Investing in early-stage infrastructure companies can be a scary experience. Money seems to disappear into holes in the ground, without ever generating any revenue.
Shareholders of CityFibre Infrastructure Holdings (LSE: CITY) may understand this. The company – in which Neil Woodford’s fund management group has a 17% stake – is building fibre networks in secondary cities around the UK. The plan is to attract corporate customers and do deals with retail broadband providers.
Initial progress may have seemed slow, but things are changing. CityFibre’s £90m acquisition of KCom‘s fibre network last year has boosted momentum. CityFibre added 5,063 new connections last year and now has contracted future revenues of £75.5m. This compares well with 1,100 new connections and £23.2m in 2015.
Revenue rose 140% to £15.4m in 2016, while gross profit increased by 145% to £13.5m. This highlights the potentially profitable nature of this business, but rising administrative costs meant that the firm still reported an operating loss of £5.1m.
CityFibre is aiming to become a third national network operator, alongside BT Group (LSE: BT-A) and Virgin Media. It’s an ambitious goal but the political climate seems to be improving. BT is being forced to separate Openreach more cleanly from its other operations, and is coming under increased pressure to level the playing field for smaller rivals.
Putting a value on CityFibre shares is difficult at the moment. The group’s stock has risen by 17% over the last month after the firm hinted that it might consider a trade sale. But if this doesn’t happen CityFibre is almost certain to need more funding. Recent press reports have suggested the group will look to refinance its entire £100m borrowing facility this year.
Although I’d rate CityFibre as a speculative long-term buy at current levels, smaller shareholders do face the risk of heavy dilution in future fundraising rounds.
Is there worse to come?
When BT confessed to a £530m Italian accounting scandal in January, it hit the headlines. But many commentators appeared to overlook the other big news it released on the same day – a profit warning.
BT told investors that it was experiencing a slowdown in UK public sector and international corporate business. This would result in “a double-digit percentage decline” in fourth quarter underlying earnings in its Business and Public Sector division.
This downgrade – plus the group’s Italian problems – led to a 5% fall in consensus earnings forecasts for the 2016/17 financial year, which ended on 31 March.
In May, we’ll find out whether the outlook for the year ahead has worsened since January. We’ll also learn whether BT’s £11bn pension deficit has got any bigger, and whether the group’s net debt of £8.9bn has started to shrink.
The wrong time to buy
At first glance, BT’s forecast P/E of 11 and prospective yield of 4.9% may seem cheap. But the weakness reported for Q4 may persist this year. I think there’s a good chance of more bad news on profits at some point this year.
I also expect BT to abandon its commitment to maintain 10% annual dividend growth and, in my view, a dividend cut is quite likely. Until the group’s highly-rated new chairman Jan du Plessis takes charge in November, I plan to remain on the sidelines.