Zayo Group Keeps Searching for Its Whale

The need to collect and analyze data has become extremely important among enterprises of all sizes. In order to take advantage of all the opportunities that cloud computing offers, you need to have the infrastructure to support key networks, and Zayo Group Holdings (NYSE: ZAYO) provides the communications infrastructure that its clients need in order to bulk up their technological capabilities. Yet over time, Zayo has only partially tapped into its strong potential as a key player in the fiber and bandwidth connectivity space.

Coming into Wednesday's fiscal fourth-quarter financial report, Zayo investors were hoping to see good bottom-line performance amid solid fundamental conditions in the industry. Zayo's numbers were largely solid, but the stock didn't react favorably to some of the obstacles that continue to plague the company.

How Zayo fared

Zayo Group's fiscal fourth-quarter results were mixed. Revenue rose just 3% to $657.6 million, decelerating dramatically from the previous quarter. But net income soared by close to 90% to $43.8 million, resulting in earnings of $0.18 per share. That figure was double what most of those following the stock had anticipated from Zayo during the period.

Perhaps the most significant thing about Zayo's results showed up in the tax line. There, the company enjoyed an unusually large $23.1 million tax benefit, comparing favorably to expenses of $11 million attributable to taxes in the year-earlier period. Without the tax provision, pre-tax net income from operations was down by almost 40% over the period.

Several of Zayo's key leading indicators came in below its expectations. The company had $8 million in net bookings during the period, compared to $7.7 million in gross installs. Churn stayed relatively steady at 1.2%, but the implied growth rate for net installations of just $1.5 million was just 3%, down from 5% three months ago and suggesting a continued slowdown. A big problem for the company was the lack of large deals, which stood in contrast to the diverse demand Zayo is getting from its various addressable market segments. A drop in demand for colocation services was also a short-term headwind.

Zayo did manage to show some signs of success. The company reported annualized revenue growth of 7% on an organic basis, even excluding some of the acquisitions it's made lately. A similar 7% growth rate for pre-tax operating earnings pointed to solid bottom-line performance as well.

Can Zayo bounce back?

CEO Dan Caruso tried to make it clear in his presentation that Zayo remains focused on the same strategic goals it's identified in the past. The company wants to build bookings, cut churn rates, and boost installation volume as it targets organic growth of 6% to 8%. A search for greater efficiency should lead to earnings gains at a rate faster than sales increases, and Zayo will keep looking for smart acquisitions to accelerate its overall pace of growth.

Some of Zayo's strategy also involves divesting units that aren't part of its core business. In late July, Zayo closed on its sale of Scott-Rice Telephone, getting $42 million and getting rid of a unit that had posted a pre-tax loss of $1.6 million for the full fiscal year.

Again, though, Zayo spent a good deal of time talking about its potential conversion to a real estate investment trust. Having finished the first phase of its exploration of a REIT conversion in May, Zayo's now talking to the Internal Revenue Service to seek a private letter ruling that would give it assurances of the favorable tax treatment accorded to REITs. In particular, if the IRS allows Zayo to treat revenue from its dark fiber and lit fiber businesses as eligible sales for REIT income purposes, then the conversion will become a much more viable option for the company.

Yet Zayo shareholders were more concerned about the failure of the company to hit some of its fundamental business targets, and the stock fell 5% at midday Thursday following the Wednesday evening. Until the company makes more progress in achieving some of its financial goals, some shareholders will remain nervous about Zayo's ability to reach its full potential.

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Dan Caplinger has no position in any of the stocks mentioned. The Motley Fool recommends Zayo Group. The Motley Fool has a disclosure policy.