FTNW: Reconfiguring the 4th Utility

The internet, and access thereto, is often referred to as The 4th Utility. This is because, like water, gas, and electricity, it has become a must have for everyday life.

Unlike the other three utilities, however, the internet is not a monopoly with significant infrastructure investments and no realistic way to offer consumers choice. Instead, it is a construct with open access. This should mean that there are potentially multiple avenues of gaining internet access, and, therefore, many options for choice among internet service providers. Sadly, however, the reality has been that options are limited. Generally speaking, users typically only have the one option of choosing between a phone company and a cable company for their internet service. This is akin to selecting the lesser of two evils.

This virtual duopoly of internet service providers in any given location has resulted in service that is disappointingly slow (and likely slower with the end of net neutrality) coupled with expensive prices for rather limited services. Corporations, in particular, are paying lots of money for access to the internet, then having to staff an IT department to keep their networks running and secure. These expenses are too high and the services can be better provided through outsourcing.

FTE Networks, with their CrossLayer service, is looking to reconfigure the traditional means of connecting to the internet by providing direct access, edge computing and bundled services directly to corporations. In doing so, they are disrupting the traditional cable/telephone duopoly of connectivity, while enabling the “smart buildings” of the future. The new model is one of providing faster customer access and functionality, along with a shared revenue model that allows building owners to benefit from the provisioning of services.

Through their disruptive CrossLayer product offering, FTE Networks bypasses traditional ISPs, provides faster, better connectivity, and shares access revenues with building owners. In doing so, CrossLayer is creating compelling incentives for rapid adoption of their services.

FTE Networks & Benchmark Builders…A Smart Combination

In the age of the millennial, the workplace is changing. Customer are demanding increased services from their landlords and, at the same time, technology is enabling owners to reduce costs while benefiting financially from providing additional services to their tenants.

In an article titled “The Future is Now: Five Smart Building Features Transforming Today’s Workplace,” Forbes speaks about these changes.

“To say that building owners are getting creative with the workplace would be an understatement. In the quest to create the coolest or most unique office buildings, we’ve seen a host of ostentatious building amenities…but the savviest building owners are making strategic investments in upgrades that more broadly and consistently benefit both the owner and the tenant.”

This is the trend that is just beginning with companies like WeWork, that are rapidly changing the traditional tenant/landlord relationship. In many cases, these changes revolve around more traditional services such as HVAC, lighting, common spaces, etc. The next round of smart buildings, however, will incorporate even more shared services offered by the landlords. Edge computing, complete WIFI coverage, and faster internet all play into this theme.

Enabling this next wave of smart buildings is what brought FTE Network Services and Benchmark Builders together. In FTE, you have a company that offers leading-edge end-to-end network infrastructure and data center solutions. Meanwhile, Benchmark is a leading general contractor when it comes to building out office space in the NY metropolitan area, touching over 100 buildings per annum.

When FTE acquired Benchmark in 2017, they had the smart building of the future in mind. By having leading technology, along with a robust high-tech general contracting team with a large backlog of projects, they could start bringing the smart building model directly to landowners through existing relationships.

It works like this…when Benchmark, which receives 90% of their business through repeat customers, bids out an RFP, they include the design for a smart building in the project. The additional expense to the building owner is rather minimal; well under $1 million for a 100K square foot building. At the same time, their benefits are quite large; they can offer highly desired services to tenants and receive an ongoing revenue stream from the services. For the landlord, it’s truly a no-brainer.

We’re only in the first inning here, but the attractiveness of the CrossLayer offering is being proven out in the early results of the combination; in situations where Benchmark has bid out CrossLayer in addition to their construction work, it has been adopted in 100% of the RFPs.

Going forward, it’s very reasonable to expect CrossLayer to be installed in a large percentage of the buildings where Benchmark is engaged for construction. Simultaneously, Benchmark is able to market themselves as a premier builder of smart buildings.

A Growth Engine…

Crosslayer is going to be a great growth engine for FTNW. Over time, one can expect to see large revenues generated by buildings enabled with their services. These revenues are going to be very sticky as changing service providers will mean a retrofit of hardware in a building, and to what gain. As long as CrossLayer is priced competitively with the duopoly of traditional access providers, they are a preferred offering for buildings.

To understand what the economics behind CrossLayer could approximate, you need to look at competitive services, which are generally priced about $1 per square foot. Thus, for every 250,000 sq. ft. building that is CrossLayer enabled, assuming competitively priced services, the incremental revenues would be $250,000, to be split between FTE and the building owner.

This is recurring revenue and Benchmark touches 100 buildings per year, so the numbers can become very big very quickly. And, it’s high margin business as FTE projects software-type profits on the CrossLayer services.

At this time, CrossLayer is in its infancy and only generating projects through Benchmark. It makes sense to consider that, likely within a year, FTE will have brought in a sales team specifically for CrossLayer and will be looking to enable projects where there doesn’t need to be an associated construction project; CrossLayer can be installed in any building easily enough, without requiring major work. If CrossLayer takes off beyond Benchmark related installations, the number of buildings could easily be in the hundreds per annum.

This scenario is more easily foreseen when you consider the first project for CrossLayer. It is currently being installed in Industry City in Brooklyn, a 25 building project owned by Angelo Gordon. With the benefits to landlords, it makes sense that the larger the landlord, the more excited they would be about CrossLayer. Major real estate owners like REITs, hotel chains, hospitals, etc. are all prime candidates for CrossLayer services. The incremental revenue to the landlords could run in the millions of dollar

…With a Large and Profitable Existing Business

Based on the compelling nature of the CrossLayer product and its early success, it is easy to envision a future, about 5 years from now, where CrossLayer could be generating well over $50-100 million in high margin revenue for FTNW. This kind of growth potential, especially when being proven out in real time, should demand a high valuation in the market.

This is not the case at all; FTNW, even at its $100 million current market cap, doesn’t trade near a growth multiple, due to the large and profitable businesses that enable the CrossLayer service; Benchmark and FTE Networks.

These two units generated revenues of $79.1 million and EBITDA of $11.6 million in Q3. Benchmark in particular, has a very strong stable of customers and a large, and growing, backlog of over $400M. To be in Benchmark’s backlog, projects need to be currently under way. Therefore, the core businesses can easily project to 2018 revenues and EBITDA that exceed last quarters’ run rate.

I believe that FTNW will have EBITDA in excess of the $45 million Q3 run-rate in 2018, a pace that should be sustainable going forward assuming no macro-economic blips that affect the construction market. This means that FTNW, even with the exciting growth of CrossLayer coming down the pipe, is trading around 2x 2018’s EBITDA.

Compelling Product, Compelling Risk/Reward

What makes for a compelling product offering? It’s a combination of several things.

First off, the product or service provided must be better than existing competition. In the case of CrossLayer, customers receive faster internet service, more functionality and features, a much shorter provisioning time, consolidated billing, and more. It is dramatically better for the users than cable or phone access.

Secondly, there needs to be compelling economics behind the product. From the CrossLayer user standpoint, they are going to be indifferent as it’s priced equally to other options. However, for the building owners, CrossLayer has an incredible economic advantage over other connection services. This advantage is found not only in the shared revenues, which are a complete bonus for landlords, but are tangentially found in increased building cache. Keeping your office space current by making it a smart building will reap significant long term rewards for owners.

Hopefully, by now, the upside potential in FTNW is evident. To be a great risk/reward scenario, however, the downside must be limited. This is the case here as the strong EBITDA forecasted for 2018 in excess of Q3’s $45M run-rate provides a great value for investors.

It is this combination of a compelling, disruptive product offering and a great value that has led Tailwinds to believe that FTNW is a very mispriced security and one that should be considered by investors looking for exciting small-cap growth companies.

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