IPO Report: ZAYO Group Holdings (ZAYO)

ZAYO Group Holdings ($ZAYO) provides fiber networks and datacenter facilities. It is headquartered in Boulder, CO.

Six other companies are scheduled for the week of Oct. 13, 2014. The full IPO calendar is available at IPOpremium.

The manager and co-managers are: Morgan Stanley, Barclays, and Goldman Sachs.

The joint managers are: RBC Capital Markets, Citi, SunTrust Robinson Humphrey, Cowen & Company, Oppenheimer & Co., Raymond James, Stephens Inc., Wells Fargo Securities, and William Blair.

ZAYO scheduled a $650 million IPO with a market capitalization of $5.3 billion at a price range midpoint of $22.50 for Friday, Oct. 17, 2014 on the NYSE. SEC filings

ZAYO Group Holdings IPO Report

Overview

ZAYO provides fiber networks and datacenter facilities.

As of June 30, 2014, ZAYO had more than $4.6 billion in revenue under contract with a weighted average remaining contract term of approximately 43 months.

On July 2, 2012, ZAYO acquired 100% of the outstanding capital stock of AboveNet, a public company listed on the New York Stock Exchange, for total consideration of approximately $2,210.0 million in cash, net of $141.6 million of cash acquired.

At the closing, each outstanding share of AboveNet common stock was converted into the right to receive $84 in cash.

Valuation

Glossary

Conclusion

Neutral minus

P/E -29; 62% by selling shareholders

Rev +12%, operating income -49%

Operating income % of rev only 5%

Loss rate on rev -16%

EBITDA 58% of rev

Per share dilution of -$26.42.  -$332mm accumulated deficit

Business

ZAYO provides fiber networks and datacenter facilities.

ZAYO is a large and fast growing provider of bandwidth infrastructure in the United States and Europe. ZAYO’s products and services enable mission-critical, high-bandwidth applications, such as cloud-based computing, video, mobile, social media, machine-to-machine connectivity, and other bandwidth-intensive applications.

Market growth

The growth of cloud-based computing, video, mobile and social media applications, machine-to-machine connectivity, and other bandwidth-intensive applications continues to drive rapidly increasing consumption of bandwidth on a global basis.

Cisco estimates that, from 2013 to 2018, mobile data traffic will grow at an annual rate of 61% and that IP traffic will grow at an annual rate of 21% through 2018.

Additionally, according to Gartner in its November 18, 2013 report, Forecast: The Internet of Things, Worldwide, 2013, “[t]he installed base of ‘things,’ excluding PCs, tablets and smartphones, will grow to 26 billion units in 2020, which is almost a 30-fold increase from 0.9 billion units in 2009.”

Consolidator

As a core tenet of its strategy for capitalizing on these industry trends, ZAYO has been a leading consolidator in the industry and have acquired 32 bandwidth infrastructure businesses and assets to date. ZAYO’s owned, secure, and redundant fiber network and datacenters serve as the foundation for its bandwidth solutions and allows it to offer customers both physical infrastructure and lit services.

Products

Key products include leased dark fiber, fiber to cellular towers and small cell sites, dedicated wavelength connections, Ethernet and IP connectivity and other high-bandwidth offerings.

ZAYO provides its services over a unique set of dense metro, regional, and long-haul fiber networks and through its interconnect-oriented datacenter facilities.

ZAYO’s fiber networks and datacenter facilities are critical components of the overall physical network architecture of the Internet and private networks.

Customers

ZAYO’s customer base includes some of the largest and most sophisticated consumers of bandwidth infrastructure services, such as wireless service providers; telecommunications service providers; financial services companies; social networking, media, and web content companies; education, research, and healthcare institutions; and governmental agencies.

ZAYO typically provides its bandwidth infrastructure services for a fixed monthly recurring fee under contracts that vary between one and twenty years in length.

As of June 30, 2014, ZAYO had more than $4.6 billion in revenue under contract with a weighted average remaining contract term of approximately 43 months.

ZAYO operates its business with a unique focus on capital allocation and financial performance with the ultimate goal of maximizing equity value for its stockholders.

Financial overview

For the years ended June 30, 2012, 2013, and 2014, ZAYO generated revenue of $376 million, $1,004 million, and $1,123 million, Adjusted EBITDA of $188 million, $554 million, and $654 million and a net loss of $1 million, $137 million, and $179 million, respectively.

For the quarter ended June 30, 2014, ZAYO generated annualized revenue of $1,187 million and annualized Adjusted EBITDA of $684 million.

History

ZAYO was founded in 2007 with the investment thesis of building a bandwidth infrastructure platform to take advantage of the favorable Internet, data, and wireless growth trends driving the demand for bandwidth infrastructure, and to be an active participant in the consolidation of the industry.

Dividend Policy

No dividends are planned.

Intellectual Property

ZAYO does not own any significant intellectual property, nor do ZAYO spend a material amount on research and development. ZAYO’s working capital requirements and expansion needs have been satisfied to date through CII members’ equity contributions, debt issuances, and cash provided by operating activities.

Competition

Given the requirement to own the underlying bandwidth infrastructure assets (e.g., fiber networks and datacenter facilities) in order to provide physical infrastructure services, the competitive environment tends to be less intensive for these products and the barriers to entry high. The degree of competition and actual competitive parties do vary by physical infrastructure sub-service and by individual market and fiber route. The competitive situation by service is described as follows:

Dark Fiber

Competition in dark fiber services tends to be less intense than for lit bandwidth infrastructure services primarily because a provider must predominantly own and operate a high count fiber network covering a substantial portion of the geographical demand in order to compete for a customer’s business.

The uniqueness, density and depth (i.e, high fiber count) of ZAYO’s metro, regional, and long-haul fiber networks is therefore a key differentiating factor.

In addition, given that providing dark fiber services often includes some degree of network expansion, dark fiber providers must also have internal project management expertise and access to capital to execute on the expansion aspect of the business.

Due to the custom nature of most dark fiber opportunities, many larger lit bandwidth infrastructure providers do not actively market dark fiber as a product, even if they own fiber networks in the desired geographies.

As a result, competition is often more limited in the dark fiber services market and highly dependent on the local (even sub-market) supply and demand environment. Given this dynamic and the generally longer contractual term of dark fiber services, dark fiber pricing tends to be more inflationary in nature.

Specific dark fiber competitors vary significantly based on geography, and often a particular solution can be provided by only one to three carriers that have sufficient fiber in place in the desired area or route.

These competitors tend to fall into two categories: first, privately owned regional bandwidth infrastructure providers with a similar degree of focus (e.g., Fibertech, Lightower, and Sunesys) and second, single market dark fiber providers with market and fiber construction expertise (e.g., DQE Communications and Edison Carrier Solutions).

Mobile Infrastructure.

Competition in mobile infrastructure services tends to mirror dark fiber services because of the need to own and operate an expansive and deep metro fiber network in order to compete.

Given the frequent need to expand upon an existing fiber footprint in order to access additional cell towers and small cell locations, project management expertise and access to capital is also a key competitive factor.

One additional criteria is that wireless carriers prefer to work with a more finite group of mobile infrastructure providers on either a metro or regional geographic basis.

As a result, the competitive group tends to match that of dark fiber services, with the addition of two competitive groups.

First, local cable providers and ILECs who will often break from their retail and small enterprise core focus to compete for FTT business, often as a result of legacy copper or coaxial-based services provided to these towers.

Second, microwave backhaul providers who focus on more remote or rural towers that have lesser bandwidth needs that they can serve with less capital-intensive (and less bandwidth-capable) microwave solutions at a lower total cost.

Examples of these additional mobile infrastructure competitors are Comcast, Time Warner Cable, CenturyLink, PEG Bandwidth, Conterra and TTMI.

Colocation

The market for ZAYO’s colocation and interconnection services is very competitive.

ZAYO competes based on price, quality of service, network-neutrality, breadth of network connectivity options, type and quantity of customers in its datacenters, and location.

ZAYO competes against both large, public colocation providers who have significant enterprise values, and privately-held, well-funded companies.

Some of ZAYO’s competitors have longer-standing customer relationships and significantly greater access to capital, which may enable them to materially increase datacenter space, and therefore lower overall market pricing for such services.

Several of ZAYO’s competitors have much larger colocation facilities in the markets where ZAYO operates. Others operate globally and are able to attract a customer base that values and requires global reach and scale.

5% stockholders

Battery Ventures            6.5%

Charlesbank Capital Partners     10.7%

Columbia Capital           11.4%

Communications Infrastructure Investments, LLC             7.3%

GTCR   20.2%

M/C Partners     11.4%

Oak Investment Partners            12.3%

Use of proceeds

DM intends to use the $232 million in proceeds from its IPO as follows:

for general corporate purposes, which may include redemption of up to 35% of its outstanding 10.125% senior unsecured notes due 2020 at a redemption price of 110.125% and 8.125% senior secured notes due 2020 at a redemption price of 108.125%, plus, in each case, accrued and unpaid interest, if any, to the redemption date; acquisitions; working capital; and capital expenditures.

Although ZAYO is always evaluating attractive bandwidth infrastructure acquisitions, ZAYO has not at this time identified any acquisition candidate for which ZAYO intends to use a portion of the proceeds of this offering. ZAYO’s actual use of proceeds will depend on, among other things, market conditions.