Consolidated Communications ($CNSL)

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Consolidated Communications ($CNSL): Undervalued from High Debt and Long Term Turnaround Plan

Consolidated communications inc. ($CNSL) is currently a copper-based telecommunications company that has operations in various states. This is a company that I have personally been invested in for a while and I believe that its inflection point is just around the corner. I think we can watch me get shanked the day before earnings (I have a solid history with that) so you guys can see my thought process before earnings comes out tomorrow before my portfolio gets taken out back and shot (good thing it’s a long term bet). The thesis with Consolidated Communications is that they are going to be running away from their low margin and declining telecommunications business into a strong fiber business across the country, with a concentration in the northeast. See the image below for where CNSL operates across the country.

States of Operation from CNSL website

Fiber is the direction for the future as the need for faster and strong connection across modern society increases. To understand this, we need to understand why fiber is better than copper wiring.

·         Fiber is faster than copper wire as Fiber uses photons traveling at the speed of light, whereas copper uses electrons that travel as an electric pulse. This allows a faster speed for data to travel while also offering a higher bandwidth and lower latency (faster connection speed).

·         Copper data also degrades over a distance (with a distance of 100m it experiences 94% loss of signal) whereas fiber degrades much less (with a distance of 100m it experiences a 3% loss of signal).

·         Fiber is more durable, lighter, and smaller which allows for lower maintenance costs.

As you can see, Fiber beats copper in just about every single category that is important when it comes to connection and data transmission. This is the cause for CNSL to be switching over to fiber, due to its consideration as “future proof”. Stimulus from the government to build out infrastructure including broadband is leading to over $170m in funding opportunities for them.

Monopolies, Duopolies, and a complete lack of competition

$CNSL basically operates in a monopoly or duopoly in just about every market that they operate in. 11% of CNSL’s footprint is monopolistic with zero competitors. Another 83% of CNSL’s footprint is a duopoly with just a single competitor. The remaining 6% is an “oligopoly” with two competitors. Thus 94% of its markets are either in a monopoly or duopoly. This control allows them to have stronger pricing advantages which leads to greater future margin expansion (most fiber companies have EBITDA margins around 50%). Having an already established base allows them to keep controlling this competitive standpoint. Additionally, their existing infrastructure and aerial fiber in New England allows them to rapidly build out fiber and replace current lines in those areas.

For perspective, aerial fiber build out is much cheaper than in ground fiber build out and already having this infrastructure allows for extremely rapid and cheap fiber infrastructure when compared to underground (roughly 44% cheaper compared to underground). Approximately 80% of New England infrastructure is aerial and they plan on having over 1 million passings in New England. The other positive aspect with this infrastructure is that they really don’t have to worry about fiber overbuilds from other companies, allowing them to expand safely with no worries of over supplying the market with competition. The chart below illustrates the advantage their current infrastructure and market position provides them in fiber expansion:.

Projected Fiber Passings, from CNSL website

Their current plan shows a roughly 100% increase in fiber passings to be built in the next 3 years, which would bring their total network to be roughly 70% fiber compared to their current 37%. This will continue to increase their revenue per user by 20% and this number will most likely grow.

2022 Guidance from CNSL website

CNSL is having to front run a lot of their capital expenditure which is causing a huge hit to the balance sheet in the coming years, though the structure is interesting. They have roughly 2.4B in debt with only $250m coming due before 2027 (revolver in 2025). The rest matures in 2027 ($1b at 4.25%) and 2028 ($1.15b at 6% and 5%). These are great terms and taking advantage of low rates in 2021 really helped push this forward. They are also divesting assets to continue paying for the capital expenditure that is needed.

Recent Asset Divestitures from CNSL website

I am sure we will continue to see nonessential assets sold off (they have announced $600m as of February 2023), although I think we are near the end of the assets that are going to be able to be divested. So, from this point on it will be about acquiring customers and growing out the business until the company can start increasing revenue from its customers.

Addressing Revenue Declines

Revenue decline is being seen in Voice Services (decline of roughly 12% over the past 3 years) and Video Services (roughly 30% decline over 3 years). Obviously, this is not ideal, but this makes sense as the company begins to focus on the fiber build out and the inevitable demand of wireless services. They still have strong revenue in their wireless partnerships which are growing at a small hit and will most likely ensure they a strong and continuous income over the coming decade (roughly $40m growing at 2% a year).

Insiders

I usually don’t comment on insider buying unless there is something exceptional going on (which is usually a good thing), and that’s what I believe we are seeing here. The CEO owns roughly 1% of the company, at ~$4.5 million and their CFO owns roughly .5% of the company at ~$2.2 million. Insiders have bought a net of roughly $4 million worth of shares in the past year (roughly .8% of market cap). This is exactly what you want to see from a company like this when their price keeps plummeting, and it shows that they are extremely committed to this fiber buildout and the implementation of it. Searchlight owns more than 10% of the company and this gives me a lot of confidence in the business as Searchlight has a history in this area and the fact, they own a large portion increases my confidence in the business. It does offer a risk though that they could take this company private (this would be a very poor choice on their part in my opinion and since they haven’t done it already, I see it as unlikely).

Valuation

CNSL is swimming in debt at a MC of $450m and an EV of ~$2.5b (which will most likely increase as cash is burnt through). This much debt isn’t always a bad thing when a company is extremely undervalued like with $CNSL. When these situations occur, the market tends to significantly undervalue the company, especially if debt hasn’t begun to get paid back yet. Unlike other growth opportunities that show no end in sight to debt increases, I believe CNSL has a very solid plan in place to address their debt situation (they have overdelivered on every step thus far). Their capex should be way down at the end of 2025 as they close in on their goal (they have hit almost every single benchmark earlier than expected). They will most likely be operating with EBITDA in the range of $600M-$800M with much lower maintenance capex as fiber is much cheaper to maintain. This gives them plenty of cash flow to pay off their debt over the coming years and improve their balance sheet. If all goes well, then we are looking at an EV of probably around $1.5B in 3 years with an EBITDA in the conservative $600M range. Based off of these figures, that would indicate that CNSL is currently trading at 3x this forward looking enterprise value.

Using this, CNSL should probably be trading at roughly 100% higher than they are currently valued based on the risks that they don’t hit their goals or keep putting on more debt (it seems that since 2021 they have lost their appetite for share dilution which lines up with management buying their stock hand over fist). If all things go well, they should be trading at roughly 4x-5x their current valuation in 3-4 years, since most of the perceived risk reduced as debt gets paid down significantly. This gives an estimated valuation now of $8/s and in 3 years a valuation of more than $16/s-$20/s.

Disclaimer: The author of this idea has a position in this security at the time of posting and may trade in and out of this position without informing the reader.

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