Maglan Capital increased in value by 20.84% (net of all fees) during the month of February.
Our portfolio exhibited exceptional strength in February. All of our long positions gained along with the broader market. However, the standout performer in the portfolio was the fund’s largest position, FairPoint Communications (FRP),1 which reached an agreement with its striking unionized workforce on February 19.
FairPoint has been a Maglan investment since the fund’s inception in January 2011, when FairPoint exited Chapter 11 bankruptcy. FairPoint became a core position for the fund in early 2012 (when the stock traded below $5/share; currently at $17.50; price-target $30+).
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Maglan’s investment in FairPoint, and FairPoint’s stock-price appreciation, is far from over. In reaction to the union agreement, a representative for the International Brotherhood of Electrical Workers (“IBEW”) said:
“Do I believe that the company is ripe for acquisition? I do…And I think this agreement makes it even more appealing.”
In connection with any M&A activity or independently, FairPoint is simply the most undervalued traditional telecom service provider; larger peers include CenturyLink (CTL), Frontier (FTR), and Windstream (WIN). Furthermore, its size and existing tax-reducing net-operating-losses (“NOLs”) make FairPoint a likely acquisition target. FairPoint is currently valued at 4.8x 2105E EBITDA. Each multiple-turn in valuation is worth nearly $10/share. Because of its soon-to-close REIT transaction, Windstream (the most likely acquiror in our opinion) could afford to pay a HIGHER rather than a lower multiple versus Frontier’s purchase price for the Verizon assets they’re expected to acquire (discussed below). At 7x EBITDA, FairPoint is worth approximately $40/share- more than double current levels.
In addition to its discounted valuation multiple, FairPoint has numerous valuable features, including, 1. FairPoint has more than $200 million in gross federal NOL carry forwards.
2. FairPoint debt carries an 8.75% interest-rate. After the reduction of long-term liabilities from the labor agreement, the debt could be refinanced at a much lower rate.
3. FairPoint stock has the most to gain among peers on a per-share basis from placing the company’s real-property assets into a REIT structure (e.g. Windstream’s current transaction).
4. FairPoint is the ONLY major telecom carrier organically growing its revenue, through additions of data customers and increasing market-share (from competitor telecom providers and cable companies).
5. Currently, FairPoint does not offer video service/triple-play package, although its network could support such an offering. The company’s revenue and profitability would increase if a video service was offered.
6. FairPoint has an exclusive, ubiquitous footprint in Northern New England (Maine, New Hampshire and Vermont). Currently, no other large telecommunications company operates in those states.
7. In contrast to every other major telecom company, FairPoint doesn’t offer its shareholders a dividend, effectively alienating much of the traditional universe of telecom equity investors.
Moreover, FairPoint’s recently agreed-to collective bargaining agreement (“CBA”) will be a boon for the company’s margins.
Maglan – FairPoint’s New Labor Agreement
On February 19, after operating for over 6 months without a CBA and after 131 days of a strike by union workers, FairPoint and its unions reached agreement. The agreement covers 1,700 employees; over 60% of FairPoint’s total workforce. The agreement follows more than a month of federally mediated negotiations. The agreement was quickly and overwhelmingly ratified by the union members, and the union members returned to work on February 25.
The consensual resolution of the strike came in the wake of a late December ruling from the regional National Labor Relations Board (“NLRB”) that rejected all of the unions’ challenges to FairPoint’s implementation of its final contract proposal that it had presented to the unions in August.
The scope of FairPoint’s labor agreement adjustments includes:
1. a health-care plan that requires employee contribution and limits the company’s contributions and administrative costs;
2. foreclosing the company’s defined benefit plan to new employees and reducing accrual for current employees by 50%;
3. wage-rate increases have been reduced, and don’t offer a cost-of-living adjustment; and
4. authorization for the company to utilize outside contractors and to eliminate jobs under a wider set of circumstances than previously permitted.
On an immediate basis, the company reduced its pension- and benefits-related long-term liabilities by over $650 million (from $950 million ($1.8 billion total previous long-term liabilities, inclusive of secured debt)). Notably, the adjustments simply bring FairPoint in-line with the wage and benefit plans offered by its peers; FairPoint has not altered its benefits in 6 years. The adjustments will reduce FairPoint’s operating costs and balance-sheet liability.
Maglan – Frontier-Verizon: Telecom M&A
In early February, Verizon announced the sale of $10.5B of landline telecommunication assets to Frontier Communications, valuing the assets at ~6.5x adjusted EBITDA. FairPoint is the biggest winner from the Frontier-Verizon transaction.2 Other than FairPoint’s organic growth, the only growth in the traditional wireline industry is from consolidation. FairPoint is the 6th largest traditional telecom provider in the US, with many valuable features that would benefit an acquiror, as highlighted above. Now, after reaching a sweeping agreement on its labor-related costs, FairPoint is in an ideal position to be acquired.
FairPoint – A Maglan Paradigm
Maglan’s investment in FairPoint Communications is paradigmatic of the fund’s core positions.
Maglan manages a concentrated portfolio of catalyst-driven investments in deeply-undervalued securities of companies undergoing bankruptcy, restructuring or operational turnaround. To most generously exploit our background and skills, we primarily focus on small- and medium-cap companies; investments that cannot be the focus of our larger peers.
If after a considerable initial investment period (e.g. 1 year), we determine that an investment has the elements necessary to deliver a 3-4x return over 3-4 years, we will focus additional capital (10%+) and resources, and transform the investment into a core position. Typically, a core position can include activism and an investment thesis that assumes a substantial growth plan (revenue, expense reduction and multiple appreciation).
We were initially drawn to the senior-secured debt of the company while it was operating in Chapter 11 bankruptcy, as a fulcrum security, with an eye toward converting the debt into equity through the company’s restructuring. The company was valued at a deep discount to peers and it was cutting its over-levered balance-sheet, which was assembled at a time before rampant supplanting of land-lines by cell phones, and before high-speed data was widely available in Northern New England (Vermont, New Hampshire and Maine). The temporary industry disruption is a hallmark of our investments- over-levered companies have greater difficulty adapting to a shifting landscape than the balance of the sector; however, once leverage is removed, the subject company should replicate the changes of the other industry participants.
The company’s expenses (labor and CapEx) were far out of sync with industry averages and were meaningfully dropping organically. In addition, revenue decline was slowing sequentially and management publicly targeted an inflection point in 2013. Lastly, the company owned some readily separable, non-core assets in the Telecom Group (collection of local networks throughout the Midwest) that could be sold at an industry-average multiple (e.g. 6x EBITDA), which would reflect well on the balance of the company’s assets.
To the market generally, the company was perceived through the lens of a secularly declining industry (i.e. traditional wireline telecom). Also, FairPoint was completing a trip through bankruptcy and its equity market-cap was too small to be relevant to most large, sophisticated investors. There was, and there still is, no big-bank analyst coverage, and at times there was an eye-popping short-interest level in the stock. And, in case that wasn’t enough, the company’s balance sheet was further weighed down by GAAP-calculated retiree-related obligations, which boggled many investors and which we understood well and knew would eventually be renegotiated.
We’re accustomed to being contrarian in thought and positioning.
Once the company’s progress and results had demonstrated that FairPoint’s increasing EBITDA and cash-flow could outpace the rise in share-price from multiple expansion alone, and could produce a 4-5x return over 4-5 years, we increased the fund’s exposure to the investment (Maglan currently controls ~7% of FairPoint’s total equity; the company’s 3rd largest investor). FairPoint presented a two-pronged profitability driver – namely, a reducible cost-structure combined with revenue growth. Moreover, FairPoint’s market value was, and still is, substantially discounted to its peers. And, lastly, we expect that certain identifiable events that will occur over to the near- and medium-term will boost FairPoint’s market value. In sum, the concurrent, dual-channeled rise in profitability, coupled with value-unlocking events in an investment that is deeply undervalued to peers, would lead to an exponential return.
Moreover, we identified and highlighted certain shareholder-friendly activities that were not germane to FairPoint and that industry peers afforded their shareholders. We were confident to express our opinions to the company’s Board and management- including, publicly airing our thoughts with “activist” machinations,3 which aided the share-price to gain from $7 to $13, even while the EBITDA-multiple “stood still” (at ~4.5x).
It’s worthwhile pausing and highlighting that all the expectations regarding revenue, CapEx, labor headcount and costs, margins, market share, and non-core assets, are simply in-line with the industry and with peers. When gauging the value and possible success of our investments, we do not project extraordinary success and we do not expect management to do anything beyond being on par with their peers. On that basis alone, we calculate our upside and make our investment decisions. However, there is always the possibility that the business, management or the sector will outperform and the investment will be valued higher than we project. In that case, many of our investments have the added option to rise exponentially.
Going forward, we are focused on FairPoint’s operational growth and efficiency, leading to continued growth in EBITDA and cash-flow, while the company continues to support its case for an industry-average valuation multiple. The company is focused on the proper sources for growth- small- and medium-sized businesses versus residential customers (focus on larger, stickier, recurring revenue); as a provider of critical infrastructure (hospitals, universities, municipal organizations); and as a data center owner and provider of disaster data recovery services.
In the coming months, the company will generate multiple catalysts that will drive the valuation and stock-price higher. There is a lot of upside to be captured in our FairPoint investment- ~100%+ in a short period of time.
Fourth-quarter and year-end earnings for many of our portfolio investments will be reported in upcoming weeks. As with FairPoint, we have been excited for some time for the anticipated catalysts to occur in connection with a few core positions (e.g. Madalena Energy, Globalstar, MGM Studios). We expect that our recent momentum will continue, and that 2015 is going to be a big year for Maglan’s investments and for our investors.
Maglan Capital is an event-driven investment fund with a core focus on all parts of the distressed cycle, investing in liquid instruments across the capital structure of companies approaching or experiencing financial distress, bankruptcy or restructuring.
We appreciate your support and confidence in our team.
Steven Azarbad, Chief Investment Officer
David D. Tawil, President