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Morningstar | Zayo's Fiscal 2Q Results Meet Expectations Amid Strategic Confusion; FVE to $29 from $28. See Updated Analyst Note from 08 Feb 2019

No-moat Zayo's fiscal second-quarter revenue and EBITDA margins were in line with our forecast. The bigger highlight, however, was the revelation and subsequent confusion regarding the reversal of the previously disclosed decision to split the company and management's new plan to reorganize its reporting segments. We wouldn't be surprised if the vacillation has caused investors angst, but we are heartened that it is not coming on the back of poor performance. To the contrary, results were fine, and our long-term view is unchanged. After adjusting our model for the quarter's results, we are raising our fair value estimate by $1 to $29 per share, and we see the stock as fairly valued.

The year-over-year revenue decline the company reported was due mainly to Allstream, Zayo's Canadian wireline carrier that is known to be in perpetual decline and will likely still be sold. Excluding Allstream, the communications infrastructure segments posted revenue growth of just over 2%, in line with our projection for the full year. Communications infrastructure adjusted EBITDA margin was 56%, 70 basis points higher than our full-year projection. The most encouraging metric we saw was year-over-year bookings growth of nearly 6%, 150 basis points higher than we projected and a harbinger of stronger sales in the next couple of quarters. However, the bookings outperformance relative to our expectations was confined to colocation, a relatively small segment. While it will boost sales all the same, we don't see it as Zayo's core business, so it doesn't lead us to be any more optimistic about the company's long-term prospects in its core fiber businesses.

Management addressed increased recent chatter that Zayo is an acquisition target but gave nothing more than the perfunctory "as a public company, we'll consider all offers" response.

Despite our somewhat negative view on Zayo, we continue to believe it would be an attractive target at current levels. Our fair value estimate is based on Zayo being a stand-alone company, but we think it would have additional value to a strategic buyer, as our bearishness relates, in large part, to our view that too much undifferentiated fiber capacity is held be too many firms. Consolidation would make the industry more attractive. We have our doubts about some of the firms rumored to be interested, and we don't see significant value to financial buyers, but we could see how they would be enticed by the steady cash flows, low maintenance, and long-term contracts associated with dark fiber.

In Zayo's press release, it reiterated its previously announced plan to separate into two publicly traded companies but said it is evaluating multiple options to achieve the core tenets of that plan. However, on the subsequent conference call, management seemed to indicate that splitting into two companies is no longer being considered, and the firm is looking to address those tenets in other ways. We did not hear clear rationale behind the decision, but management alluded to tax ramifications, a lack of prompt clarity from the IRS, and customer and investor preferences for a unified company. Management then disclosed that it would reorganize its operating segments and would now have a network segment, a zColo cloud segment (colocation and cloud services), and Allstream. We don't think the communication of these decisions was handled optimally, but we have no basis to be suspicious or think it will hurt the company.