The 12% surge in the Dow over the last three trading sessions was certainly welcome but has hardly alleviated the level of anxiety felt by most investors as it could easily turn out to be a bear market rally. It is interesting to see from the adjacent table by Paul Kedrosky that out of the 13 biggest two day advances in the Dow Jones Industrial Average that have occurred going back to the stock market crash of 1929, 11 of them took place during the great depression and 5 of these occurred before the Dow hit its bottom in July 1932.
In this uncertain environment it is easy to find companies not only selling at low single digit P/E ratios (with earnings in jeopardy, investors are looking at low P/E ratios with a wary eye), but often below tangible book value. A quick stock screen I ran brought up 2,181 companies that are trading below book value. However there are only a handful of companies that are trading below book value, have little or no debt and are actually trading below the cash they hold on their balance sheet. One such company is our portfolio holding Towerstream (TWER), a provider of commercial wireless internet service, which we featured in the July 2008 edition of our investment newsletter.
The stock has lost nearly half its value since then but interestingly enough the story has hardly changed and if anything has gotten better. The stock with a market cap of $23.5 million not only sells for below book value of $35 million, it is selling at a discount to the $25.4 million in cash it holds on its balance sheet after removing $2.6 million in debt.
Towerstream reported third quarter 2008 results earlier this month and almost every single metric improved year-over-year with the exception of average revenue per user (ARPU) for new customers, which decreased from $748 in Q3 2007 to $733 last quarter. Gross margins increased from 63% to 64%, ARPU per customer increased from $694 to $827 and churn rate dropped from 1.26% to 1.22%. Towerstream has consistently maintained low churn rates and from what I have heard, customers who have initially purchased an internet line from them as a backup or load balancing solution have often made it their primary internet connection. While operating expenses dropped from $6.26 million to $6.09 million on a sequential quarter basis, they increased significantly from $3.96 million in Q3 2007 due to the company entering new markets and expanding its sales force.
Shortly after results were announced, Canaccord Adams upgraded the stock from a hold to a buy with a $1.50 price target over a 12 month period. While I think that price target is conservative, it still represents the potential of over 100% gains from these levels. Obviously the key concern with Towerstream is its ability to scale the business while at the same time reducing or eliminating cash burn. Cash burn in the third quarter was $3.9 million after falling for two consecutive quarters. Anyone who has been involved with start-ups can tell you that attempting to scale a business while preserving capital is a tough act.
I got a chance to talk to Towerstream’s CEO Jeff Thompson last week and he reaffirmed the company’s outlook of becoming EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization) positive by the end of Q1 2009. He also addressed my concern about an economic slowdown affecting small businesses and in turn impacting Towerstream’s business by letting me know that a majority of Towerstream’s customers are mid to large size businesses. The company’s 8 MBPS solution at a very competitive price point has also been received well by customers. Having priced a 1.5 MBPS T1 internet line and periodically looking through Towerstream’s offerings, I can personally attest to their competitive pricing.
In light of the roll out of WiMax in countries like South Korea where wireless access is available in subways and buses as well as Australia’s plan to spend nearly AUD $1 billion to provide wireless access to rural areas, the United States has been slow to adopt WiMax. Since Towerstream has been one of the early members of the WiMax forum, I asked Jeff his opinion about the ramp up of WiMax in the U.S and competing technologies. Jeff mentioned that with Clearwire shareholder approval in place of the ClearWire, Sprint, Google, Intel, Comcast and Time Warner deal (could there be any more companies collaborating on this deal?), WiMax adoption will hopefully increase. He also mentioned that LTE, a technology that is being touted as a WiMax alternative, is probably 3 to 4 years away.
According to Jeff, one of their equipment providers is another portfolio holding Alvarion (ALVR) and they have been happy with their experience with Alvarion as it does not take “10 engineers to get their stuff working”. However they have the option to use various other manufacturers and expect equipment prices to come down next year, helping reduce cash burn even more.
The stock has been under $1 since October 22nd and would normally get a delisting notice from Nasdaq as the stock has been under $1 for 30 consecutive days. Given the number of stocks that are currently trading below $1, the Nasdaq has temporarily suspended this rule and hence delisting is not an immediate problem.
Companies usually have a six month period after violating listing requirements to meet those requirements again. Some companies opt for a reverse merger to accomplish this but with a few exceptions like Priceline (PCLN), stocks of companies using reverse mergers generally tend to drop after the merger. As I was mentioning to a friend, Sun Microsystems (JAVA) was trading in a $3 to $5 range for quite some time before its 4 to 1 reverse split, that pushed its price all the way up to $20 post split only to see the stock meander back down to a little over $3 today. Had the reverse split not occurred, Sun’s stock would have been trading under $1 right now. Please note that beyond stock price, there are also other requirements related to market cap, shareholder equity and net income. You can find all the Nasdaq listing requirements here (pdf).
Overall management sounded very confident on the call and while Towerstream has all the risks associated with start-ups, it certainly feels like the company is at the point of proving out its business model while posting impressive year-over-year growth even in this difficult environment. I am going to add 3,000 shares of Towerstream to our existing position in the model portfolio and also plan on adding to the position in my personal portfolio after this blog entry is published. The closing price of the day will be used for the model portfolio.
Voluntary Disclosure: Long Towerstream.