ZAYO Group Assessment: Global network provider grows through 37 acquisitions

by David Dixon of FBR &Co (edited by Alan J Weissberger)


ZAYO Group has a global network which provides bandwidth and connectivity over fiber optics network infrastructure. Founded in 2007, Zayo has grown exponentially via acquisitions, taking advantage of transactional demand from hyperscale service providers for bandwidth infrastructure, with its meteoric rise driven by 37 acquisitions in its nine-year history. The company has assembled an attractive services mix, with potential for leveraging its dense metro, regional, and long-haul fiber networks. Industry bandwidth demand continues to increase.

ZAYO reported mixed fiscal 4Q16 results, with the Allstream acquisition driving consolidated revenue growth of 40.2% YoY. On April 1, 2016, Zayo acquired Clearview International, LLC, a Dallas-based collocation and cloud infrastructure services provider for $18.3M in cash. Clearview generated $2.3M in revenues and $0.7M in adjusted EBITDA in the March quarter.

Dixon’s Opinion:

Zayo’s ability to benefit from the exponential growth in bandwidth demand considering technology shifts in wireline and wireless segments, could be gating factors.

The company remains confident about achieving $3M in net installs and $7M in bookings in the next handful of quarters (excluding Zayo Canada).

Acquisition synergies ahead of plan; expected to continue.

As expected, Zayo is extracting significant cost savings from Zayo Canada through an aggressive head-count reduction of 1,700 employees (from 2,200 to 500) as part of the transformation of a mature relationship-based company to a transaction-based company. In the quarter, Zayo generated $7.3M in synergies ($29M annualized); we expect annualized synergies to peak by mid 2017. Management is in the heavy-lifting integration phase; our checks with signature accounts suggest a high likelihood of greater-than-expected high-margin enterprise revenue erosion, which we are closely monitoring.


1.  What is the impact of an architecture shift on Zayo business model? Do telecom and cable companies have sufficient metro fiber in place to deploy distributed compute networks?

We see limited competition from other dark fiber and mobile infrastructure providers but believe the real question is the impact of network technology changes underway on the outlook for demand for Zayo s products and services. In the metro fiber segment, we see a move underway within the telecom and cable segments toward distributed compute bandwidth and storage platforms, potentially on fiber infrastructure already in place. This will likely serve as the foundation for transferring data traffic from Internet content and applications from the core network to mini datacenters at the edge of the network in each metro location. This is similar to the content (not computing) challenge solved by Akamai in the early days of the Internet.

2. Are there wireless technology shifts underway disruptive to Zayo’s business model?

On the mobile infrastructure front, there are multiple trends underway: (1) more heavy lifting by low-cost super Wi-Fi-like indoor, versus outdoor, LTE deployments on commodity servers; (2) new cloud-based, shared spectrum bands; and (3) the use of wireless back-haul and front-haul in lieu of fiber connections to cell sites.

3.  Synergy potential is high at Allstream, but what is Zayo’s ability to execute its largest and most complex acquisition to date?

While Zayo expects $60 million in annualized cost synergies, we see key challenges, including: (1) a horizontal-based, versus vertical-based, sales and profitability platform (Canadian enterprise customers may not transition well to a transactionalbased relationship); (2) an entrepreneurial, versus mature, business culture; (3) Zayo s limited experience in managing a cybersecurity service portfolio, which may increase churn and lower revenue growth; (4) similarly, management’s lack of experience in managing a mature voice service platform (still a key part of an enterprise customer solution), which may result in increased customer and revenue churn; (5) the transition of Allstream SMB business to a pure reseller, which may increase customer churn.

From the Motley Fool:

CEO and co-founder Dan Caruso was generally pleased with the company’s progress. During the conference call following the announcement, Caruso pointed to the high potential of the overall movement toward 5G network technology, saying, “I can’t think of one macro trend that doesn’t play in favor of having deep, dense fiber networks and a communication infrastructure strategy.” That should bode well for the company’s overall business.

The nice thing about Zayo’s situation right now is that it has time to move forward at a healthy but measured pace. Thanks to its debt restructuring, Zayo has bought considerable time to consider expansion plans, with its new offering of notes maturing in 2025 allowing for longer-term strategic thinking. It’s true that the quarter’s GAAP loss was largely due to the immediate impact on Zayo’s financial statements that the extinguishment of the restructured debt had. But the long-term impact to Zayo’s business prospects should be extremely positive going forward.

Giving some of Zayo’s moves a higher profile would be one good way to bolster future growth. The company entered into an agreement with the Denver Public Schools system, connecting 153 sites and two data centers using more than 600 miles of network assets. An even larger school-district network in Texas also helped Zayo identify what could become a growth niche as education requires greater connectivity.