Cbeyond Fourth Quarter in Line With Estimates as Churn Remains Elevated

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Cbeyond’s fourth quarter 2013 revenue and EBITDA were in line with the consensus expectations. With the company’s emphasis on high-bandwidth facilities-based offerings, the carrier continues to experience competitive pressure at the low end of the market from multi-system operators (MSOs) and telecom service providers.

This pressure resulted in continued elevated churn and a 6% annual decline in EBITDA. Customer retention has remained especially challenging for mobile services. While cloud services growth remains positive at 28%, it was offset by an 8.2% decline in the carrier’s traditional network services. Although Cbeyond was able to produce an annual increase in average revenue per user (ARPU), we believe that competitive pricing pressure will remain a factor in the market as 2.0 product revenue continues to represent less than 20% of total sales.

This high mix of price-sensitive traditional customers will keep churn elevated in the near term, in our view. Although early indications of its success with 2.0 services are positive for Cbeyond, we believe the pressures faced in 2013 will persist in 2014. Accordingly, we prefer to remain on the sidelines and maintain our Market Perform rating on shares until Cbeyond can prove it can be successful with its transition and deteriorating operating metrics reverse the trend on fundamentals.

Revenue of $111.5 million was in line with our estimate of $110.9 million and the consensus of $111.1 million on an annual decline of 6.2%. Network, voice, and data revenue declined 8.2% annually, to $103.2 million, as the company refocuses efforts on 2.0 products, which encompass managed hosting and cloud revenue and a portion of network, voice, and data revenue where customers purchase network access. Revenue from managed hosting and cloud grew 28.3% annually, to $8.4 million. In the quarter, 18.4% of revenue came from the company’s 2.0 products, versus 15.7% in the previous quarter.

Adjusted EBITDA of $17.7 million, an annual decrease of 6.0%, were slightly above our estimate of $17.1 million and consensus of $16.9 million. The adjusted EBITDA margin was flat sequentially at 15.9%. During the quarter, Cbeyond lost 1,723 net customers as gross additions declined to 1,107, from 1,377 last quarter, and churn was 1.7%. ARPU increased 0.8%, to $658, from $653 last quarter.

Revenue is expected to be in a range of $410 million to $430 million, versus consensus expectations for $425 million. Adjusted EBITDA are expected to be in a range of $50 million to $65 million, versus the consensus estimate of $68 million. Cash capital expenditures are expected to be in a range of $45 million to $50 million, and free cash flow is expected to be in a range of $5 million to $15 million.

Based on management’s commentary, company guidance, and quarterly results, we are revising our estimates. For 2014, we estimate revenue of $424.0 million, versus our previous estimate of $431.7 million, and adjusted EBITDA of $58.2 million, versus our previous estimate of $73.8 million. For 2015, we estimate revenue of $410.1 million and adjusted EBITDA of $60.6 million.

Shares of Cbeyond trade at 3.3 times our 2014 EBITDA estimate. We believe that shares are appropriately valued given the near-term risks associated with the strategic shift. Accordingly, we rate shares Market Perform.

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