Steel City Capital Investments, LLC is the management company of the Steel City Capital fund. Michael G. Hacke is the fund’s founder and managing member. Recently, Steel City Capital released its Q1 2020 Investor Letter – a copy of which can be downloaded here. For Q1 2020, the fund reported a net return of -10.7%, while the S&P 500 returned -20.00%.
In the said letter, Michael G. Hacke spoke about Boingo Wireless Inc. (NASDAQ:WIFI) and Sp Plus Corp (NASDAQ:SP) stocks. Boingo Wireless offers mobile Internet access for wireless-enabled devices. SP+ facilitates the movement of vehicles, people, and personal belongings. Here is what Michael G. Hacke said:
“With stay-at-home orders covering the vast majority of the country and most people respecting social distancing guidelines, sporting events have been cancelled, malls are closed, and airports are empty. Among the more incredible illustrations of the fallout I have seen is a year-over-year comparison of the number of travelers who have passed through TSA checkpoints since the beginning of March. Overall traveler volumes are down a jaw-dropping 95%! Even as stay-at-home orders are gradually lifted, it is highly likely that people will continue to avoid large, densely populated locations. This spells trouble for both Boingo Wireless (WIFI) and SP Plus Corporation (SP).
WIFI acquires long term wireless rights at large venues like airports, transportation hubs, stadiums, arenas, universities, convention centers, and office campuses; builds wireless networks at these venues; and monetizes them through a variety of products and services. The company is the largest operator of indoor “Distributed Antenna System” networks in the world.
I have long been critical of WIFI’s preferred financial metric – EBITDA. As a brief refresher, the company includes non-cash revenue at a 100% margin in its EBITDA calculation. While the company reported ~$80 million of EBITDA in FY’19, nearly $70 million of it was tied to project build-out and non-recurring construction costs. Even the remaining $10 million of cash EBITDA was low quality as it included a $4.8 million contribution from non-recurring contract renegotiation fees and another $1 million benefit tied to a reduction in the fair value of acquisition-related contingent consideration. Accounting for all of the adjustments, true recurring cash EBITDA was more likely in the realm of $5 million. Management had previously announced a restructuring and cost cutting initiative that it forecast would save $11 million of cash costs annually, but even giving the company the benefit of the doubt for these savings, free cash flow would be fairly de minimis after accounting for $10-$12 million of maintenance capital expenditures. WIFI’s current market capitalization is ~$575 million. What is a company that doesn’t generate any free cash flow worth?
Making matters worse, a significant portion of WIFI’s revenue is at risk due to stay-at-home orders. The largest bucket of WIFI’s at-risk revenue is the company’s Wholesale offering where carriers pay usage-based network access fees based on utilization by customers. Wholesale revenue comprised $44 million, or 22% of the company’s recurring cash revenue in FY’19. Another $24 million of recurring cash revenue, or 12%, is tied to a combination of retail access where end-users pay to connect to the company’s network (for example, a business traveler might pay to access the internet while waiting in the airport lounge) and advertising driven access (for example, a company might provide travelers free internet access after they user is exposed to a splash page with an advertisement). With fewer people visiting venues served by Boingo – airports, train stations, stadiums, etc. – all three of these revenue categories will be negatively impacted, straining the company’s already weak cash flow.
SP Plus manages parking facilities, ground transportation, and ancillary services for airports, hotels, cruise lines, and similar customers across the country. The company offers service through two types of contracts: Lease and Management. In a Lease type contract, SP commits to pay a mostly fixed rental stream to the owner of a parking facility and in return collects all of the revenue and shoulders all of the expenses associated with the particular facility. SP bears most of the risk in this type of arrangement. In a Management type contract, the company receives a fixed rental stream from the owner of the parking facility and manages it on their behalf. The owner bears all of utilization risk and operating expenses, thereby reducing SP’s risk exposure. About 20% of SP’s gross profit is from Lease type contracts, with the balance coming from Management type.
There are several prospective pain points that I believe make SP a good short. For starters, approximately one-third of the company’s FY’19 gross profit was tied to aviation related services. With air travel having all but evaporated, airport parking lots are effectively empty. Second, the company’s Lease type contracts place a heavy fixed cost burden on the company. SP’s 10-K shows ~$230 million of lease obligations in the current year. Despite Lease type arrangements representing only 20% of the company’s gross profit, any prospective decline in parking revenue will be magnified through this fixed cost. Third, SP’s Management type contracts don’t afford the company as much revenue security as some believe. Specifically, SP notes that its Management type contracts “are typically for a term of one to three years, although the contracts may be terminated by the client, without cause, on 30-days’ notice or less, giving clients regular opportunities to attempt to negotiate a reduction in fees of other allocated costs.” I’m going to go out on a limb and guess there’s going to be a lot of Management type contracts cancelled and renegotiated in the coming year. Finally, the collection of issues highlighted above raise the possibility that the company runs up against its leverage covenant. Leverage was 3.0x at year end 2019 while the covenant currently sits at 3.75x, implying enough cushion for a potential decline in EBITDA of no more than 20%.”
In Q3 2019, the number of bullish hedge fund positions on WIFI stock decreased by about 7% from the previous quarter (see the chart here).
In Q3 2019, the number of bullish hedge fund positions on SP stock decreased by about 15% from the previous quarter (see the chart here).
Disclosure: None. This article is originally published at Insider Monkey.
