May 16, 2008
PEER 1 Network (TSX-V:PIX)
Technology – Communications and Content – Telecommunications
Q3/08 RESULTS: PURE GROWTH
We maintain our BUY, top pick rating and C$2.25 target price
for PIX-V shares
We believe the PEER 1 Network’s 5.6x EV/EBITDA multiple of our
F2009E EBITDA of $33.1 million (year ending June) is poised to expand
and bridge the gap with its comparable companies, which trade at 10.2x
EV/EBITDA, as these Q3/08 results reinforce our confidence in our 18%
EBITDA growth expectations for 2008, due to the company’s consistent
20%+ revenue growth and Q3/08’s 560 bps Y/Y EBITDA margin
expansion. PEER 1 reported better than expected Q3/08A revenues of
$22.8 million, up 21.0% Y/Y and Q3/08A EBITDA of $7.4 million, up
Because of the Q3/08 results, we are increasing our 2008E EBITDA to
$28.0 million from $27.1 million, but maintaining our 2008E revenues
steady at $90.3 million. We also believe there could be upside to our
2009 estimates as a result of these Q3/08 results, since our F2009E
EBITDA margin estimate stands at only 31.5%, well below the 32.6%
reported during Q3/08.
We also expect PIX shares to graduate to the TSX from TSX-V since the
regulator required three years of full financial results before the
company could move from the Venture Exchange to the TSX. With those
historical results in hand, the company is now poised to move within the
next few weeks.
At C$1.48, the PIX shares currently trade at 5.6x our F2009E EBITDA of
$33.1 million, a 34% discount to our C$2.25 12-month target, which
reflects an 8.7x EV/F2009E EBITDA (fiscal year-end June), which is still
below the industry average of 10.2x EV/EBITDA.
PEER 1 reported Q3/08 results in line with our expectations as revenues grew by 21.0%
Y/Y and 2.5% Q/Q, driven primarily from accelerating revenue growth in the dedicated
server division of 17.1%, offset slightly by slowing co-location growth of 26.1%. Note that
both bandwidth and services also contributed to overall revenue growth but only represent
17% of total revenues. We believe the slowing co-location growth was mainly a function of
a weaker Canadian dollar since a majority of the co-location revenues are in Canadian
dollars, while the company reports in US dollars.
While we had not assumed EBITDA margin expansion in our model for Q3/08, the
company outperformed our EBITDA estimate by 5.6% due mainly to a 560 bps Y/Y
improvement to EBITDA margins and 160 bps above our estimate. Note that Equinix
produces 40% EBITDA margins and PEER 1 management has said that the company’s
incremental revenues currently generate approximately 40% EBITDA margins using its
spare capacity. Therefore, we expect these EBITDA margins to be sustainable despite the
potential for the build-out of new capacity in Toronto and Vancouver over the next few
Q3/08A capex of $3.7 million was higher than our $2.7 million estimate, offsetting some of
the EBITDA outperformance, resulting in Q3/08A free cash flow of $2.8 million, in line
with our estimate and Q3/08 EPS of $0.02. By annualizing this free cash flow, we calculate
that PEER 1 trades at a 5.8% FCF yield, despite the company’s 20% revenue growth and
potential for further margin expansion.
Looking for more data centre space in Toronto and Vancouver
Management has indicated that it is actively looking for new data centre space in Toronto
and Vancouver. We estimate PEER 1 could support investments into two new data centres
during 2008 from its internally generated cash flow and by tapping its currently unused
$20 million line of credit. We estimate these two new data centres could provide capacity
for future growth of the company’s Canadian co-location and dedicated server segments,
which are growing at 42.3% and 21.9% Y/Y respectively as of the last quarter ended
Shortage of data centre capacity in Toronto is causing price increases.
With the Toronto telecom hotel at 151 Front St. almost full, customers are looking for
alternative locations. This shortage of capacity in Toronto is driving prices higher for data
centres not only downtown, but also in the surrounding regions. PEER 1 has just finished
filling up its space at 151 Front presumably at the higher prices. The company is looking to
build a new data centre in Toronto. We believe this capacity shortage and the long lead
times required to build new data centres due to power issues bodes well for PEER 1’s
VALUATION AND RECOMMENDATION
We derive our 12-month target price of C$2.25 from a DCF analysis, discounting our PEER
1 free cash flow estimates at a 13.0% rate and a 17.5x FCF multiple of our US$23.1 million
F2010E FCF. This results in a US$283.7 million market capitalization that we divide by
130.6 million fully diluted shares outstanding. At C$1.25, the PIX shares currently trade at
6.3x our F2008E EBITDA of $27.1 million, a 45% discount to our C$2.25 12-month target,
which reflects a 8.7x EV/F2009E EBITDA (fiscal year-end June). The 8.7x EV/2009E EBITDDA
multiple of our C$2.25 target price represents a discount to the average multiple of the group of
comparable companies, which currently trades at a 10.2x EV/EBITDA multiple. Therefore,
based on this valuation and our view of improving industry trends, we recommend investors
BUY PIX shares.
• Pricing pressure and customer churn from an increasingly competitive environment
with declining per-unit costs.
• Technological changes that could decrease the value of assets already deployed.
• The purchase price and the integration of potential acquisitions.
• Increased costs of operations such as electricity.
Posts: 9 | From: Vancouver | Registered: May 2008
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