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Morningstar | Disappointing Quarter for GTT Isn't All Bad but Highlights Challenges; Shares Still Overvalued. See Updated Analyst Note from 08 May 2019

No-moat GTT missed consensus and fell short of our first-quarter estimates on the top and bottom lines. More concerning, the firm again saw revenue decline, excluding the benefit of acquisitions. Although GTT was able to increase margins, as management has targeted, we believe the only way the firm can justify its current valuation is to show it can materially grow revenue organically. We see nothing to change our view that that will be difficult, so despite a huge stock decline following earnings, we still see the shares as overvalued. We are reducing our $31 per share fair value estimate to $28 to reflect a more muted long-term growth forecast. Given the firm's debt load, lack of assets, and business prospects, we would steer investors to alternatives even on a further pullback.

On a pro forma basis to account for last June's acquisition of Interoute and currency movements, revenue declined 1% year over year. Management attributes the decline largely to typical transient factors regarding acquisition integration, and it maintained its target to of $3 billion in annual revenue by 2021. We remain concerned that the only way for the firm to materially grow revenue is through acquisitions (which are assumed in the $3 billion revenue target), and while we believe the firm can realize synergies as a serial acquirer, we question the value if integration efforts will perpetually inhibit organic revenue growth. In our view, top-line prospects are more challenged by a business model that requires GTT to take on behemoth global competitors in an industry with deflationary pricing pressures and technological advances that allow superior services at lower costs.

The firm's EBITDA margin expanded over 300 basis points year over year, beating our estimate by 40 basis points. After losing $0.49 per share in the first quarter, we think, barring acquisitions, the firm can become profitable on the bottom line by the fourth quarter and remain that way throughout our forecast.

The firm is on track to realize the $100 million in synergies it assumed from the Interoute merger. Still, we think the 30% adjusted EBITDA margin the firm is targeting by the end of 2019 (from 27% in the first quarter) is overly aggressive. We forecast another 200 basis points of EBITDA margin expansion throughout the year but think even that may be difficult to achieve.

Management stated that its funnel of acquisition opportunities remains healthy and that it expects to make some smaller acquisitions in 2019, as it plans to do every year. Not only do we think the company's leverage (currently over 6 times EBITDA) will make meaningful acquisitions difficult, we think the acquisitions may mask the lack of true growth opportunities. We don't deny potential acquisitions can be accretive and worthwhile purchases, but we don't see them as sufficient to justify recent GTT stock prices.