Player Avatar pseud (97.39) Submitted: 12/31/2009 1:37:56 PM : Underperform Start Price: $15.81 CBEY Score: +26.49

My attention was first drawn towards CBEY when they made the Citron Research Hall of Shame. Not content with taking Citron's research at face value, I decided to dig into the numbers myself. Upon scratching below the surface, my conclusion is that their operational metrics are far worse than it appears at first glance. The key culprit here is churn rate.

If you look at the current churn rate of 1.4-1.5% per month, it seems to appear that their average customer lasts 5.5 to 6 years. With a $750 per month ARPU and their historical 18-22% cash profit margin (before capex and working capital adjustments), the math tells you that each customer should be worth approx. $8,000 (assuming zero capex and 10% discount rate). The market is valuing their 49,000 or so customers at $8,700 today. A little pricey but not bad given that they have been growing their subscriber base by entering new markets (and in the process burning up pretty much all of their free cash flow).

But this is where the numbers begin to get convoluted. It seems that most of their customers have 3 year contracts. If you glean through their public filings and look at their customer base 3 years ago and the number of customers they were adding at that time, you will see an entirely different picture. Based on the publicly available numbers, it is my estimate that 75-80% of their customers do not renew their contract with them after 3 years. One, that speaks something about the value proposition of their business and two, even if the remaining 20-25% of their customers stay with them for 6-8 years, it gives them an average customer life of 3.6 to 4.2 years. Assuming a customer life of 4 years, the implied churn rate is 2.1% and a generous valuation per customer is $5,700. In reality, the company will need to spend capex even if it stops growing, so a more accurate valuation would be $4,000-$4,500 per customer.

While in the short term the company may continue to grow their subscriber base, they are running out of growth opportunities and their customer attrition will ultimately catch up with them. Add to that (i) the ongoing economic pressures on small businesses and (ii) declining ARPU due to commodity like product and fierce competition from much larger providers. Nothing seems positive for this company.

In my view, this business is worth $200-$250 mm today, implying a $8-$9 stock price.

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