EUR 850.00 For Business Accounts Only

Morningstar | No Surprises in Zayo's Decision to Be Taken Private for $35 or Its Fiscal 3Q Earnings Results

After months of speculation that potential buyers were lurking, and management's disclosure two months ago that it was evaluating strategic alternatives, Zayo announced on May 8, 2019, that it had agreed to be taken private by Digital Colony Partners and the EQT Infrastructure IV fund. Although we thought Zayo had more value to a strategic buyer, it is not surprising to see it go to an infrastructure fund, given recent chatter, a dearth of strategic buyers that made sense, and high levels of recent activity of infrastructure funds. The buyers will pay $35 per share in cash, and Zayo expects the deal to close in the first half of calendar 2020. The board has already approved the transaction, and we feel it was well publicized that Zayo could be for sale, so we expect this deal to close and don't foresee competing bidders entering the picture. We will raise our $29 fair value estimate to $32-$33, which reflects our time value of money discount to the sale price.

Communications infrastructure firms from data centers to tower companies have disclosed a pickup in recent competition from infrastructure funds. We think those funds' activity is likely a sign of a credit environment that is providing cheap money, but it is inflating asset prices, dampening returns, and providing more challenges for public companies, in our view. We don't expect it to persist. Nonetheless, given the stand-alone fair value estimate we assigned to Zayo, we think this was a fair price for a financial buyer taking control of the firm.

In conjunction with the takeout news, Zayo released its fiscal third-quarter earnings results, which were largely in line with our estimates. Revenue fell 0.3% year over year, slightly better than the 1% decline we forecast. However, the firm's adjusted EBITDA was about $3.5 million lower than we forecast, as the margin fell by 70 basis points sequentially to 49.6%. We had projected a 30-basis-point rise.

The units with declining revenue were Allstream (Zayo's Canadian enterprise wireline carrier), zColo (data centers), and enterprise networks. We forecast each unit to decline in 2019, as they've all had recent challenges, and we see Allstream and enterprise networks as being in long-term secular declines. Fiber solutions, which accounts for over one third of Zayo's revenue and includes dark fiber and mobile network solutions, is likely where the bulk of the firm's value lies, and that segment continued to be strong. It grew revenue 12% year over year, above the 10% rate management targets for it on a long-term basis.