Unitek Global Services, listed on the Nasdaq, is a contractor with two business lines: (1) it installs and maintains home satellite and cable connections on behalf of DirecTV and Comcast (the “fulfillment” segment); and (2) it performs network engineering, design, construction and project management for the wireless and cable broadband industry (the “E&C” segment).
The fulfillment segment is Unitek’s bread and butter. It earns its revenues under long-term, fixed-fee master service agreements and therefore enjoys high revenue and gross profit visibility and those modest competitive advantages that accrue to regional scale. Small, independent contractors are losing business (and/or selling themselves) to larger regional players like Unitek and MasTec. Fulfillment’s revenue growth, therefore, has mostly come from acquired and organic market share gains. The benefits from DirecTV’s own market share gains and the benefits from increased subscription churn have been lesser tailwinds.
The E&C segment, on the other hand, is Unitek’s growth business: increasing demand for broadband wireless has meant increasing infrastructure capex by the major wireless service providers, and Unitek’s E&C segment has benefitted from its association with AT&T in particular. These are trends and relationships that will more likely than not continue over the medium term although, in competing with the likes of General Dynamics, Bechtel, Quanta, and Dycom, its gross margins in this segment will necessarily remain modest.
Regional scale economies and some modest customer stickiness ought to translate into a reasonably profitable business earning low-to-mid teen returns on capital and, after shedding itself of unprofitable geographies where it had no scale Unitek’s underlying performance conforms to those expectations:
Unitek's footprint, by segment
The strategic use of the word “underlying”, however, and the fact that Unitek’s market cap is $30 million, lets us know that there is more to this story.
First, and least interesting, is that with amortizations of debt discounts and acquired (non-operating) intangibles, noncash impairments, transaction costs, and all the rest of it, the difference between GAAP earnings and underlying earnings is comically substantial:
Second, in taking on a substantial amount of debt to fund its acquisitions, Unitek was inviting a near-fatal accident. And, when it acquired Pinnacle Wireless in 2011, that invitation was accepted: a year and a half later, an investigation by the Board’s audit committee discovered fraudulent revenue recognition practices at Pinnacle; the CFO, Controller, and division president were terminated; and the company was unable to file its 10-K and, later, its 10-Q’s, on time. It received a notice of suspension from Nasdaq, of course, but more important for our purposes, its inability to file financial statements triggered a default under the terms of its borrowings.
At this point, its lenders could have taken it to Ch. 11, wiped out the equity and brought it back under their ownership. (Between December and April, the share price fell by a quarter and holders of the common fingered their worry beads; between April and June, the market cap was cut in half as even the devout fled).
That the lenders (and Cerberus, especially) did not do so ironically reflects the value of the business. (I think we can all agree that a business that generates $25 million of free cash flows to equity is worth more than $30 or $60 or even $90 million). In a Ch. 11 process, transaction prices would have been high, the administrative fees as extravagant as usual, and the implied returns to the acquirer therefore low. And besides, DirecTV had served Unitek with a 180 day notice of termination which meant that time was tight.
The lenders’ alternative option – one that promised higher returns – was to add penalties (warrants for 20% of the equity, please!) and higher interest charges on the debt. And that, in the end, was the outcome.
So, Unitek’s future, under highly conservative growth and margin assumptions, looks something like this:
Apply a conservative multiple to 2016 earnings, discount back to the present, subtract the inevitable cash costs related to the forensic audit, the refinancing, and any litigation costs that may arise from the alleged fraud at Pinnacle Wireless, and Unitek’s value is likely two, three or four times its current market cap, even with the 20% dilution. At the other extreme, as Unitek de-levers and grows, MasTec will be an imperfect, but good enough, comp and MasTec trades at 22x.
Disclosure: I am long Unitek Global Services