Fiber Valuations: Riding the Tide

April 8th, 2009 by · 2 Comments

In response to my post Fiber Valuations – April 2009, a reader who goes by the moniker Homer made an interesting comment:

you might want to add an extra column with a measure of “% increase in value of common stock per unit increase in EV/EBITDA multiple”… this delta measure would tell your readers which stocks would benefit the most from a recovery of valuation multiples towards historical “normals”… equity investors would see where they would get the most leverage in such a recovery

Homer’s point is that the rise and fall of the market’s valuations of fiber-based telecoms does not translate into parallel stock price movements for these companies.  Let’s just suppose for a moment that the tide is coming in, i.e. that the market’s valuation of telecom will improve and EV/EBITDA multiples head back toward 8-10.  One can always argue about whose assets are better positioned, but what if we just want to ride the tide – which boat rises fastest? The answer, it turns out, isn’t hard to calculate.  First, with valuations so low we can for now neglect convertible bonds, as they are all well out of the money.  Second, we will just use debt at par value rather than guess its progression.  For example, here is one way to look at it that is based on a spreadsheet Homer was kind enough to pass along:

What’s XO Holdings (news, filings) doing on top of that list?  Aren’t they still worth a couple of dimes a share?  Well, leverage works both ways.  XO’s common stock got annihilated when the company’s total valuation fell well beneath the liquidation value of its high levels of preferred stock and debt.  Related stories are behind the collapses in the common stock of Level 3 Communications (NYSE:LVLT, news, filings), PAETEC (news, filings), and glbc.  But if the tide comes back in, then what goes down must come back up.  Others like TW Telecom (NASDAQ:TWTC, news, filings) and ftgx which do not have such high leverage have seen less dramatic effects from the downturn on their stock price and would see less from a general recovery. So if one were to attempt to take advantage of a restoration in the market’s valuation of fiber, some boats are better than others.  Of course, to buy the idea that XO is the place to be in a recovery, one has to be willing to play in Icahn’s private sandbox, but that is another matter entirely.  Also, it isn’t at all clear when or if the market will recognize the economic value of fiber any time soon, i.e. it is hard to ride a tide that isn’t guaranteed to come in.  It could be the waves that matter most, when the boats to be in would be the most seaworthy ones.

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