This Secondary Offering Is Worth a Look

07/21/2011 9:30 am EST

Focus: STOCKS

This company has been doing good work for a long time, and this secondary offering is a good chance for investors to get in at a good price, writes Paul McWilliams of Next Inning Technology Research.

Towerstream (TWER) announced last week that it would put the shelf offering it filed earlier this year to work.

The money raised will be used to fund a more aggressive acquisition strategy, expand TWER’s network to other cities beyond New York City, and hire more sales people to address the expanded coverage.

As I’ve broken down carefully in past reports, TWER comes in three pieces...

The first is its legacy wireless-enterprise-broadband business model that has shown steady growth, and is nearing critical mass—a point where it will deliver nice bottom-line profits. I think this part of the TWER equation is worth something between $4 and $5 per share today.

A second piece to the TWER puzzle is the WiFi offload business model we’re all excited to see get off the ground—so far, this model is being internally funded and driven.

While we’ve not heard any news about a formal contract for WiFi offload, TWER has stated very clearly it expects one to be issued this summer.

Given the comments made during the conference call announcing the secondary offering, my thinking is that one is very near, and that the customer wants TWER to open WiFi offload services in one or more markets outside of New York City (where it built the first system).

TWER also noted with some authority during the call that it expects to leverage these WiFi offload networks to drive revenue from location-based searches, and what it terms as "daily deals." WiFi is inherently location-aware, and therefore can deliver location-based data to telecom and other customers who want this location data for search-based advertising.

In addition to this, there have been a host of coupon companies similar to Groupon spring up in major markets that sell daily-deal advertising. Success in the daily-deal coupon market is very dependent on location information.

The third piece of the TWER puzzle is what I’ve referred to as "bolt-on" acquisitions.

TWER isn’t the only company in America that has launched wireless-enterprise-broadband networks. However, as I’ve noted all along, the only way to make money in that market is with size.

The short story is the wireless-enterprise-broadband business model is one that carries very high fixed costs. As such, it takes scale before those costs can be overcome and deliver bottom-line profits.

What’s happening is, the financial backers of these small (and often localized) network operators have learned, over time, that there are few opportunities to scale local or even regional networks adequately. So they are simply money pits.

Due to the fact that TWER has the critical mass to synergize much of the fixed cost, it is in an optimal position to buy these networks. And since the financial backers are lining up to exit, the deals are attractive.

During the past 15 months, TWER has completed three acquisitions. I believe it has several potential new ones on its plate, with one that sounds as though it could close soon that has an estimated price tag of about $4.75 million. That is roughly 25% larger than the next largest of the three it has closed already.

Based on this data point, and other comments made during the conference call, it sounds as though TWER is going to be a bit more aggressive than it has in the past with its acquisition strategy.

In these acquisitions, TWER is essentially paying about 10% to 20% less than it would cost it just to deploy the equipment. However, equipment cost is not the issue—the issue here is these are not only turnkey networks, but ongoing businesses with subscribers that TWER can turn Earnings Before Interest, Taxes Depreciation, and Amortization (EBITDA) positive in fairly short order.

The problem for current operators is that the revenue is simply not big enough to overcome fixed costs. With what is rapidly growing to be a large network with presence in many major metro areas already, TWER can much more effectively absorb fixed costs.

For example, when TWER buys a network, it essentially terminates all localized fixed costs, save a couple of local techs to support the network, and absorbs the functions inside its existing centralized operational structure.

While it’s common for a secondary offering to put temporary pressure on a stock, I think TWER is taking this step because it sees very attractive opportunities to rapidly expand its business and leverage its fixed operational costs across a larger revenue base.

Based on this view—and while I will certainly examine any major acquisition or significant expansion effort carefully before arriving at a conclusion—at this juncture, I think the odds of a successful outcome outweigh the risks. As such, I think adding shares on weakness merits consideration.

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