Summary
- GTT will generate over $200m in free cash flow in FY20, putting the company at over a 22% FCF yield at today’s prices.
- GTT has significant headroom to cover its interest payments, with approximately $540m in FY20 EBITDA vs. a cash interest expense of $175m.
- Salesforce additions in 2H FY19 will result in a return to organic growth, which should be a catalyst to the stock.
- Recent M&A transactions indicate GTT is worth $52/share if it was put for sale, 225% upside from today’s levels. By FY21, we expect GTT to be worth between $75 and $100/share vs. ~$15/share today.
- We believe management might put the business up for sale soon, given a large shareholder is now on the board and the recent stock drop. We believe the stock would likely double just on the announcement that GTT is exploring strategic alternatives.
Introduction:
Following the recent Wolfpack short report, we completed our own analysis to analyze the contentions raised, spoke with management and other industry sources, and want to post our own conclusions. The report can be found here. The report centered on a lack of free cash flow and recent weak organic growth. Our analysis shows the FCF conclusions and organic growth declines stated in the report are significantly overstated, as well as misleading. Wolfpack uses unadjusted numbers instead of run rate adjusted numbers, including recent acquisitions, to skew the math. When you do a very large acquisition, there are many real one-time costs which should be factored into your financials because they are non-operational and temporary in nature. Short reports are often written to present a one-sided argument, omitting relevant facts that would otherwise discredit your thesis. We believe this was the case here. While some of the analysis in the report is technical correct, a reader must understand the specific context in which it is presented and, equally important, understand what important information the authors omit to fit their narrative. In our report, we try to address the most material mischaracterizations and omissions; please do not view this as exhaustive of our disagreements with the recent short report.
Free Cash Flow Analysis:
We believe the short report did not accurately portray GTT Communications' (NYSE:GTT) free cash flow. The FCF analysis in the report used GAAP numbers, with all the temporary non-operational charges and presented the numbers in a way to imply that these charges will remain constant in the future and did not account for temporary swings in working capital. Given that these non-operational charges are winding down (which we highlight later in the report) and swings in working capital will reverse, we would like to present our view of GTT's FCF. Our math is simple. In 2019, GTT should generate about $500 million in adjusted EBITDA, pay $175 million in cash interest expense, approximately $5 million in taxes, $115 million in capex, and have a $25 million negative swing in working capital. All in, this leads us to $180 million in free cash flow. On the most recent share price, this is a 22% FCF yield on the equity. In FY20, margins should increase as they get the full synergies from the recent acquisitions. Assuming no acquisitions and ~2% organic growth, we get to $1.850 billion in FY20 sales. At a 29% EBITDA margin, that yields $536 million in adjusted EBITDA and $220 million of FCF in FY20, putting the shares at a forward FCF yield of ~25%. This is a recurring revenue business, with no debt maturities until 2024 and interest coverage of 3x; hardly a business that is under stress.
