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
