Towerstream Drops the Connection

05/29/2012 8:15 am EST

Focus: STOCKS

“Let them have bandwidth!” may be the clarion call for the early 21st century telecommunications revolution, but it isn't happening as fast as some investors and corporations would like, writes Paul McWilliams of Next Inning Technology Research.

Question:
Thanks for your detailed and unbiased review of Towerstream (TWER) this week. I have allocated a large portion of funds to TWER and DragonWave (DRWI) in the hope that they will start building traction in the second half of 2012.

I was in on the TWER conference call couple of weeks back, and it was very frustrating not to have minimum details of the carrier contracts. I think they learned a lesson, and gave little bit more clarification today during their presentation at B. Riley & Co. Investor Conference.

I heard Jeff Thompson mentioning that the rental of these nodes range anywhere between $200 to $1,000, with regions like New York City commanding three times higher than the other markets. This tells me that we can expect at least $500 to $600 for the 1,500 nodes that they have in New York City. If we take an average of $400 per node for 5,000 nodes that they expect to complete in another nine months, I would say $2 million per month per carrier is guaranteed revenue.

If they can sign at least two more carriers, it would be at least $6million month (discounted $2 million for tier two and three carriers). If we calculate for the whole year, it comes to $70 to $75 million in revenue. With TWER profit margin as high as 60%, we can expect it to report at least $35 million in profit for 2013.

With a clear road map and visible revenue,do you think TWER can go down even further before going up? It was frustrating to watch it go down by 40% in the last two months after announcing the carrier deals.

Answer:
Thank you for your thoughtful input. I agree with your opinion that the added color is very helpful.

Interestingly, after posting my review of the quarterly results, a couple readers asked why I was taking such a negative position on TWER, when in fact all I did was explain why I thought the price went down after TWER presented what was logically good news (a second signed carrier).

Given the clarification offered by Jeff, it appears Jeff realized he shortchanged investors during the quarterly conference call, and took a step towards providing us with the color we need to make better informed decisions.

I realize you are intentionally taking a conservative stance in your model. I'm jammed up right now with a project, so I can't take the time to get into the details, but my "back-of-the-envelope" calculations are as follows (I'm not with your discount, but didn't include it in the following data):

  • 5,000 nodes
  • $400 per carrier per month average
  • $2 million per month per carrier/$6 million per quarter per carrier
  • Two carriers: $48 million per year
  • Four carriers: $96 million per year

If we assume this run rate will start beginning with the second quarter of 2013, and model forward for the next four quarters, I think it's reasonable to add about $34 million (to get a round number) for the legacy enterprise broadband business. This results in about $130 million for the year that follows.

If I use a traditional non-GAAP projection (including depreciation, but excluding amortization of acquisition costs and stock based compensation), I think we should model about 65% gross profit. That results in gross profits of $84.5 million. If we assume non-GAAP operating costs around $30 million, the non-GAAP operating profit would be $54.5 million.

If we assume a fully diluted share count of 60 million (I think this will more likely prove to be somewhat low than too high), the resulting non-GAAP operating profit per share would be about 90 cents (untaxed). In my view, that would support a one-year target price in the mid-teens.

Please note, this is chock full of assumptions, and,as I like to say, one assumption is a Scientific Wild Ass Guess (SWAG), and with two or more you can remove the "Scientific." In other words, this is a highly speculative target.

As to your last question, could the price of TWER sink further before moving higher? Absolutely—there's a variety of events that could lead not only the price of TWER lower, but the price of many other stocks too.

That said, at its current price, which is at the low end of the trading channel range I shared in our quarterly review, I think there is room for investors with high risk tolerance to speculate in a higher price over time—possibly a much higher price if the sun, moon, and stars align in the fashion TWER suggested in its presentation.

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