Quick Post-Earnings Updates on WOW and STKL

Latest thoughts on two portfolio ideas

With earnings season in full swing, I'm back with updates on two portfolio names: WOW and STKL (short). I would consider the update on WOW mostly positive, while STKL's recent earnings were more mixed, but I believe the investment thesis remains on track.

Let’s dive right in.

WideOpenWest (WOW) — initial post here, last update here

A quick recap for those unfamiliar with the investment thesis: WOW is a cable and fiber overbuilder that, in May, received a non-binding takeover proposal at $4.80/share from a consortium led by its major shareholder, Crestview Partners (owns 39%), and the digital infrastructure investment firm DigitalBridge. Several equity holders, including the largest minority shareholder, LB Partners (owns 8%), have opposed the acquisition, calling it lowballed and highly opportunistic. Multiple reference points, including industry transactions and peer valuations, suggest significant headroom for a higher offer.

WOW recently reported Q3 results. Let’s start with the most important takeaway from the earnings release: the takeover process remains ongoing. During the earnings release and conference call, management emphasized that the special committee continues to review the takeover bid from Crestview and DigitalBridge, stating that “nothing has changed” regarding the go-private process (see the exchange below). WOW’s recent announcement of a new $200m loan might have raised some concerns for the buyout thesis. So, this update is clearly a positive, suggesting that the takeover by the major shareholder is still very much on the table.

Question: Great. You probably can't comment, but I just wanted to see if you can confirm that both DigitalBridge and Crestview were still involved in the pursuit for the go private or if anyone dropped out? Or has anyone else approached you on the deal? Is there anything you can comment around that?

Answer: I guess what we can say is that nothing has changed from our previous updates that we've given you.

On the operational performance front, results for the quarter were mostly in line with management’s expectations and previous trends. Revenues and high-speed data (HSD) subscriber decline aligned with management’s earlier Q3 guidance, while EBITDA came in above the guidance range.

One point I would like to elaborate on is the modest net broadband subscriber decline, which stood at 4.4k subscribers for the quarter (vs. 481k total HSD subscribers). It’s worth noting that a large portion of this decline, 1.9k, was due to customer roll-off related to the Affordable Connectivity Program. Why highlight this? Well, the modest decline confirms that the significant subscriber churn seen in H2 2023 has now normalized. To quickly recap, poorly managed price increases, coupled with intensifying competition, led to a substantial decline in WOW’s subscriber numbers in Q3 and Q4 (see the chart below, in Q2 2024 declines were driven, in large part, by customer roll-off related to the ACP). So, we can reasonably conclude that the steps taken by WOW’s management, including updated pricing plans in early 2024, have significantly improved customer retention since Q1. Given that the buyer consortium made an acquisition offer just days before Q1 results, the normalization in churn highlights the opportunistic nature of the takeover bid.

As for the fiber build-out, penetration rates have continued to grow across WOW’s greenfield build-outs and most of the edge-out vintages (see the chart below). The expansion slowed significantly during the quarter (growth capex at $11m vs. $33m in Q3 2023), as the company was “preserving liquidity” while awaiting the $200m loan. However, with the financing now secured, management expects expansion capex to recover and remain in line with 2024 levels (c. $70m) “for the next year or two.”

WOW management’s FY24 guidance is broadly in line with year-to-date performance. While the company expects a substantial decline in subscriber base in the range of 16.5k–19.5k, most of this decline is expected to be driven by one-off events, including the ACP roll-off (6.9k subscribers) and recent hurricanes (6k–7k). Speaking of the hurricanes, management highlighted that most of WOW’s network in Florida is already operational, indicating no significant infrastructure damage.

So, these are my quick thoughts on WOW’s Q3 results. To quickly summarize, the key takeaways are: 1) the takeover process is ongoing, and 2) there were no major updates on the operational performance front that could negatively impact the buyer's perception of WOW’s value. So, I would consider the earnings as positive for the takeover thesis.

Now, you might point out that the time elapsed since the non-binding offer—six months—is somewhat concerning, especially considering Crestview’s long history with the company (stake in WOW acquired in 2015). Nonetheless, given that WOW’s management reiterated the sale process is ongoing, and considering Crestview and DigitalBridge’s solid reputations, I don’t believe this extended timeline indicates any significant negotiation difficulties. I would also note that this timeline is not unusual for non-binding takeovers from major shareholders. For example, CNSL received a non-binding takeover bid from a consortium led by its major shareholder, Searchlight Capital Partners, in April 2023, before announcing a definitive agreement in October 2023.

WOW's share price has increased slightly since the earnings release, and the stock now trades at a 15% premium to the non-binding offer, reflecting the market’s view that a price bump is likely.

Where could the price increase land? To answer this, let’s quickly reassess WOW’s valuation. At current prices, WOW is trading at 5x 2024E and TTM EBITDA. This is an undemanding valuation, aligning with the lower end of historical lower-quality copper/DSL asset acquisitions, and below peer multiples of 6x+. Nonetheless, valuing WOW’s existing cash-generative assets at this multiple and simply adding the capex spent on the fiber assets would yield a price target of c. $7/share, or a 25%+ upside.

And this valuation at cost may significantly undervalue WOW’s fiber assets. To illustrate, I would refer you to WOW’s medium-term forecasts released as part of the $200m loan agreement. As shown below, at the low end of management’s projections, the greenfield fiber assets could generate over $50m in EBITDA by 2028. Applying any sort of conservative multiple to this earnings stream, say 7x, and valuing WOW’s remaining business at the current EBITDA multiple, would imply a price target of around $9/share. And I would highlight that, during the Q3 call, WOW’s management noted that the projections might be conservative and do not incorporate investments into fiber build-out expected to be made with proceeds from the new loan (see the quote below).

What we put out, Brandon, was pretty -- the trajectory of the model that was used while we were out raising the funds. That could be your baseline starting point. One thing that, that didn't anticipate was that the money would actually be raised. So I think you're going to have to look at it in that light. We'll give more clarity to what we think '25 looks like when we do next quarter's call.

I must note that these fiber asset value estimates are not precise as they rely on management’s medium-term forecasts. Nonetheless, this exercise directionally highlights the headroom for the buyer consortium to raise the offer while still preserving ample value for themselves.

Given the attractive setup dynamics, I continue to view WOW as one of the most intriguing special situations in the market, and I have maintained my position.

Sunopta (STKL) — initial post here, last update here

Let's turn now to another portfolio position, the STKL short.

To quickly recap the investment thesis, STKL provides an opportunity to bet on a potential downturn in the plant-based milk industry. Historically undersupplied, this market saw explosive demand growth during the pandemic, prompting a significant increase in production capacity. The crux of the thesis is that with this increased capacity and demand normalizing, the industry will shortly tip from undersupplied to oversupplied. This is likely to lead to lower plant-based milk prices, negatively impacting producers' growth and margins.

Yesterday, STKL reported Q3 results. The strong operational performance seen in Q2 continued this quarter, with solid 16% revenue growth, driven by a 21% increase in volumes. Strong performance was driven largely by continuing strong growth in the foodservice (i.e., coffee shop) channel. Higher volumes were partially due to continuing ramp-up of the third line at STKL’s Midlothian facility (see the quote below).

Output in Midlothian is increasing with the third line contributing as expected. To provide just a few data points on Midlothian's performance this quarter, the facility produced more than double the volume of 3Q 2023, and more telling about the opportunities ahead, produced 20% more units than in the second quarter of 2024. We continue to see opportunities to drive further improvement in Midlothian run rates and output.

As for outlook, management reaffirmed its 2024 guidance, with mid-teens growth in revenues and EBITDA expected for the year. The company highlighted the recent announcement of a major expansion of one of its oat milk products to 6,700 stores for one of its largest coffee shop customers. This expansion will utilize nearly all of the oat extraction capacity at STKL's Modesto, California, plant. As a quick reminder, STKL completed a significant expansion of the Modesto facility's oat extraction line back in June.

So, I would regard the earnings as negative for the short thesis. With strong volume and revenue growth over recent quarters and management planning further production ramps to meet incremental demand, one could reasonably conclude that the anticipated plant-based milk industry inflection has either not yet materialized or has not significantly impacted STKL's performance.

While the short thesis has not played out as expected so far, I continue to expect a negative inflection in the plant-based milk industry. Why? I believe the industry is nearing oversupply in the coming quarters, given increasing capacity and normalizing consumer demand. On the supply side, as discussed previously, the third line of the Midlothian facility will bring total industry supply to 1,250m liters, which is roughly in line with total industry demand at 1,278m as of 2023. On the demand side, I would highlight recent data showing that plant-based milk retail sales have continued to decline, with a 5% drop in the 52 weeks ending mid-July.

Now, you could reasonably state that the weaker demand in the retail channel has been more than offset by growth in the coffee shop channel. While this appears true, I think STKL’s management might be overstating the importance of foodservice. Why? The company has repeatedly stated that untracked (i.e., foodservice) channels comprise the majority of its sales, with management mentioning in the Q2 call that tracked channels represented only “one fifth of the market we serve.” However, I find it difficult to reconcile this with the growth rates seen in the retail and foodservice channels. Management has stated that foodservice is growing at double-digit rates (11% last disclosed in Q1 2024) compared to overall plant-based milk growth at mid-single digits. Though growth for tracked channels hasn’t been disclosed, management mentioned that company’s tracked channel customers have outperformed the overall category. With these data points, one could reasonably conclude that the company generates roughly 40–50% of its revenue from the retail channel. Interestingly, this would be in line with STKL’s peer OTLY, which generates 46% of its North American revenue from the retail channel. Here, I would also note that the lack of channel breakdown disclosure from STKL, despite the foodservice channel's touted importance and solid performance, is somewhat puzzling.

Another aspect I would highlight is the sustainability of the rapid volume growth in the foodservice business over recent quarters. The surge in volume growth in 2024 appears to have been largely driven by new product launches and market share expansion. During the recent conference call, STKL's CEO noted that c. 50% of Q3 revenue growth was due to new product launches, with the remainder attributed to market share expansion. Significant further market share growth might be unlikely, as STKL already holds c. 70% of the shelf-stable milk market, making it the dominant player. As for new product launches, while difficult to predict, given broader consumer weakness, I would not expect this to be a steady driver of strong foodservice channel performance. Now, this is partly speculation on my part, but my point is that the rapid volume growth seen in recent quarters, which might have helped masked some underlying weakness in the foodservice business, could potentially normalize going forward.

So, that’s my take on Q3 results: While the thesis hasn’t worked out as expected so far, I continue to believe that we may be approaching a negative inflection for the plant-based milk industry. This would likely lead to a deterioration in STKL’s pricing, which would impact top-line growth and margins in the coming quarters. So, I am inclined to give STKL another quarter before reassessing my short position.

Now, let’s quickly reassess the valuation. At current share price levels, STKL is trading at 12.1x 2024E EBITDA. I still believe that 2024 EBITDA ($90m at the midpoint) does not reflect the company’s normalized earnings power. Nonetheless, even on an elevated 2024E EBITDA, the multiple seems too high for a business that has consistently struggled with profitability and cash flow, has a volatile growth history, and operates in an industry likely facing a downturn.

I will be waiting for OTLY’s Q3 results and monitoring any relevant industry news or data. For now, I still believe STKL remains an attractive short and have maintained my position.