In recent years, I have seen a trend of analysts shunning asset–heavy stocks for their more efficient counterparts. However, investors should not confuse capital inefficiencies with competitive advantages derived from assets. Asset intensive companies also typically face less threats from substitute products and the entry of new competitors. EarthLink, Inc. (NASDAQ:ELNK), a domestic IT services, network and communications company, belongs to this category of companies with a significant network footprint covering most of the country. Furthermore, EarthLink, Inc. (NASDAQ:ELNK) sports a decent 3.4% dividend yield and has the strongest balance sheet amongst its peers. It is also valued attractively at 4.1 times EV/EBITDA, at a discount to its peers.
Hard assets provide barriers to entry
Although there is a trend of companies moving towards asset-light business models with an eye on better margins, hard assets represent barriers to entry that really keep new entrants and competitors at bay. In EarthLink, Inc. (NASDAQ:ELNK)’s case, its broad network footprint covering more than 90% of the U.S. is not easily replicated, with the estimated cost to build networks of EarthLink’s scale running into billions of dollars. EarthLink is not resting on its laurels and it expanded its data center presence with the opening of several new next generation data centers in Chicago and Dallas in the past year.
The trend is not only a trader’s best friend
The adage “the trend is your best friend” does not just work for traders; investing based on fundamental analysis could derive valuable insights from observing trends in operating metrics. For example, while many listed companies quote “strong recurring revenues” as one of their key investment metrics, it is necessary to examine trends such as the amount of customers failing to renew or cancelling their existing contracts and the length of existing customer relationships. EarthLink, Inc. (NASDAQ:ELNK)’s customer churn for both its business and consumer segments are on a downward trend, with consumer churn of 2.2% in the first quarter of 2013 representing a historical low, according to its most recent investor presentation. In addition, more than 70% of consumer subscribers have been with EarthLink for more than five years. Customers who stay longer with EarthLink tend to be happier customers as well. This results in tangible benefits such as less customer complaints, which are a drain on call center resources, and a lower occurrence of late customer payments and defaults.
Signficant tax assets to reduce future taxable income
The ideal stock investment from a tax advantaged viewpoint, is a turnaround or transition story with accumulated retained losses offsetting growing earnings. EarthLink, Inc. (NASDAQ:ELNK) is such a stock with growth in its IT services business offsetting the decline in revenues from its legacy products and services such as voice services. EarthLink has significant tax assets that will help to reduce income taxes going forward. In addition to more than $700 million of net operating losses (NOLs) for state income tax purposes, EarthLink, Inc. (NASDAQ:ELNK) also has federal NOLs amounting to close to $500 million. Furthermore, it will also be able to utilize depreciation and amortization tax shields from its 2010 purchase of One Communications, which is treated like an asset acquisition for taxation purposes.
Peer comparison
EarthLink’s peers include TW Telecom Inc (NASDAQ:TWTC) and Windstream Corporation (NASDAQ:WIN). EarthLink, Inc. (NASDAQ:ELNK) is valued by the market at 4.1 times EV/EBITDA, at a discount to its peers. In comparison, TW Telecom and Windstream trade at higher EV/EBITDA multiples of 10.1 and 6.0, respectively.
