Investments

Jun
26
2019

Tucows Inc. (TCX)

Three Terrible Businesses In One

Disclosure

We are short shares of Tucows Inc. Please click here to read full disclosures.

Tucows (TCX) operates two declining tech/telecom businesses and a fledgling low-return fiber division, yet is being valued by the market at 60x trailing normalized earnings. Its two profitable segments barely deserve double-digit earnings multiples given their bleak growth profiles, and the company’s cash flow is being plowed back into a third segment that will prove to be a massive destroyer of capital. TCX’s valuation is wildly overstretched and the stock is worth 50%+ less.

Ting Mobile, the company’s mobile virtual network operator (MVNO) division, saw subscribers peak in 2017, and has witnessed declines ever since. Historical examples of MVNO failures are abundant – like Disney/ESPN, Virgin and Amp’d Mobile – while MVNO successes are rare, and the trajectory of Ting Mobile is proving to be no different. Brutal competition, particularly from Comcast’s Xfinity Mobile as well as Charter, has reversed Ting’s organic growth from several years ago into declines today, and the bleeding shows no sign of abating. Making matters worse, if the T-Mobile/Sprint merger goes through, we believe Ting Mobile will have to shift its customer base to another wireless provider such as Verizon or AT&T, which will likely lead to substantial churn and lower margins.

Tucows’ Domains business is suffering similar stagnation. Industry-wide, growth is abysmal. GoDaddy and Verisign have been suffering low single-digit growth while TCX’s own revenue CAGR has been 1% over the last 3 years as it’s been losing market share. The business is highly commoditized, with little to differentiate any individual firm other than price. TCX has been boosting prices to inflate growth metrics but this will simply accelerate churn and share loss.

Recognizing the dreary prospects of its legacy businesses, TCX management has been spinning a story about its nascent fiber operations, Ting Internet, into which it’s redeploying the cash flow from the Domains and MVNO segments. Investors are being led to believe that this fiber business will deliver $1,000 in gross profit on $2,500 to $3,000 in capital invested. Our research indicates the unit economics will be far worse, with at least $4,000-$5,000 in capital invested per sub and $500-$650 in EBITDA per sub, which barely justifies Tucows’ cost of capital. Ting Internet will ultimately prove to be negative NPV, suffering from many of the issues that have beset prior fiber builders. No public company has generated a high return fiber network successfully. After 13 years investing in fiber, Verizon cut back investment because its ROIC was in the single digits. Since launching Google Fiber in 2010, Google has fired several CEOs, cut headcount dramatically and de-emphasized the division. If Google and Verizon cannot build an attractive fiber network, how can a small Canadian company with no ISP expertise? The fiber business is a fraction of TCX’s total business from a revenue perspective, but we believe the market values this segment at over half of Tucows’ value.

Tucows will likely report a large miss versus consensus 2019 EBITDA, forcing investors to face reality and value TCX closer to a more reasonable range of $25-$30 per share. Like all bad telecom businesses, Tucows’ share price should soon suffer the same fate as its subscribers: churn and attrition.

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