Value Trap or Equity Value?
Is the hotel room television destined to the same fate as the hotel room telephone? Is LNET equity worth anything? We can’t do anything about what we don’t know, such as who owns LNET debt and at what cost. But there are some things we do know that can be examined for clues to the future value of current LNET equity.
For example, just two weeks ago (on 10/26) LNET experienced its third-highest volume trading day ever, with 10x the usual number of shares traded and the price closing 26% higher than the day before. If there is anything to account for that upward surge I haven’t found it. The official short interest remained at 3.71M on 10/31, down only 250K from 3.95M on 10/15. Maybe the hurricane market closures delayed 10/26 settlements? I haven’t found anything that indicates that.
In addition, one month earlier LNET experienced its 11th and 13th highest volume trading days ever (on 9/28 and 9/27), with shares closing 68% higher after both days. This coincided with a delisting notice and overlapped the last of Mark Cuban’s selling; both presumably negative, not positive, events.
Finally, while it’s true that on 10/19 LNET quietly rescinded the 550,000 restricted shares it had so publicly granted to the new CEO the month before (and what was Battista given to compensate for this $203,500 loss from his recent employment agreement?), equity options for 550,000 shares that were granted at the same time remain in force. So there are very recent inside actions that indicate certain value for current equity. They may be mistaken or even otherwise explained, but they cannot be denied.
It is increasingly easy to manipulate (intentionally or unintentionally) a low-float stock. It may be that speculation has taken the upper hand in the recent share action, interrupted occasionally by informed movements. LNET’s entire float has turned over in just the past 2½ months since 9/4 even though almost 30% of outstanding shares presumably are not participating as the Mittlemen Brothers continue to hold 6.6%, Pecora holds 6.3%, Penn Capital 4.9%, MAST 4.6%, Cuban 3.5%, Matlack 1.9%, and Peterson 1.3%. These seven major holders alone represent about 7.8M shares of equity that should be in the same boat as retail owners. Since MAST, Penn Capital, Cuban, and Pecora all had a hand in placing Matlack on the board, we might interpret that their interests are aligned with equity. Reviewing MAST’s initial 11/23 letter to the board also emphasizes the importance of equity.
So might this third quarter report contain a measure of hardball designed to free up precious cashflow for use in the capital-intensive race to upgrade fast enough to stabilize LNET at a significantly more profitable level? The company’s apparent inability to stem the loss of customers is very worrisome. However, the continued-reliable increase in revenue generated by higher-margin HD rooms seems to suggest a viable business model that LNET is uniquely positioned to capitalize on. And the Envision platform, ad insertion, gaming initiative, and return of new hotel construction all provide proven avenues of growth for years to come. That’s why I’m here, and hopefully that’s what MAST and others are after as well.
By their remaining presence alone (even at relatively insignificant valuations), the major holders above (with the exception of the Mittlemen Brothers who now view their position as a lotto ticket on a Battista turnaround) must believe that LNET represents a decent chance for recurring profit flow in an economic climate where return on investment is increasingly difficult to come by. But does their path include current equity or do the major holders intend to capitalize on this opportunity by capturing LNET through other means?
The only real pressure on LNET comes from the debt. To the extent that current creditors either don't believe or don’t care that the race to profitability can be won, their legitimate demands (as demonstrated by covenants and payment structures) create a self-fulfilling prophesy. Vendors (competitors) such as DirecTV and HBO also may be willing to pile onto LNET with brass-knuckle negotiations for content, as DirecTV did with Viacom last summer. Is there any reason for these creditors to demonstrate flexibility that allows an acceleration instead of slowdown in capex now in order to lock-in increased EBITDA later?
Probably not, which may be why there are gratuitous mentions of bankruptcy, change in control (with no NOLs which arrangement is that ominous warning supposed to reference?), and even a presumptuous reclassification of long-term debt liberally sprinkled throughout the third quarter report. Following a bankruptcy filing MAST would be in control of LNET through Battista and Matlack. Creditors and vendors would lose legal recourse to full payments due, and the majority of LNET’s assets are intangibles or other structures that don’t have much monetization value outside of their current use (established relationships with hotels and Hollywood studios, an installed infrastructure that remains far superior to the closest competition in a high-barrier business, an experienced services group long-employed system wide, innovative technology with targeted application, etc.). So the message to creditors and vendors is “why force the stick”?
On the other hand, LNET cannot continue to violate covenants or receive unpaid programming absent agreements with creditors and vendors, and either or both may be willing to sink LNET for a small loss rather than double-down in the hopes of full payoff later on. So perhaps Miller Buckfire and FTI craft the obvious carrot in the form of an out-of-court restructuring or even a pre-pak (if things get ugly)?
In the greater scheme of things the dollar amounts now are so small that everything will come down to a simple calculation of whether or not LNET is worth the trouble to save and sustain. With creditors and vendors preferring to avoid loss rather than needing immediate cash, and major holders apparently willing to invest in a turnaround, the odds seem to favor a dilution or buyout of current equity.
Either way, adjusting for depreciation/amortization, goodwill, and restructuring costs, current cashflow of course remains ridiculous and yields a DCF calculation that suggests a NPV that is multiples higher than Friday’s close or tomorrow’s wide swings. With the low float and unusually active interest of major holders in this “worthless” penny-ante issue, retail holders should be prepared for a wild ride that ends in payoff or theft.
