Cincinnati Bell Inc. NEUTRAL ZACKS CONSENSUS ESTIMATES (CBB-NYSE) SUMMARY

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1 March 04, 2015 Cincinnati Bell Inc. Current Recommendation SUMMARY DATA NEUTRAL Prior Recommendation Underperform Date of Last Change 11/03/2003 Current Price (03/03/15) $3.49 Target Price $ Week High $ Week Low $2.93 One-Year Return (%) Beta 1.24 Average Daily Volume (sh) 857,544 Shares Outstanding (mil) 210 Market Capitalization ($mil) $733 Short Interest Ratio (days) 8.03 Institutional Ownership (%) 75 Insider Ownership (%) 3 Annual Cash Dividend $0.00 Dividend Yield (%) Yr. Historical Growth Rates Sales (%) -2.0 Earnings Per Share (%) Dividend (%) N/A using TTM EPS N/A using 2015 Estimate 43.6 using 2016 Estimate -N/A Zacks Rank *: Short Term 1 3 months outlook 3 - Hold * Definition / Disclosure on last page SUMMARY Risk Level * (CBB-NYSE) Cincinnati Bell is poised to post stable financial results in the coming quarters, owing to its increased investments in strategic products, high-speed Internet offerings and higher managed service demand. The company s Wireline segment stands as the prime growth driver with strength in the Fioptics business from continuous fiber deployment. Further, the acquisition of CyrusOne will help it meet high demand for data center colocation services. However, erosion in local access lines owing to fierce competition poses a major roadblock in the company s growth path. Cincinnati Bell is also winding down its wireless operations amid persistent subscriber loss to national carriers, thus closing a recurring revenue stream. Hence, we expect the stock to perform on par with the broader market and retain our Neutral recommendation on it. Average, Type of Stock N/A Industry Diversified Com Zacks Industry Rank * 209 out of 267 ZACKS CONSENSUS ESTIMATES Revenue Estimates (In millions of $) Q1 Q2 Q3 Q4 Year (Mar) (Jun) (Sep) (Dec) (Dec) A 312 A 311 A 308 A 1,257 A A 320 A 328 A 308 A 1,279 A E 284 E 291 E 293 E 1,1392 E ,177 E Earnings Per Share Estimates (EPS is operating earnings before non-recurring items, but including employee stock options expenses) Q1 Q2 Q3 Q4 Year (Mar) (Jun) (Sep) (Dec) (Dec) 2013 $0.01 A $0.04 A $0.03 A -$0.05 A $0.02 A 2014 $0.04 A $0.00 A -$0.03 A -$0.07 A -$0.08 A $0.04E $0.17 E -$0.02 E -$0.02 E $0.08 E $0.01 E Projected EPS Growth - Next 5 Years % Zacks Investment Research, All Rights reserved S. Riverside Plaza, Chicago IL 60606

2 OVERVIEW Based in Cincinnati, OH, Cincinnati Bell Inc. is a full-service regional provider of data and voice communications services over wireline and wireless networks, a full-service provider of data center colocation and related managed services, and a reseller of information technology (IT) and telephony equipment. The company provides telecommunications service to businesses and consumers in the Greater Cincinnati and Dayton areas primarily on its owned wireline and wireless networks. Cincinnati Bell also provides business customers with outsourced data center colocation operations and related managed services in world class, state-of-the-art data center facilities, primarily located in Cincinnati, Houston, Dallas and Austin. The company has three operating segments: Wireline, Wireless, and IT Services and Hardware. Wireline (accounted for 57.7% of 2013 revenues): This segment provides local voice, data, longdistance, Voice-over-Internet Protocol (VoIP) and other related services to customers primarily in Ohio, northern Kentucky, and southeastern Indiana. Wireline voice and data services are offered through the company s ILEC subsidiary Cincinnati Bell Telephone Company LLC. The company also offers expanded voice and data services through its other subsidiary Cincinnati Bell Extended Territories LLC in Dayton and Mason, Ohio. Wireless (16%): The segment offers advanced digital voice and data communications services through the operation of a Global System for Mobile Communications/General Packet Radio Service (GSM) network with a 3G Universal Mobile Telecommunications System (3G) network overlay. Cincinnati Bell provides services in the company's licensed service territory, which includes Greater Cincinnati and Dayton, Ohio, and areas of northern Kentucky and southeastern Indiana. IT Services and Hardware (26.1%): This segment provides a full range of managed IT solutions, including managed infrastructure services, IT and telephony equipment sales, and professional IT staffing services. These services and products are provided in several states through the company's subsidiaries, Cincinnati Bell Technology Solutions Inc. (CBTS), CBTS Canada Inc. and CBTS Software LLC. In Jan 2013, Cincinnati Bell separated its Data Center Colocation segment through an initial public offering of CyrusOne Inc. Data Center Colocation (0.2%): From Jan 2013, CyrusOne Inc. Cincinnati Bell s former data center business started operating as a separate entity under the symbol CONE. An operating partnership CyrusOne LP will manage the data center business. Although Cincinnati Bell owns approximately 69% of the interests of CyrusOne via its ownership of common shares and partnership units of CyrusOne L.P, the former exhibits no control over the operations of the newly formed company. REASONS TO BUY Cincinnati Bell remains focused on transforming the company into a fiber-based communications, entertainment and IT solutions company, with growing revenues, profitability and cash flow. With a well-designed marketing program, popular brand value and strong reputation of offering highquality service, the company expects to increase its wireline revenues. The company operates a number of distribution channels with stores located in affordable areas to support the functions of the wireline segment. Post the sale of its wireless assets, Cincinnati Bell will continue to sell Equity Research CBB Page 2

3 Verizon s wireless products at its retail locations. In the third quarter of 2014, the company successfully completed the sale of its wireless spectrum for $194 million. Increased investments in strategic products are expected to open up ample opportunities for enterprise customers, thus enhancing revenues and profitability. Continuous demand for higher speed is poised to boost strategic revenues from business customers. Bolstered by these positive factors, the company has issued a revenue and adjusted EBITDA projection of approximately $1.1 billion and $297 million (plus or minus 2%), respectively, for 2015, excluding the wireless segment. In the Wireline business, the company s investments in Fioptics products, which provide entertainment, high-speed Internet, and traditional voice via fiber line to the home, are on an uptrend. Cincinnati Bell continues to deploy fiber network, which is expected to provide high quality video and internet service to its residential customers. Revenue growth in Fioptics along with enterprise fiber-based and VoIP products should negate some of the access line losses in the wireline segment. Cincinnati Bell continues to expand the availability of its Fioptics fibre-tothe-home product suite, which provides entertainment, high-speed Internet and voice services. Fioptics video subscribers totaled 91,400 at the end of the fourth quarter, up 23% from the yearago quarter. The company also intends to continue investing in Fioptics networks and expects to spend $75 $80 million in expansion. These investments enhance customer experience, thus improving ARPU and checking the churn rate. We also appreciate the company s focus on upgrading its network with the help of software improvement. Cincinnati Bell is concentrating on developing its IT Services and Hardware division with the aim to reap in more businesses from the segment. This unit of the company is designed to reduce cost and mitigate operational risks at the other two segments. The company s team of efficient and highly skilled IT professionals offers a wide array of services to clients at competitive rates and is foreseeing increased demand for our virtual data center and staff augmentation services. Demand for Managed & Professional services remains strong and is expected to enhance the company s results. Further, with the majority interest in CyrusOne, the company expects to gain from its strategic locations and strong relationships with high quality customers. Cincinnati Bell continues to scrutinize all options to monetize its investments and enhance shareholder returns. The carrier wants to maximize its return to meet the capital requirement of its fiber business. For 2015, CyrusOne expects revenue and EBITDA growth of 14% and 12%, respectively. A healthy financial base also supports the performance of Cincinnati Bell. The company ended the fourth quarter with net debt decreasing to $1,784.2 million from $2,260.6 million at the end of REASONS TO SELL Cincinnati Bell continues to experience erosion in high margin local access lines. With Digital Subscriber Line (DSL) and cable modems gaining widespread acceptance, customers are deactivating the extra phone lines that were used to access the Internet via dial-up modem. In addition, the shift toward wireless services and aggressive rollout of VoIP and long distance services by Tier-1 competitors such as AT&T and Verizon in Cincinnati and Dayton has further contributed to access line erosion. The company exited the fourth quarter with 82,400 wireless subscribers, including 43,500 and 38,900 post-paid and prepaid customers, respectively. This compares unfavorably with 339,700 wireless customers recorded in the year-ago quarter and 176,800 in the previous quarter. Like other wireline carriers, Cincinnati Bell is confronting competitive threats from local cable operators (such as Time Warner Cable), who aggressively deploy local phone service in addition to television. This has already resulted in the loss of major Equity Research CBB Page 3

4 business customers. Additionally, improved housing market in Greater Cincinnati has led residents to switch homes, thus increasing multi-tenant Fioptics churn. Expansion as well as maintenance of the company s networks requires significant capital expenditures. As other national and regional wireless carriers are continuously upgrading their networks with various technologies, Cincinnati Bell needs to constantly keep up with the latest technologies to safeguard its position and counter competition. The company is lagging behind its national competitors in areas of 4G networks as well as network speed. Further, closing down of Cincinnati Bell s wireless operations will put increased pressure on its cash balance this year. Further, the company might face cash pressure owing to the recently declared IT outsourcing initiative. The company also continues to invest in Fioptics, which is very crucial for its wireline growth. These investments are likely to affect the company s earnings in the future. Although CyrusOne will operate as a separate entity, we believe that Cincinnati Bell will take some time to fully reap the benefits of this spin-off. The process of segregating CyrusOne into the company has resulted in impacting the ongoing business structure, standards, procedures and policies of Cincinnati Bell. The failure of Cincinnati Bell to comply with the organizational changes will likely affect its earnings and cash flow in the future. Cincinnati Bell, along with its subsidiaries, faces a number of lawsuits, actions, proceedings, claims and other matters. We are apprehensive that the company s reputation and finances will be hampered if the verdicts of these cases are against it. Moreover, it is extremely difficult to estimate the expenses associated with these legal cases. RECENT NEWS Cincinnati Bell (CBB) Posts Q4 Loss as Expected, Revenues Beat Telecom service provider, Cincinnati Bell Inc. (CBB), reported mixed financial results for the fourth quarter of 2014 with the top line surpassing the Zacks Consensus Estimate and the bottom line meeting the same. On a GAAP basis, quarterly net loss stood at $20.9 million or $0.10 per share compared with a net loss of $30.7 million or $0.15 per share in the year-ago quarter. However, adjusted (excluding special items) loss per share of $0.07 was in line with the Zacks Consensus Estimate. Quarterly total revenue stood at $308.3 million, flat year over year but above the Zacks Consensus Estimate of $287 million. Operating income stood at $7.3 million, down 82% year over year owing to higher service costs and depreciation and amortization charges. Meanwhile, adjusted EBITDA (earnings before interest, depreciation and amortization) decreased 13.3% year over year to $78 million in the reported quarter. EBITDA margin stood at 25% in comparison with 29% in the year-ago quarter. Cash Flow In the fourth quarter of 2014, Cincinnati Bell generated $54.4 million of cash from operations compared with $19 million in the prior-year quarter. Quarterly free cash flow was a negative $0.4 million compared with a negative $30.9 million in the year-ago quarter. Liquidity Equity Research CBB Page 4

5 Cincinnati Bell ended the reported quarter with cash and cash equivalents of $57.9 million, substantially up from $4.6 million at the end of Net debt decreased to $1,726.3 million from $2,260.6 million at end Segmental Results Wireline revenues improved 3% year over year to $188.4 million owing to a 34% increase in Entertainment revenues and 3% hike in Data revenues. The improvement was partially offset by an 11% decline in voice revenues. Meanwhile, long distance and VoIP revenues remained same year over year. Meanwhile, investments in the strategic fibre business produced strong wireline revenues for the company. Total local access lines deteriorated 2.5% from the previous quarter to 480,600, of which residential customers accounted for 238,300 lines while business customers claimed 242,300. The company lost 6,000 high-speed Internet customers (Fioptics) during the reported quarter, taking its total subscriber tally to 269,900 (including 156,200 DSL broadband users). Cincinnati Bell continues to expand the availability of its Fioptics fibre-to-the-home product suite, which provides entertainment, high-speed Internet and voice services. Fioptics video subscribers totaled 91,400 at the end of the fourth quarter, substantially up from 3,600 in the year-ago quarter. IT Services and Hardware revenues moved up 27% year over year to $109.5 million. The upside was driven by 32% higher revenues from Telecom and IT equipment distribution and 19% revenue growth in Managed and professional service revenues. Wireless revenues declined 65% year over year to $16.8 million owing to lower service revenues (down 64%) and equipment revenues (down 70%). The company exited the fourth quarter with 82,400 wireless subscribers, including 43,500 and 38,900 post-paid and prepaid customers, respectively. This compares unfavorably with 339,700 wireless customers recorded in the year-ago quarter and 176,800 in the previous quarter. CyrusOne Results At present, Cincinnati Bell effectively controls 44% of CyrusOne as an equity method investment, valued at $785 million, as of Dec 31, CyrusOne reported strong fourth-quarter 2014 revenues of $87 million and adjusted EBITDA of $45 million. Outlook For full-year 2015, the company expects revenues and adjusted EBITDA of approximately $1.1 billion and $297 million (plus or minus 2%), respectively, excluding the wireless segment. VALUATION The stock is trading at a premium to the peer group and the S&P 500, based on forward earnings estimates. We remain wary of loss of revenue due to access line losses, closing of the wireless business and expected pressure on cash balance. Cincinnati Bell displays strong long-term prospects driven by an improving wireline unit, robust rollout of Fioptics products and growing demand for data center services. The company s focus on customer satisfaction along with investments to enhance its Fioptics operating Equity Research CBB Page 5

6 base is expected to prove beneficial in the long run. Hence, we maintain our Neutral recommendation for Cincinnati Bell with a target price of $3.75, based on 46.9x our 2015 earnings estimate. Key Indicators F1 F2 Est. 5-Yr EPS Gr% P/CF 5-Yr High 5-Yr Low CINCINNATI BELL (CBB) Industry Average S&P IDT CORP-CL B (IDT) B COMMUNICATION (BCOM) VONAGE HOLDINGS (VG) HAWAIIAN TELCOM (HCOM) TTM is trailing 12 months; F1 is 2015 and F2 is 2016, CF is operating cash flow P/B Last Qtr. P/B 5-Yr High P/B 5-Yr Low ROE D/E Last Qtr. Div Yield Last Qtr. EV/EBITDA CINCINNATI BELL (CBB) Industry Average S&P Equity Research CBB Page 6

7 Earnings Surprise and Estimate Revision History Equity Research CBB Page 7

8 DISCLOSURES & DEFINITIONS The analysts contributing to this report do not hold any shares of CBB. The EPS and revenue forecasts are the Zacks Consensus estimates. Additionally, the analysts contributing to this report certify that the views expressed herein accurately reflect the analysts personal views as to the subject securities and issuers. Zacks certifies that no part of the analysts compensation was, is, or will be, directly or indirectly, related to the specific recommendation or views expressed by the analyst in the report. Additional information on the securities mentioned in this report is available upon request. This report is based on data obtained from sources we believe to be reliable, but is not guaranteed as to accuracy and does not purport to be complete. Because of individual objectives, the report should not be construed as advice designed to meet the particular investment needs of any investor. Any opinions expressed herein are subject to change. This report is not to be construed as an offer or the solicitation of an offer to buy or sell the securities herein mentioned. Zacks or its officers, employees or customers may have a position long or short in the securities mentioned and buy or sell the securities from time to time. Zacks uses the following rating system for the securities it covers. Outperform- Zacks expects that the subject company will outperform the broader U.S. equity market over the next six to twelve months. Neutral- Zacks expects that the company will perform in line with the broader U.S. equity market over the next six to twelve months. Underperform- Zacks expects the company will under perform the broader U.S. Equity market over the next six to twelve months. The current distribution of Zacks Ratings is as follows on the 1126 companies covered: Outperform %, Neutral %, Underperform 8.2%. Data is as of midnight on the business day immediately prior to this publication. Our recommendation for each stock is closely linked to the Zacks Rank, which results from a proprietary quantitative model using trends in earnings estimate revisions. This model is proven most effective for judging the timeliness of a stock over the next 1 to 3 months. The model assigns each stock a rank from 1 through 5. Zacks Rank 1 = Strong Buy. Zacks Rank 2 = Buy. Zacks Rank 3 = Hold. Zacks Rank 4 = Sell. Zacks Rank 5 = Strong Sell. We also provide a Zacks Industry Rank for each company which provides an idea of the near-term attractiveness of a company s industry group. We have 264 industry groups in total. Thus, the Zacks Industry Rank is a number between 1 and 264. In terms of investment attractiveness, the higher the rank the better. Historically, the top half of the industries has outperformed the general market. In determining Risk Level, we rely on a proprietary quantitative model that divides the entire universe of stocks into five groups, based on each stock s historical price volatility. The first group has stocks with the lowest values and are deemed Low Risk, while the 5 th group has the highest values and are designated High Risk. Designations of Below-Average Risk, Average Risk, and Above-Average Risk correspond to the second, third, and fourth groups of stocks, respectively. Equity Research CBB Page 8