EUR 850.00 For Business Accounts Only

Morningstar | Concerns of an Oversupplied Market Temper Our Enthusiasm for Zayo; Initiating Coverage with $28 FVE. See Updated Analyst Note from 25 Nov 2018

We are initiating coverage on Zayo with a no-moat rating, stable trend, and fair value estimate of $28, implying an EV/EBITDA multiple of 11 based on our 2019 forecast. Though Zayo should benefit from industry tailwinds, we are not convinced it has a competitive advantage that would make the stock attractive at current levels, despite the large recent decline.

Zayo's strategy has been to collect a large portfolio of fiber assets, which allow it to provide the infrastructure necessary to enable society's surge in data consumption. It has about 130,000 route miles of long haul, regional, and metro fiber throughout North America and Europe that connects to data centers, central offices, cell towers, and other enterprise buildings. To build its asset base, Zayo has relied heavily on acquisitions, completing 45 deals since 2007, mostly smaller in nature. However, along with the fiber it desires, Zayo has often received noninfrastructure assets, primarily business services operations, in its targets, leading to a less focused business than management prefers. To address the abundance of noncore assets, Zayo intends to split into two companies in 2019, with one company maintaining the core infrastructure assets and the other comprising the rest.

Given we believe fiber is oversupplied over many routes, particularly long haul, we think consolidation is good and perhaps necessary for Zayo's business to thrive. However, in our view, the acquisitions Zayo has made--collectively for $6.7 billion--are too small to really change industry dynamics, and we question the value, given the undesired assets Zayo often picks up in tandem. We think splitting off the noncore assets is a good idea, especially because it should allow Zayo's core business to become a REIT, leading to tax advantages. However, we expect the core business to follow a similar pattern and again accumulate unnecessary assets that it will not nurture to their full potential, thus putting a drag on the company.

Though fiber is vital in today's world, and we think its importance is only increasing, we don't see Zayo's assets in a unique position or scarce enough to make for a great business. Short of meaningful industry consolidation—in which case we see Zayo as more likely to be a target than an acquirer—we doubt the pricing power Zayo has on its sizable fiber asset base. However, with the biggest U.S. telecom and cable carriers owning the most fiber, we believe antitrust laws preclude much consolidation between Zayo's biggest competitors.