A key challenge that fast growing companies encounter is how to fund their expansion at a price that will add value for existing shareholders, but without exposing them to undue risk. Seeing a market opportunity worth exploiting is one thing, having the capital structure in place to take advantage of it is quite another.
Bearing this in mind, Aim-traded BigBlu Broadband (BBB:106p), a provider of alternative superfast broadband products that is targeting 27m potential customers in Europe and a further 1m in Australia who only have download speeds of less than 4MBps so are suitable for satellite or fixed wireless broadband, has come up with a novel solution to raise capital for its Quickline subsidiary, a leading provider of UK fast fixed wireless broadband.
The operation has performed incredibly well since BigBlu’s acquisition two years ago, growing customer numbers by two thirds to 7,500. It is highly profitable, too, accounting for a third of the £3m cash profit BigBlu’s UK division reported in the first half to end May 2019, and on a profit margin of close to 50 per cent, a performance that more than justifies the £8.4m cost of the acquisition including earn-outs.
Quickline’s churn rates are low at 9 per cent, thus creating a valuable high margin revenue stream as the business scales up. Low attrition rates are hardly surprising given that there are 2.5m homes in the UK with internet speeds below 4Mbps, mostly in rural areas, most of which are crying out for faster internet access. Also, fixed wireless solutions offer fibre-like speed but at significantly less cost per premises, and with faster roll-out times.
It’s not surprising either than fibre broadband is being focused on urban areas, where there are greater economies of scale to be reaped, rather than rural. This is a major issue for Building Digital UK (BDUK), the government agency responsible for delivering superfast broadband and local full fibre coverage, which estimates that 10 per cent of UK homes are unlikely to receive commercial access to full fibre. As a result BDUK has launched a £200m fund, The Rural Gigabit Connectivity programme, to target these specific geographic areas over the next 18 months. There is also another UK government funded scheme, The Rural Gigabit Voucher Scheme, to provide homes with vouchers worth up to £3,500 for each Small and Medium-sized Enterprise (SME) and up to £1,500 per residential premise to facilitate faster broadband speeds.
A huge opportunity
This represents a huge opportunity for Quickline, the largest rural fixed wireless broadband provider in the UK and a business that has successfully applied for and received support for BDUK funded projects in the past. In fact, BigBlu’s directors believe that they can quadruple Quickline’s 7,500 customer base to 30,000 within three years and at a cost of £20m, the capital being deployed mainly on new network (masts) and infrastructure build, BDUK related projects, and customer equipment. It’s not unreasonable to expect Quickline’s profits to quadruple too if the aggressive ramp up in the customer base is achieved, suggesting BigBlu’s subsidiary could be making annual cash profits north of £6.5m on revenue of around £13m by 2022.
The really smart part is that BigBlu has attracted £8m of new equity investment in Quickline from funds managed by highly respected Harwood Capital LLP based on an equity valuation of £13.8m for Quickline (pre-new money). That valuation not only highlights the value BigBlu has already created in the business in the two years since acquisition, but there is obvious scope for value creation in the years ahead given that the £12m balance of the £20m planned investment will be split equally between BDUK grants and Quickline’s free cash flow over the next three years. Quickline has also put in place a £4m debt facility with HSBC priced at 3.99 per cent above LIBOR. Clearly, Quickline’s founder and chief executive Steve Jagger sees the potential as the £1.4m earn-out he is due and is included in the £8.4m aforementioned acquisition price BigBlu paid, is being converted into equity in the new Quickline vehicle, giving him a 7.7 per cent stake.
Potential for significant value creation
This leaves BigBlu with a 69.7 per cent equity stake in Quickline which will continue to be fully consolidated in the company’s accounts, thus recognising that proportion of the subsidiary’s profits. The point being that by tapping new investors in this way, BigBlu can accelerate Quickline’s expansion to take advantage of the positive move by UK Government in driving up rural fast broadband adoption while also creating significant value for the company’s shareholders without taking on additional leverage.
To put the potential value creation into perspective, Quickline’s pre-new money enterprise value of £15m equates to around 7.5 times its annualised cash profit. On the same basis, applying the same multiple on a potential cash profit of £6.5m for Quickline in 2022 implies an enterprise valuation of £48.75m. Even after accounting for a modest level of debt on Quickline’s balance sheet, BigBlu’s share of Quickline’s equity could easily be worth £30m in three years time, a thumping return on its £8.4m investment. It could also represent half of BigBlu's current market capitalisation of £60m.
The other point worth noting is that the combination of improving free cash flow generation, and the £4m first tranche of the new equity investment being made by Harwood Capital in Quickline will help drive down BigBlu’s net borrowings from £16.9m at the end of May 2019 to £9.2m by the 30 November 2019 financial year-end, according to analyst John Kardis at house broker Numis Securities. Mr Kardis also expects a similar level of net borrowings at the end of the 2020 financial year.
This means that BigBlu’s proforma enterprise valuation of £70m equates to a very modest 7 times its forecast annual cash profit of £10m this year, falling to a miserly 6 times Numis’ cash profit forecast of £11.4m for the 2019/20 financial year.
Accelerating organic growth opportunities
The other major take from my results call with BigBlu’s directors is the ongoing strong organic growth being generated in their satellite businesses, accounting for 80 per cent of the business mix.
In the latest six month trading period, BigBlu’s underlying revenues increased by 12.8 per cent, driven by a 5 per cent rise in the customer base to 119,000 and a near 6 per cent hike in average revenue per user (ARPU) to £43.70. BigBlu now operates across 30 countries making it the largest satellite broadband company outside North America. Recurring revenue accounted for a solid 83 per cent of total revenue of £30.5m with churn rates declining from 19.2 per cent to 18 per cent. Chief executive Andrew Walwyn is targeting a 15 per cent churn rate which seems achievable to me as more new and existing customers adopt new products with faster broadband speeds and unlimited download limits.
Furthermore, customer connections are set to benefit from BigBlu’s partnership with Eutelsat (NYSE/Euronext: ETL) during the second half of this year in light of the confirmed launch in December 2019 of its “Konnect” satellite that will enable 100Mbps services across the company’s core European markets for the first time. This means BigBlu will be able to provide its retail customers double the 50 Mbps internet speeds that are currently available under its existing Eutelsat and Viasat contracts, another reason for improved churn rates and profit margins, too.
The Eutelsat partnership is clearly working out well as BigBlu has signed up 10,000 new customers since it joined the preferred partner programme in December 2018. Moreover, following a contract extension earlier this month, the company is targeting 25,000 new customers across Europe from the Eutelsat partnership over the next 12 months, thus adding further weight to the directors’ prediction that BigBlu will hit its December 2020 target of 150,000 customers.
Government funded support a key driver of end user demand
Government support across Europe is also highly supportive of BigBlu’s ongoing strong growth under an EU directive that states that customers should have access to download speeds of at least 30 Mbps by 2020, and 50 per cent of all households should be able to have access to download speeds of at least 100Mbps by 2025. For instance, a tenth of BigBlu’s customer base is in France, so the company is well placed to take advantage of the country’s first national subvention scheme which offers financial assistance to 2m households that are unable to access a minimum of 8Mbps through ADSL/Fibre by 2020.
Worth noting, too, is BigBlu’s ongoing organic growth in Australia. Since entering the satellite broadband market in 2016 following the acquisition of Skymesh, the company has strengthened its position to such an extent that it has taken a 50 per cent market share for the past nine months of net new customer additions under the Australian government funded NBNco scheme. Finance director Frank Walters revealed to me during our results call that BigBlu’s Australian business has added around 5,000 net new customers in the past 12 months to take the total to 38,000, helping that business to post a half year cash profit of £1m on revenue of £7m. There has been no let up in new customer additions since the half year end either.
Indeed, the potential for increasing adoption of alternative broadband products by consumers and businesses, and the concerted effort being made by central and local governments to enhance broadband coverage across Europe, were key reasons why I first advised buying BigBlu’s shares at 82.5p ('Blue-sky tech play', 21 March 2016). The 165p target price I outlined in my last article could yet prove to be conservative ('Record new customer growth drives BigBlu into orbit', 11 July 2019). Buy.
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