In the last post I discussed how the NTS fiber roll-out might progress over the next few years. The discussion focused specifically on typical residential and business customers. But NTS also has the opportunity to sell “backhaul” services (sometimes also referred to as fiber-to-the-tower) to telecom companies. Backhaul consists of providing ground transportation (via fiber) for data coming to and from wireless towers. In some of NTS’s ARRA  towns, AT&T and Verizon offer spotty or no 4G coverage. If Verizon or AT&T or another telecom competitor wants to offer high-bandwidth wireless services in these towns, the easiest way to do it will be to utilize NTS fiber for backhaul, since the fiber is capable of carrying so much more bandwidth than the old copper backhaul infrastructure that is currently in place and creating bottlenecks that are barriers to 4G service.

The beauty of backhaul revenue for NTS is that it costs nothing to provide. NTS would simply be agreeing to allow the data to traverse its already-laid fiber, so the profit margin is essentially 100%. I have no way of quantifying the size of this opportunity or estimating how much backhaul revenue NTS will generate, or may already be generating. All I can say is that the AT&T/Verizon coverage issues prove that some opportunity still exists. Even if NTS ended up selling just $1 million of backhaul services, that would still translate to an added $1 million of pre-tax profit.

Now to NTS’s legacy copper, or “CLEC” business. This business is in a slow but steady decline:

The CLEC business as whole has two components: providing T1/DSL services to residential and business customers, and providing “private line” services to business/government customers. The CLEC business as a whole is currently generating just under $40 million of revenue.

In the T1/DSL business, NTS acts as a reseller, buying capacity on other companies’ copper networks and re-offering it via voice/data packages to customers. This business is in steady decline as customers switch to fiber and in some cases wireless. Eventually the business will be gone completely, but how long that will take is hard to say.

In the meantime, NTS has been doing a good job of reducing costs in the T1/DSL business as it declines. Consolidated SG&A has actually gone down (from about $6 million quarterly to $5 million) even as total revenues have stayed flattish, with growth in fiber offsetting declines in the T1/DSL business.

The other CLEC business—the private line business—is a bit more complex. This business uses 3^rd party copper, fiber, and Ethernet assets, as well as, increasingly, NTS’ own fiber assets, to form specialized wide-area networks specifically for local government and enterprise customers. NTS management hasn’t spoken much to the trends in this business, but other companies that provide similar services (Global Telecom & Technology, or GTLT, is one) have seen growth roughly in line with GDP.

I don’t know if NTS has ever disclosed the size of its private line business, but I can make a guess. Based on this very helpful data from communications industry research firm JSI Capital Advisors, access lines industry-wide have been declining at about 10-11% per annum. However, over the past three years the NTS CLEC business has averaged just 7-8% declines, suggesting that the private line portion—which is probably not shrinking much if at all—is approximately 25% of the total CLEC business, or $10 million of revenue. Even as the residential and business CLEC revenues whittle away, the private line business should remain. I don’t know the margin but I assume it’s about 10% EBITDA based on private line industry research I’ve done.

So, adding it all up, here is where I come out:

I’ve averaged the EBITDA figure at the bottom to reflect the fact that these numbers are based on end-of-year subscriber counts, but the actual profits generated will be less because the company will start each year at a lower subscriber count than the count at which it finishes the year.

Obviously I’ve assumed zero contribution from backhaul here. I think ultimately the backhaul revenues will materialize because I don’t think the telecoms have many other options, but I’m not assuming anything here because I don’t know how to quantify the opportunity.

Here is how I think the EBITDA forecasts above will flow through to cash flow and the balance sheet:

A couple of notes:

1. NTS has net operating losses that it can apply to future profits. Between those NOLs, the depreciation expense related to the fiber build-out, and the interest the company is paying on its debt, I don’t anticipate NTS paying cash taxes during the next three years. 
2. I use maintenance capital expenditures of $200 annually per subscriber. This is approximately equal to what Comcast and Time-Warner cable both report for total capital expenditures per subscriber. I think the actual expense for NTS should be lower given that rural labor is cheaper and NTS won’t have to contend with dense urban infrastructure when it needs to fix things, but $200 is fine for now since it’s a good comparable data point. 
3. I haven’t included any ARRA network-related capital expenditures because those expenditures will be covered by drawdowns on the unused ARRA debt. I’ve assumed NTS will continue to draw down the ARRA debt over the next three years until the entirety of the debt is drawn. 
4. I’ve assumed $7 million of growth capital expenditures; $1 million to finish up the Wichita Falls network, and $6 million for the two new unnamed markets NTS announced it has begun building out. The Wichita Falls network cost $3 million to construct; I’m assuming each of the other new markets costs the same. 
5. In year 3, I assume all the options (save for a few tranches that are almost certain to expire worthless) are converted, bringing the company $11 million of cash, but also increasing the fully diluted share count to 51 million. 
6. For the sake of simplicity I’ve assumed that excess cash simply builds on balance sheet, but in reality I think it will be used pay down the non-ARRA debt aggressively, given that the rates on that debt are in the double digits. Rapid reduction of that debt would increase cash flow by reducing interest expense. 

In the next and final piece on NTS, I’ll explain why I think NTS can be a $3 stock in three years.

To be continued…