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TOP 10 POTENTIAL SURPRISES FOR 2019

Posted by Natalie Steinwand on January 2, 2019
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INSIGHT Our fifth annual list of “Top 10 Potential Surprises” for the New Year includes events that are (1) underappreciated by the investment community, (2) have at least some chance of occurring during 2019, and (3) would likely be associated with significant stock price ramifications. We hope you find it thoughtful, stimulating, and/or entertaining. Good luck in 2019! – The Cowen Comm Infra/Telco Team

What Will Surprise In 2019? In an effort to stimulate discussion and aid out-of-the-box thinking, we have scanned our large-, mid-, and small-cap coverage universe for potential surprises. In order to qualify for our list, a “surprise” must constitute an event that is less than 50% likely, not well discussed or anticipated by the market, and potentially material (associated with significant stock price implications). Our team has conjured up ten such events that fit this definition and rank ordered these events from #10 (most likely to occur) to #1 (least likely to occur). We do not necessarily advocate any investment strategy into these “surprises”, but rather hope that a more open debate of their possibility is of interest and potential utility to investors.

Cowen’s Top 10 Potential Surprises for 2019

10. AT&T loses the NFL Sunday Ticket and its accretive to EBITDA

9. Cable takes “Boost” prepaid and enters into an MVNO agreement with New T-Mobile

8. Digital Realty purchases Megaport

7. Verizon starts messaging that a buyback is likely in 2020

6. Verizon buys Zayo

5. Zayo sells its colocation business

4. Equinix buys CyrusOne

3. Interxion merges with CoreSite

2. Equinix buys Zayo

1. SBA senior mgmt. participate in one of our conferences All Are Discussed On The Pages That Follow

10. AT&T loses the NFL Sunday Ticket and it is accretive to EBITDA

The NFL Sunday Ticket has been a mainstay at DirecTV since 1994, however, with the seismic shifts in the OTT/media landscape, the exclusive longstanding carriage relationship could be coming to an end. DirecTV renewed the agreement in late 2014, inking an 8-year, $12B deal ($1.5B/year). The deal takes the carriage rights through the 2022 season, however the NFL has the right to reconsider following the current 2018/19 season, and allowed to renegotiate after the Super Bowl (February 3). With a shrinking satellite base, choppy NFL ratings, improved quality of live sports streaming (tested this season on Amazon Thursday Night Football), and premier content being bid up by deep-pocketed new entrants, we believe the NFL could rescind its current agreement as it looks for more “reach” and to tap a wider addressable market. The NFL Sunday Ticket is ideal as an all-digital streaming product and should not burden ISP networks given the agreement only allows for out-of-market games (i.e. lower/manageable volume). We believe Apple, Amazon, or ESPN Plus would be an ideal home. That said, losing the NFL Sunday Ticket may not be a bad thing for AT&T. While AT&T does not disclose specific subscriber or financial metrics, it’s been reported that AT&T does not make a profit on the deal in isolation, and instead makes up for it on subscription fees and other upsells (a typical model for sports packages). To that point, if we illustratively assume a $1.5B/year programming cost, a $366/season fee ($20 activation fee, $293 per season, $396 for “MAX” including RedZone), a $130/month DirecTV ARPU, and 20% service margin, then AT&T begins to lose EBITDA only if it permanently disconnects >2.2MM NFL Sunday Ticket subscribers. Anything less than ~2.2MM loss, and AT&T actually profits (because it sheds the $1.5B rights). For example, if 10% of DirecTV subscribers take NFL Sunday Ticket (~1.96MM subs), which we think is a good educated guess, and a sizable 50% of subs leave (~980K), then AT&T would still actually generate incremental EBITDA.

9. Cable takes “Boost” prepaid and enters into an MVNO agreement with New T-Mobile

Assuming the Sprint/T-Mobile deal gets approved, the DoJ could impose structural remedies as part of the transaction. While some suggest the DoJ/FCC may force a spectrum sale, another remedy that has been considered is a sale of the prepaid business as a combined Boost/Metro has outsized market concentration, especially in urban areas. New T-Mobile will likely keep the stronger of two prepaid businesses (Metro by T-Mobile), shedding Boost (~7.5MM subs) while Virgin (~1.5MM subs) may be included but harvested to extinction. Potential buyers include PE firms, TracFone, and other international players. However, we believe cable could be the best home as we continue to believe in the inevitable convergence of Cable and Wireless (see page 54 linked here) and a Boost purchase could turbocharge such a strategy for instant scale/distribution, tribal knowledge, and provide out-of-footprint opportunities. Sizing the deal, using back-of-the-envelope math, we assume $800 EV/sub on 8.5MM Boost subs for ~$6.8B. The rationale for Altice seems obvious in that they already have a partnership with Sprint and an urban/NYC presence with Optimum. Comcast may be hamstrung by debt driven by the Sky deal, recently rescinding its buyback to focus on de-leveraging as the equity markets have subsequently put the company in the penalty box. That said, Charter has the balance sheet, is at the tail end of integrating Time Warner/Bright House, and has a presence in 10 of the top 30 markets. In addition, we believe New T-Mobile would also be incented to do a deal specifically with cable considering it lacks adequate local wireline assets that will become increasingly important in a 5G world that is reliant on fiber fed small cells. As such, New T-Mobile could be incented to cut a very attractive MVNO relationship (better than what Comcast/Charter currently have with Verizon) in exchange for favorable pricing/access to the cable company’s wireline network.

8. Digital Realty purchases Megaport

As Cloud Service Providers (CSP’s) expand their service offerings, a primary focus is making said services available to as many enterprise customers as possible. Accordingly, an important factor in hyper -scale CSPs selecting a third -party data center provider is the breadth of interconnection it can provide. In the past few years, virtual interconnection providers such as Megaport have emerged to enable enterprise customers the ability to connect to multiple clouds without having to physically be in the same facility as the CSP interconnect node, as Megaport provides a physical connection between the locations that it sells in a cost effective on -demand way. We believe the solution set that Megaport provides will become increasingly valuable as virtual interconnection proliferates and enterprise customers move out of their own data centers where economies of scale will limit the ability of virtual interconnect providers like Megaport to offer their services. To this point, we believe there is strategic rationale to Digital Realty acquiring Megaport, given in part that it already has a 7.3% stake in the company. The relationship goes beyond this though with the two companies having co – developed software solutions together, including Digital Realty’s Service Exchange solution. An acquisition of Megaport by Digital Realty would arguably accelerate Megaport’s product development and Megaport’s go -to -market strategy at a time when establishing market share is critical. In addition, Digital would be able to further enhance its relationship with key hyper -scale CSPs as well as other third -party data center providers, which would be an offensive counter to Equinix’s expanding Cloud Exchange Fabric strategy. That said, an obstacle to a potential deal would be valuation considering Megaport trades at ~ 1 2 x 2019E EV/Sales, however considering the relatively small size of Megaport to Digital Realty and the importance of virtual interconnects as a key driver of future interconnection growth, we believe this acquisition could make long -term strategic sense, even if initially dilutive.

7. Verizon starts messaging that a buyback is likely in 2020

Considering the fervor of M&A within the cable and media sectors, Verizon has been rewarded with its narrowed -focus 5G/network and “do nothing” M&A strategy. To that end, Verizon shares admittedly lack a near -term growth catalyst as 5G, while compelling, will not move the revenue needle for a company as large as Verizon until 2020+. In the meantime, while the narrowed 5G focus is important and value – constructive, it can be done under the current ~$17B annual capex envelope. Thus, without transformative (and likely dilutive/distracting) M&A, and with a welcomed rational wireless market, we expect Verizon to de -lever at a fairly rapid clip (~0.3 turns per year). This is important as we think about Verizon’s long -standing promise to bondholders to “return to a pre -Vodafone credit profile” which we interpret as an upgrade to an A – rating and approaching ~2.0x net leverage (currently ~2.3x). By our model, the carrier has a clear path to 2.0x by mid -2019, and with a credit upgrade in store, the question will become what Verizon does next. At our recent IR meeting, Verizon noted it is “not in the business of hoarding cash”, and while we note there are plenty of M&A options whether it be fiber, cable, or media, IR made it very clear that it has heavily scrutinized all potential M&A and there are no ongoing discussions right now. All said, in 2019, we think Verizon can spin the “do nothing” M&A strategy to its advantage, especially if the broader market turns sour, by providing commentary that net leverage will be on a path below 2.0x in 2020E with measurable improvements thereafter. Subsequently, mgmt. could start to message that a buyback starting in 2020 is likely. Our model shows Verizon can purchase nearly ~$20B of stock per annum (~8% of its market cap) and remain at ~2.0x net leverage and in turn drive accelerated EPS and FCF/share growth.

6. Verizon buys Zayo

Verizon’s narrowed strategy is focused on wireless/5G where the company believes it is uniquely positioned given its deep fiber network, distributed nodal/C -RAN architecture, and mmWave spectrum portfolio, among other things. Over the past several years Verizon has strategically continued to build -out its own fiber network and while it has been relatively quiet around its specific 5G plans, it continues to aggressively lay fiber in the top 50 markets. In addition, Verizon also has a history of doing fiber M&A including XO Communications and WOW’s Chicago fiber assets, both of which it acquired in 2017. While one could argue it did XO more for the mmWave spectrum and WOW more because it was purpose built for wireless, at a high level it shows Verizon’s broad willingness to do fiber M&A. While Zayo would be a much larger deal (>$14B), it would still be a relatively small deal versus the overall size of Verizon and thus we believe it would be a fairly easy acquisition for the company to digest and Verizon investors would be unlikely to take significant issue. From a strategic perspective, we believe Zayo would be appealing to Verizon considering the important role fiber will play in a 5G world where all the wireless carriers will need to have a fiber strategy similar to Verizon. To this point, an acquisition of Zayo would be a tactical affront to New T – Mobile, that beyond the limited wireline assets it would pick up from Sprint, has essentially no fiber, as well as to AT&T, who outside its own LEC footprint also has limited local fiber assets. As a result, if Verizon were to take Zayo out of the market it would make it more difficult for the other wireless carriers to attain fiber quickly/efficiently as they increasingly shift their focus to 5G in the coming years, considering the lack of large scale independent fiber companies that now exist in the U.S. This consequently would also make Crown Castle of greater value in our view as it would leave them as the only large scale independent fiber company in the U.S. to which New T -Mobile and AT&T would be heavily reliant on.

5. Zayo sells its colocation business 

On November 7th, Zayo announced the intention to split into two publically traded companies including one focused on the core infrastructure business (“InfraCo”) with the split expected to occur in late 2019. However, we believe Zayo could look to further simply “InfraCo” this year by selling its zColo business, which is currently comprised of ~50 data centers and ~1MM billable square feet generating ~$236 MM of revenue and ~$112MM of EBITDA on a run -rate basis. While Zayo has had success bundling network with colocation, the zColo business has been underperforming the past few quarters including bookings below historical levels last quarter, although Zayo does expect improvement over the coming quarters as it has worked to rebuild the funnel following a change in zColo leadership last summer and as it works through some one -off churn events. While better execution within the zColo business is a high priority for the company, mgmt. has also acknowledged it is sub -scale and thus believes the company will need to add additional scale through M&A or potentially look to sell the business. This view makes sense to us considering the level of consolidation we expect to play out in the data center space over the coming years and thus the value these “mega” data center providers will be able to offer to their customers in the form of geographical scale, which in turn will put those without scale at an increasing disadvantage. In addition, considering the price to which data centers have been commanding in M&A transactions, and Zayo’s own stock price, it’s also important to realize that if Zayo elected to participate in meaningful data center M&A as a buyer, its own investors likely would not view such a transaction positively. Assuming Zayo could get a 12 -13x multiple for zColo, which we think is reasonable, implies it could sell the business for $1.5 -1. 6B, which it could then return to shareholders through additional stock buybacks.

4. Equinix buys CyrusOne

Equinix first referenced its desire to expand into hyper -scale in 2017 and later announced the creation of its Hyper -scale Infrastructure Team (HIT) in early 2018 to focus on structuring and planning Equinix’s expansion into hyper -scale. At its Analyst Day in June, mgmt. provided investors with the logic for expanding into hyper -scale, which stems from an awareness that the landscape of interconnection is shifting to one of enterprise -to -cloud, with the large hyper -scale deployments serving as magnets for enterprise customers. As such, Equinix has begun pursuing hyper -scale deployments as it looks to preserve its market leadership in interconnection, however in practice it is moving slower than initially anticipated. While we appreciate Equinix is primarily planning on entering the hyper -scale market via off -balance sheet purpose -built hyper – scale facilities, we believe acquiring CyrusOne would be an attractive alternative to organically building. CyrusOne’s current footprint and land bank already have significant scale that Equinix could use to build new interconnect ecosystems around and further expand the already established hyper -scale deployments within its facilities. In addition, CyrusOne is currently focused on expanding in Europe where Equinix is also focusing its hyper -scale efforts. Accordingly, a takeout would remove what is likely to become a significant competitor in the European market and would allow Equinix to piggyback off CyrusOne’s more dynamic approach to building/expanding. Furthermore, hyper -scale is growing faster than retail colo, thus an acquisition would augment Equinix’s growth profile, which despite the lower returns, investors would likely reward with a higher multiple as the blended company return would still be industry leading. Also, for Equinix purists, the company could segment the business so as not to conflate the two. Making a deal more difficult though is that Equinix would have to use equity to finance a deal and the BoD of both companies likely believe their stock is too cheap at current levels, thus Equinix would likely have to make an unsolicited offer and/or wait until its own valuation improve s.

3. Interxion merges with CoreSite

As the data center landscape continues to evolve, a greater focus is being placed on having a global platform by third -party data center providers as hyper -scalers and multi -national enterprises alike solve for their global IT infrastructure needs. Accordingly, in the last year we have seen CyrusOne enter Europe via Zenium and Digital Realty enter LatAm via Ascenty while Equinix added scale in Australia through its acquisition of Metronode. Among the third -party DC providers yet to expand beyond their legacy regions are Interxion and CoreSite, despite some well -known attempts including a merger of the two a few years ago. More recently, Interxion’s mgmt. has said that it appreciates the need to solve for global scale but has also pointed out that it has a long enough runway of demand in Europe, thus making international expansion less of a near term priority. However, more recently during our NAREIT meeting in November, mgmt. was clear in calling out the U.S. as a region to which expansion would be prudent. To that point, we believe a merger with CoreSite is the most likely way to solve for this as 1) CoreSite has a similar strategy including a focus on interconnect with a smaller focus on hyper -scale, 2) CoreSite’s largest shareholder Carlyle would likely go along with it as it would be able to roll its equity into the combined company, and 3) with CoreSite’s stock down 25% since September 1, a deal could be structured as a near merger of equals. To this last point, Interxion could offer a typical M&A premium, with CoreSite shareholders having a majority ownership. Pouring some cold water on the idea, during our NAREIT meeting, Interxion mgmt. did note that a U.S. expansion would likely come in the form of a smaller bolt -on acquisition rather than transformative M&A (i.e. CoreSite), although admittedly mgmt. messaging around future M&A has for obvious reasons never been exactly clear.

2. Equinix buys Zayo

The line between data centers and network is increasingly blurring as evident by the success of virtual interconnection providers like Megaport as well as Equinix’s investment to connect all of its data centers together through the Equinix Cloud Exchange Fabric. Equinix’s CEO Charles Myers also laid out key initiatives last year including expanding its go -to -market engine and continuing to make investments to help enable customers to implement their hybrid/multi -cloud architecture of choice. By acquiring Zayo, we believe Equinix would be able to establish a presence in other regional third party data centers where enterprise customers want to continue to reside, but also increasingly need access to the cloud providers that are present within facilities like those Equinix has. This in theory then would ensure Equinix’s current interconnect oriented facilities maintain their strategic value as the central location of the Internet and therefore Equinix’s pricing power. At the same time, Equinix’s business within its Americas region is maturing and an acquisition of Zayo’s InfraCo business, which we estimate can grow in the mid -to -high single digits, would add a new layer of growth while it would likely jettison the EnterpriseCo business similar to the strategy to which Zayo is already intending to execute. In addition, Equinix would also likely be able to better leverage Zayo’s zColo assets than Zayo itself can, given its scale advantage. Now let’s not fool ourselves. Such an acquisition would be unlikely to be well received by Equinix investors and would have a “guilty until proven innocent” perception to it. And that itself is probably why such a transaction never comes to fruition. However if the combined company can create a product set/strategy that takes advantage of their unique assets, and if the Zayo split (under Equinix’s ownership) occurs without incident, then over the long -term we believe such an acquisition could be value accretive.

1. SBA senior mgmt. participate in one of our conferences

During the eight years that we have covered SBA, senior mgmt. has never participated in one of our conference events including our TMT Conference in New York (which this year will be May 29 -30) and our Communications Infrastructure Summit in Boulder (which this year will be August 1 2 -13). That’s not to say they haven’t done anything with us as VP of Finance/IR Mark DeRussy has participated numerous times and senior mgmt. has always been happy to host us for HQ visits, but it’s just not the same as senior mgmt. attending our signature conferences. Especially in the evolving world of the sell -side, where let’s face it, corporate access is an ever growing component of the model. It’s been quite the ego bruiser for me personally as literally every other one of the 16 names under coverage have had members of senior mgmt. participate in one of our conferences at least once and that includes mega caps like AT&T. Is playing golf with us in Boulder not as fun as shooting clays with Ric in Park City? What if I promise to stop talking about small cells? Is it because you’re a Miami Dolphins fan and I’m a Buffalo Bills fan (which after 40 years of disappointment I could be persuaded to abandon if that’s it)? Joking aside, SBA is covered by 15 analysts and it’s unfair to think senior mgmt. can attend everyone’s events, and the company does a great job making itself accessible to investors, and if they aren’t able to fit us in then we will continue to respect that. I just think it would be fun (and informative) to go back and forth with CEO Jeff Stoops up on stage who many already know has an excellent dry wit personality that I think would match well with my own approach to fireside chats! Good luck to everyone in 2019!

January 2, 2019

How did we do with last year’s predictions? 10. The rural telco stocks all work: NO

9. T -Mobile makes a bid for U.S. Cellular: NO

8. CyrusOne makes a bid for QTS: NO

7. A new crop of infrastructure companies make their public debut: NO

6. Towers get included in the benchmark RMZ index: NO

5. American Tower or Crown Castle make a bid for SBA: NO

4. Amazon enters the wireless business: NO

3. Congress passes broadband legislation: NO

2. Zayo elects not to become a REIT: NO

1. Wall Street will come to Brooklyn: YES! …So we got 1 out of 10

 

 

 

 

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