Two items in the past several days have come up questioning the viability of Zayo's acquisition strategy. Following the agreement to purchase AFS on the heels of the AGL deal, they certainly must be considered as a very aggressive purchaser of such assets right now. After some 15 acquisitions over the past three years, though, we already knew that much eh? Over at On Rad's Radar, Peter Radizeski asks:
"Zayo as a group does about $59M in revenue per quarter which is about $240M per year from $400M in invested capital. At 10% growth, how do you even pay back the note?"
And in an anonymous comment on this site yesterday:
"there seems to be very fair question here as to whether zayo is simply raising 15-20% (or whatever) capital to buy 10% returns."
In other words, is Zayo paying too much for metro fiber?
I think it all depends on how one sees the economics of this business developing over the next decade. Dan Caruso and Zayo and their backers believe that such assets are fundamentally undervalued right now. How can this be at 9-10xEBITDA? EBITDA helps measure the current state of the business, but it doesn't tell us the future. Simply put, they think that they can grow EBITDA and cash flow at a faster rate than others think is likely, whether because the whole sector accelerates or because they start taking a bigger share of the pie, or more likely both.
Can they do it? Hey, they are taking the chances and will bear the risks and reap the rewards. What I will say is that for all the 'obviousness' I tend to ascribe to the value of metro fiber on this blog, there are actually only a handful of executives in this business who have demonstrated that they know how to really operate such assets profitably, plus another handful who think they have it and are actively trying to prove it. Even amongst that select group, there are substantial differences about how the economics work a few years out on things like wireless backhaul. It's not for the faint of heart.
Private equity groups sense something is there, and there are a bunch that want a piece of the action. But this isn't the datacenter business, which is a business model that is fairly easy for outsiders to understand at a basic level - you buy land, build a big facility with familiar internal structure, then sell the space by the rack and cage, rinse & repeat. In the metro fiber business, the geographical variations both between and within markets, the much wider range of customers and customer behavior, and the rapidly changing mix of traffic being carried are all things that don't lend themselves nearly as well to financial analysis. I think much of that private equity money has thus far been unsure what to pay.
So is Zayo a roll-up that will inevitably implode due to paying too much for assets that will never develop the way they think they will? Or are they a visionary company that sees the future of a valuable asset more clearly than the spreadsheet jockeys? Bluntly, Zayo will have to prove it on the ground over time and actually do more with those assets than their previous owners would have. They do seem to understand that quite well, and amongst other things they are making pretty big bets on the wireless backhaul space and are taking greater advantage of stimulus money than most. The designation 'just a roll-up' is one that gets applied to a company that fails to differentiate its own performance from the assets' previous owners, and I'd rather give these guys some time to prove otherwise before I make a judgment. It's much, much too early yet.
I do think that others will be winning auctions for metro fiber assets this year, and will be paying similar multiples to what Zayo is paying. There is a groundswell of new private equity money looking for a home that will find a way in eventually. Zayo isn't the only one that sees what they see, they are just more confident about it right now.
What do you think? Are metro fiber valuations at a local maximum or are we just getting started?
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