When they rang the cash register on $11.6M in adjusted EBITDA and $2.5M in net income (around $.45 per share) in the 3rd quarter, FTE Networks (FTNW) broke firmly into the ranks of profitable enterprises. This report, however, was just the start for what could be an incredible earnings and cash flow generating story for years to come. When FTE reports their 4th quarter and year end 2017 results sometime in the next two weeks, it’s my guess that investors will awaken to the true earnings capacity of this Company.
The closing of their acquisition of Benchmark was a seminal event for FTE. It transformed the company from a straightforward network infrastructure solutions company to a unique enterprise that is disrupting the way in which corporations connect with their businesses with the world.
It also transitioned FTE from a money losing, slowly growing corporation to a cash generating, rapidly expanding Company. Wall Street has been slow to catch on to this transformation, as the shares of FTNW, despite recent strength, still trade a bargain basement levels.
It is Tailwinds’ belief that this upcoming earnings report, combined with the plethora of recent (and anticipated) contract wins, will finally awaken the Street to the true potential of FTE. It is the goal of this blog piece to help investors get ahead of this awakening by modeling out this potential prior to the earnings report.
Building a Model for FTE
When looking at FTE, the Company has three distinct business units. They are:
- Jus-Com Inc., which operates as FTE Network Services the legacy business which provides network infrastructure solutions, primarily to large telecom companies.
- Benchmark, a construction manager with over 100 projects per annum in the NY metropolitan market, primarily working with Fortune 500 companies.
- CrossLayer, the newest unit of the Company that provides connectivity and related services to corporations and building owners.
These are three separate business units, yet it is their integrated offering that drives the compelling nature of the FTE story. Benchmark gets the Company in the door early to provision a building when the walls are still down, FTE Network Services knows how to build out a network, and CrossLayer then provisions the network, making the building a smart building and providing customers with higher quality connectivity and services at rates that compete with traditional service providers.
~ For a more detailed description of the business model, read this article; FTNW: Reconfiguring the 4th Utility ~
The synergies between these units is becoming very evident as the Company continues to announce large contract wins on a weekly basis. However, to model out the earnings, it is best to break FTE down into these three units as they all have different growth rates and margins.
Below I detail how I model each segment, before bringing them back together for the total earnings power of FTE. This model is based off of Q3 reported numbers and is, in my opinion, an ultra-conservative model; with the recent contract announcements, I hope to see these numbers blown out of the water.
How I model the units…
Of the $79M in reported revenue in Q3, Benchmark was the vast majority. Additionally, of the roughly $400M in backlog, Benchmark represents around $300 million. This is lower margin business. For my model, I take a conservative growth rate of 2.5% quarterly sequential and use a 11% gross margin.
Jus-Com (FTE Network Services)
FTE’s legacy business, Jus-Com was about 10% of the revenue in Q3 and represented around $100 million in backlog. This backlog is tougher to model as there are no definitive timelines associated with it, so I simply model the same 2.5% sequential growth in backlog and base revenues off the Q3 starting point of around $6M. Margins have historically averaged around 35% for FTE.
The high growth aspect of FTE’s business, CrossLayer has only started booking revenue here in Q1 of 2018, with the announcement of their Industry City contract. Based on the fact that Benchmark touches 100 buildings per annum and CrossLayer is being installed in every recent win, I have backed into a final year end revenue figure of $20M for CrossLayer. This business, when looking at competitors, should be very profitable; I use a conservative industry average of 60% for GMs here.
~ On a side note, it’s likely that CrossLayer doesn’t win 100% of Benchmark’s clients as customers. It’s also likely, however, that they win additional business unrelated to the Benchmark platform, so I’m comfortable sticking with this figure. ~
All that being said, here’s what I come up with for revenues and EBITDA contributions by business unit for Q4 2017 and the next three years, through 2020.
Pulling it all together…EPS
When bringing these numbers together the benefit of CrossLayer becomes rapidly apparent…recurring revenue that grows at $20M per annum with high margins rapidly becomes a very significant factor in EBITDA and EPS. If you were to model this out a few more years, CrossLayer quickly becomes the majority contributor to the Company’s bottom line. This in turn would suggest that FTE Networks will end up deserving a high multiple for due to the recurring, high-margin nature of its business, but that’s a conversation for a future date.
In the meantime, I have modeled some growth in share count and, more importantly, a conservative net margin. I say this as the Company reported $1.66 per share in adjusted net income in Q3; a number that comes from taking out one time expenses related to the Benchmark merger and employee stock grants.
My model uses a number much closer to the actual net income reported. I do grow this over time, but not to the levels indicated by that $1.44 figure; like I said, trying to be conservative.
Here are my net income and EPS numbers for the next three years:
As the numbers show, FTNW is capable of putting up some very impressive figures over the next couple years. And, this is basing all my assumptions on what I believe to be very conservative figures.
The earnings and cash flow generating power of CrossLayer is immense. It is also driving more companies to Benchmark and, therefore, FTE, for developing the smart buildings of the future.
When the Company reports earnings in the next two weeks, I will be comparing the results closely with this model. If, as I suspect, they exceed my forecasts, the story will just get that much more compelling. In the meantime, FTNW shares look like a bargain in a stock market that offers few of them.
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