due to the huge discount it is selling at.

One company which appears to fall into this category is Fairpoint Communications (FRP).

The backstory of the company is as follows:

In 2007 Verizon Communications (VZ) announced plans to sell its landline operations in Maine, New Hampshire, and Vermont to FairPoint for $2.7 billion. Of that amount, $1.7 billion would go to Verizon Communications in cash and debt and approximately $1.015 billion would go to Verizon shareholders in FairPoint common stock.

Once approved by the regulators, Fairpoint became the eighth largest telephone company in the U.S.



The narrative that followed is typically of a small company expanding by taking an excessive debt load and excessive operational responsibilities. Upon the takeover, it was clear that the increase in subscriber base was more than Fairpoint management could handle. Among the many operational problems that plagued the New England subscribers of FairPoint's services, included:



  • recurring billing errors
  • very poor customer service
  • lack of (and delay of) an electronic bill-pay option
  • slow or intermittent services


Things got so bad that in August 2009, the State of Vermont comtemplated revoking FairPoint's right to provide services in that state.

Poor operational performance seems to be a result of a capital structure that was simply unsustainable.

On May 5, 2009 FairPoint indicated as such. On Oct. 26, 2009, FairPoint Communications filed for Chapter 11 bankruptcy protection.

The company emerged from bankruptcy in January 2011 with new management and IPO'd at $25 per share. Since that time there appeared to be a major sell-off reaching a low of $9 on May 18, 2011.

The main catalysts for the drop in share price were the following:



  • On March 22, 2011, FairPoint Communications Inc. announced that in connection with the preparation of the consolidated financial statements of 2010, its management has discovered accounting errors that impact the accuracy of FairPoint Communications’ previously issued unaudited 2010 interim consolidated financial statements.
  • On their first quarterly call on May 17, 2011, CEO Paul Sunu focused on discussing operational improvements to the business from the standpoint of capital infrastructure as well as improving the overall customer experience.
Listening to the call, Mr. Sunu spoke like a business owner focusing on his customers and the quality of service his business is providing, which is not what analysts and people who view a stock from quarter to quarter wished to hear.

Behind the scenes a few of the major shareholders who received shares in the re-organization, one of them being Marathon Asset Management, seemed to be rushing to exit. As of now they have completed sold out of their positions.

Interestingly, as of May 19, two of the largest current shareholders are distressed debt experts Angelo, Gordon & Co. L.P. (19.5%) and Paulson & Company Inc (8.8%). Both firms are widely regarded as "smart money."

From a valuation standpoint Fairpoint has a top-line revenue of $1-1.2 billion per annum and EBITDA of $150-190 million.

Applying the assumption that Fairpoint can ultimately improve its EBITDA margin to 20%, that puts it at approximately $200 million.

If you were to apply a conservative valuation of 4x EBITDA, that would put the value of the business at approximately $800 million, representing a share value of about $30.

I'm long Fairpoint stock.

Rating: 2.4/5 (8 votes)

Comments

Hester1
Hester1 - 3 years ago


According to your analysis there is no value for the equity, I'm not sure why your long. If the business has $800 million in value, per 4 times EBITDA, then the equity is far underwater as net debt is $1800 million. You may want to rethink your anaylsis and include EV in your calculation instead. Since EV is over $2 billion, the implied EBITDA multiple at current market prices is over 13.

Also, there will certainly be shareholder lawsuits after the accounting misstatement. The enterprise value certainly deserves some discount for that high probability risk.
Hester1
Hester1 - 3 years ago
I'll add that the appeal to authority that Paulson is long, is weak, since he's had many post bankruptcy equity plays that have gone horribly wrong. See Supermedia. All the other "smart money" is and has been rushing for the exit.
mo77
Mo77 - 3 years ago


Hester,

I don't think the comparison with Supermedia and Fairpoint is a valid one. Supermedia has the dying business of yellowpages publishing and is trying to enter into the hypercompetitive world of online advertising, whereas Fairpoint is a broadband telecom provider in the unloved and boring world of rural out-of-the way broadband/telecom. In some areas it is one of two or the only provider of broadband/telecom services.

I think the business has good prospects and potential cash flows for the next 15-20 years, provided there is competent management and a sustainable cost structure (which i believe there is).

You are correct that I should not use the "smart money" as a cushion.

However this security is fairly obscure and w/ very low trading volumes, when a large institutional investor is dumping their position in a small cap it turns into a "Mr. Market on steriods" situation.

As of 3/10/2011, after re-organization book value stands at $475 million w/ tangible book (minus goodwill & intangibles) at about $75 million.

Current liabilities are at about 1.8 billion of that about 1 billion of that as long-term debt and 350 million in tax-deferred liabilities.

I suppose I just see it differently. I see tremendous value for a patient investor.

I guess that what's makes a market.

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