Is Cbeyond (CBEY) the subject of an undisclosed Law Enforcement Investigation? Citron Has the Docs.

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Cbeyond (NASDAQ:CBEY) Relevant Highlights:

Shares Outstanding 28.7 m
Recent Market Cap 410.8 m
Trailing P/E 154
Forward P/E 102
Ttm Earnings Per Share .13
Current Cash Burn Rate $9m – $10m per year
Background

Three weeks ago, Citron introduced readers to Cbeyond (NASDAQ:CBEY), a sales company offering bundled telecommunications services specializing in small business customers.  Citron’s inquiry focused on indicators of stalling growth and failure to gain traction in new markets to match the company’s results in its flagship city markets earlier in the decade.

Plenty of companies are facing business headwinds, especially in the current economic turmoil, but very few of them are sporting forward PE’s of over 100, and trailing PE’s of over 160.  Citron stated its opinion that there is a gross disconnect between perception and reality in valuing this company.

It gets worse …. Much worse

In an attempt to get clarity on the seeming large number of customer complaints about Cbeyond posted on the web, a Freedom of Information Act inquiry was filed with the Federal Trade Commission.

What was returned was a 100+ page file of customer complaints – and a lot of them are very serious indeed.  Many of them represent very serious losses encountered by businesses either contracting with Cbeyond for service, or those trying to cancel and go elsewhere.  One recurring pattern is Cbeyond stalling when required to turn over a customer’s phone numbers to a new firm. As usual, Citron provides the link so you can read for yourself.

FTC Complaints (PDF)

“Law Enforcement Investigation”

Of even more concern is that over 100 pages of documentation were specifically withheld by the FTC because, as it cites, the documents were obtained by the Commission “in a law enforcement investigation”.  We doubt shareholders will be happy to learn of this from Citron rather than from a company 8-K filing, as required to disclose material events.  See paragraph 4 here:

FTC Cbey (PDF)

The numbers are worse than we originally thought

The attached chart examines three new markets launched in 2007 – San Diego, Detroit, and San Francisco, and the company’s cumulative cash burn in these three markets.  This shows what really happens to CBEY when they enter new markets….good luck in Seattle.

CBEY FCF (PDF)

None have yet “turned the corner” and Citron believes competitive challenges combined with the recession’s harsh economic realities render these new markets unlikely to generate cash flow profitability for the foreseeable future.

Meanwhile the company burned free cash at the following rate:

Period FY 2006 FY 2007 FY 2008 Q1 2009
Free cash flow burn ($4.3m) ($5.4m) ($9.3m) ($2.3m)
Conclusion

Red flags are abounding here.  Citron will continue to follow the story, but reiterates its opinion that CBEY is generously overvalued at half its current share price.

Cautious Investing to All.