Zayo Group Is Macquarie's Top Growth Pick For 2016

• In a report issued Monday, Macquarie analysts Kevin Smithen and Will Clayton singled out Zayo Group Holdings Inc (NYSE: ZAYO) as their Top Growth Pick for 2016.
• They upgraded the stock to Outperform and raised the price target from $28 to $30.

For analysts at Macquarie, it’s always been about valuation and management setting realistic expectations at fiber bellwether Zayo. According to the report, “the underlying demand trends for metro fiber for content delivery, for cloud-based data center connectivity, for small cells and for wireless backhaul have only increased since ZAYO’s IPO a little over a year ago.”

Moreover, the company’s leadership in the dark fiber in the US, and increasingly around the world, should help it maintain or even increase its pricing power in the future. In their view, the market now understands more clearly “the lumpiness in bookings and capital intensity of ZAYO’s business as its CY17 EV/EBITDA multiple (as adj.’d for stock-based comp and ETFs) has fallen from a peak of over 10.5x last winter to just ~9.5x currently.”

When the firm initiated coverage of Zayo, they pointed out that the stock should trade at a 11.5x multiple, “but with tower AFFO multiples having compressed 2-3 turns (to 15-17x) and with ZAYO acquiring some voice revenue with Allstream,” the experts now think that 10.5x is an appropriate multiple for the company as a whole, especially with the U.S. Federal Reserve set to raise interest rates.

According to Macquarie, even though the potential sale of sponsors’ shares could continue to create a short-term overhang for the stock, the increased liquidity will permit growth and infrastructure investors to accumulate positions over the next few months, before FCF begins to surge.

The firm would “buy the shares aggressively now. At just $10bln, ZAYO’s EV is relatively small for the solid collection of N. American & European fiber assets it possesses,” they noted. In fact, they believe “suitors have emerged at current valuation levels as cable MSOs, telcos and perhaps tower players may covet ZAYO’s infrastructure assets.”

Disclosure: Javier Hasse holds no positions in any of the securities mentioned above.