When looking at individual stock issues, one of the many common themes of value investing is that the uglier a business appears on the surface, the more truly beautiful it is due to the huge discount it is selling at.
One company which appears to fall into this category is Fairpoint Communications (FRP, Financial).
The backstory of the company is as follows:
In 2007 Verizon Communications (VZ) announced plans to sell its landline operations in Maine, New Hampshire, and Vermont to FairPoint for $2.7 billion. Of that amount, $1.7 billion would go to Verizon Communications in cash and debt and approximately $1.015 billion would go to Verizon shareholders in FairPoint common stock.
Once approved by the regulators, Fairpoint became the eighth largest telephone company in the U.S.
The narrative that followed is typically of a small company expanding by taking an excessive debt load and excessive operational responsibilities. Upon the takeover, it was clear that the increase in subscriber base was more than Fairpoint management could handle. Among the many operational problems that plagued the New England subscribers of FairPoint's services, included:
- recurring billing errors
- very poor customer service
- lack of (and delay of) an electronic bill-pay option
- slow or intermittent services
Things got so bad that in August 2009, the State of Vermont comtemplated revoking FairPoint's right to provide services in that state.
Poor operational performance seems to be a result of a capital structure that was simply unsustainable.
On May 5, 2009 FairPoint indicated as such. On Oct. 26, 2009, FairPoint Communications filed for Chapter 11 bankruptcy protection.
The company emerged from bankruptcy in January 2011 with new management and IPO'd at $25 per share. Since that time there appeared to be a major sell-off reaching a low of $9 on May 18, 2011.
The main catalysts for the drop in share price were the following:
- On March 22, 2011, FairPoint Communications Inc. announced that in connection with the preparation of the consolidated financial statements of 2010, its management has discovered accounting errors that impact the accuracy of FairPoint Communications’ previously issued unaudited 2010 interim consolidated financial statements.
- On their first quarterly call on May 17, 2011, CEO Paul Sunu focused on discussing operational improvements to the business from the standpoint of capital infrastructure as well as improving the overall customer experience.
Behind the scenes a few of the major shareholders who received shares in the re-organization, one of them being Marathon Asset Management, seemed to be rushing to exit. As of now they have completed sold out of their positions.
Interestingly, as of May 19, two of the largest current shareholders are distressed debt experts Angelo, Gordon & Co. L.P. (19.5%) and Paulson & Company Inc (8.8%). Both firms are widely regarded as "smart money."
From a valuation standpoint Fairpoint has a top-line revenue of $1-1.2 billion per annum and EBITDA of $150-190 million.
Applying the assumption that Fairpoint can ultimately improve its EBITDA margin to 20%, that puts it at approximately $200 million.
If you were to apply a conservative valuation of 4x EBITDA, that would put the value of the business at approximately $800 million, representing a share value of about $30.
I'm long Fairpoint stock.
