CrossLayer About to Enter The Big Time
By Daniel Carlson - May 22, 2018
FTE Networks (FTNW) reported their earnings yesterday. The good news was that things appear to be right on track for hitting their guidance. Revenues of $85M and adjusted EBITDA of $7.4M are trending towards the official guidance of $350 million and $30 million respectively. This is all very positive.
The better news, and more important to the long term story of FTE, was the commentary surrounding their CrossLayer business. Remember that CrossLayer is a brand new business. They launched it in November of 2017, there were zero revenues until Q1 of this year, and it recorded a minimal $200,000 in revenue in that quarter.
Do not let the small numbers out of the gate fool you. CrossLayer is set to be a huge business. And, based on what management said on the call, this ramp in business will happen starting right now and be continuing for a long time to come.
“Speaking of progress, as mentioned earlier, we have been named as a technology provider for one the largest commercial real estate services and investment firms in the world. This is a significant achievement and we are honored to be among a few key service providers that will partner with the firm to provide advanced technology services to building owners and their tenants. It speaks volumes about the value of our CrossLayer solution.” ~ Michael Palleschi, CEO
The above quote is from the Company’s earnings call on May 21st, 2018. In that call they discussed a recent deal that has yet to be formally publicized. This relationship with a very, very large commercial real estate partner will basically be the formal debut of CrossLayer. They are unveiling what has been a business concept and taking it to a national stage.
The market seems to have assigned minimal importance to this announcement, but allow me to try to explain why this is of incredible significance to FTE. I’ll lay out the logic here…
One of the world’s largest real estate firms likely controls billions of square feet. Let’s assume they have 1 billion square feet of space. At an average building size of 500,000 sq. feet, that represents 2,000 buildings.
CrossLayer enables building owners to have an additional revenue stream, which increases the value of their buildings. They also enable smart buildings, which command more rent and can be cheaper to operate (think smart lighting, heat, etc.). Overall, they bring a value proposition, additional revenue driver, and increased value to the asset. One can easily assume a vast majority of office buildings will want to switch.
FTE generates approximately, per the conference call, $400,000 per building. This is high margin, 60% or more, business.
There’s no reason not to believe that CrossLayer can’t be in 20% of these buildings over the next 5 years. Which would mean an incremental $160M in annual, recurring revenue and over $100M in incremental annualized EBITDA.
A top four firm manages more than 2,000 buildings…
Let’s dig a little deeper into these points, starting with the space controlled by the largest property owners in the world. Here’s a list of the top 5.
Assuming that “one of the largest commercial real estate services and investment firms in the world” is one of the top four, we’re talking 1 billion square feet being a very conservative number. Suffice to say that each of the top four manages well in excess of 2,000 buildings.
CrossLayer reduces costs and adds value of a building…
When property owners look at their buildings they evaluate them on a cap rate. For those who don’t know, this is simply the ratio of Net Operating Income (NOI) to Property Value. On an apples to apples basis, similar properties will have similar cap rates.
By virtue of their revenue sharing agreement with landlords, FTE generates additional NOI for building owners. Which means that, if cap rates are constant, they have just increased the property value. I don’t think this can be overemphasized…by allowing FTE to install CrossLayer, owners see an immediate increase in property value.
This increase is based on additional revenue generated from CrossLayer as they sign up and bill the tenants for connection services. There are also savings that can be generated by having a smart building. These savings are obtained from using technology in ways such as smart lighting and smart heating. Similar to the CrossLayer revenue increasing NOI, savings on building operating expenses result in a corresponding increase in NOI. Again, CrossLayer’s installation provides an opportunity for further increasing property values.
Typically, turning a building into a smart workplace is an expense item for a property owner. This is where the value proposition of CrossLayer helps owners. By building out the network themselves, CrossLayer assumes the expense of making a smart building. This can result in savings to a building owner of several hundred thousand dollars; money they would have spent to generate the savings of being a smart building.
The final add of the CrossLayer offering is the cache that comes with being a smart building. Look at WeWork as an example of a company that touts the futuristic workplace. CrossLayer enables any building to compete with a WeWork on the technology side. This certainly will provide for happier tenants and the opportunity to increase rents relative to other, older offices.
Thus, for all these reasons, CrossLayer is of tremendous value to building owners. There is no reason to think that FTE will be restricted in the percent of buildings they are engaged to connect; instead, it makes sense for landlords to try to roll them out as quickly and broadly as possible.
How to value CrossLayer?
FTE is guiding for CrossLayer in 30 buildings this year, which is a number I think they’ll easily beat. But, just based on this number, CrossLayer can add $12M in run-rate revenue at year-end. This would equate to over $7.5M in additional run-rate EBITDA. With a big ramp in front of them, one could easily put a 20X multiple on EBITDA right now, suggesting that CrossLayer alone is worth over $20 per share.
I would suggest that this is just the tip of the iceberg and CrossLayer will be on an eventual march to well over the $160M in EBITDA I detailed above. They should sign more contracts and could easily exceed 1,000 buildings on net over the next 3-5 years. But, sticking to the $160M number for 5 years from now, CrossLayer at that time might be worth 10X EBITDA? Seems reasonable for a fast growing, high-margin business. That would make it a $230 stock in 5 years on CrossLayer alone.
The truth is, we’re still in the early innings for CrossLayer and there is a lot to prove. However, I am in the camp that the business is worth a whole lot more than is baked in the current price just based on this year’s EBITDA rate. The stock can easily move a lot higher now, still leaving plenty of upside if they can manage to pull off the big picture and grow into their multi-billion potential.
The investment community missed the big news on the earnings call. When their partner, one of the world’s largest real estate firms, comes out with a press release in the next couple weeks, it should be eye-opening to the markets. For now, we get to buy the shares before the street catches on.
