Advent Wireless is an authorized dealer of wireless and wireline communications products of Rogers Communications, the largest such telecommunications provider in Canada.  AWI has a niche-focus on Asian neighbourhoods with 19 stores and kiosks in the Greater Toronto Area and 5 in Vancouver.  What makes Advent so remarkable is that it trades for less than cash despite having an operating business that is very profitable and has been consistently so for many years.  For a share price of $0.95 you get a business with $0.96 in cash at year-end and TTM EPS of $0.14.  At a valuation of only 11x trough earnings plus cash the company is worth over $2.00, which represents substantial upside from the current $0.95 level.  Furthermore, there should be significant downside protection with $0.96 in cash and management’s track record of not doing anything wasteful with it.

Advent operates under the trade names of Am-Call Wireless and Star Wireless, but as an exclusive dealer the stores are all heavily branded with either Rogers or Fido (Fido is Rogers’ discount brand).  Rogers is the largest wireless provider in Canada with over 9 M subs (7 M under the Rogers brand, 2 M under Fido).  Three companies essentially own the wireless market in Canada, with the other two being Bell and Telus, each with 7 M subs.  AWI generates revenues from: 1) the sale of phones and related accessories and 2) various bonuses and commissions tied to voice and data plan activations, upgrades, volume targets, CSAT scores, cable transactions (internet, TV, home phone), and monthly residuals for customers AWI initiates.  Around 64% of revenues are from Rogers and the current contract with them runs until May 2014.

Highlighting a few points important to the thesis:

1) The business has historically been very consistent, and has not had the margin/earnings volatility seen in other retailers.  Revenues have grown from $16.5 M in 2005 to $25.8 M in the TTM.  Over that period, operating margins have ranged from 8.1% to 13.0%, but for the vast majority of the time have been in a fairly tight band of 9 - 11%.  This stability is a function of a number of factors: low inventories (inventory turnover of 15-30x), no fashion risk in that inventory, certain recurring commission revenues (monthly residuals), and products with consistent demand (wireless products/services for the leading national carrier with 35% market share).

2) Margins are currently at the bottom end of their historical range, minimizing the likelihood of further erosion and representing a source of future growth; TTM EBITA margins are only 8.4%.  Rogers reduced commissions on renewals starting in Q2 2011 (while increasing commissions on new activations), so I have actually based my valuation off of where I think earnings will be after Q1 2012, once the commission reduction anniversaries.  As a result, I am assuming only 6.3% operating margins, which is clearly well below the historical range.  While a valuation target of 11x earnings at trough margins certainly doesn’t embed much future margin expansion, I think it’s likely that the company gradually gets back into its historical margin range, which is over 50% higher.

3) There should be EBITA margin expansion over the next few years from the 6.3% level I have modelled.  A number of factors have conspired over the past year to drive margins to this trough level, many of which should arguably moderate.  As mentioned above, a major contributor has been the reduction in commissions for renewal transactions by Rogers.  Because this happened so recently, the dealer base hasn’t had much time to adjust yet.  I think it’s likely that this squeeze by Rogers will result in the closure of some of the weaker dealer outlets, which obviously benefits all remaining dealers.  Advent themselves responded to this action by recently consolidating their two stores in Toronto’s Chinatown into a single location (they were < 5 mins apart walking distance); this specific action should also benefit AWI’s margins going forward.

Also, the wireless market in Canada became more competitive with the entrance of three new carriers in AWI’s markets (WIND, Moblicity, and Public Mobile).  Before market entry, the Canadian wireless industry was already a strong oligopoly of 3 carriers (Rogers, Bell, and Telus), each with a dual brand strategy for segmentation.  Considering the significant scale advantages of the incumbents, I think it’s highly likely that all of the new entrants eventually fail and pull out of the Canadian market.  While it’s tough to quantify the impact these companies have had on AWI’s operations to date, the marketing blitz of 3 companies simultaneously trying to establish their own wireless brands in Canada -- and generally with the lure of aggressive pricing -- has certainly not helped Rogers and its dealers.

Finally, 2010 benefited from the launch of the iPhone 4, without a similar event in 2011.  The iPhone 4S should benefit Q4 2011, which hasn’t been reported yet, but clearly not to the same extent.  With an iPhone 5 likely slated for 2012, this should also contribute to improved results in the latter half of 2012 over 2011.

4) The company has historically grown revenues at a 7-8% annual rate, and I think they should be able to continue growing revenues at a 5%+ rate going forward.  The wireless market in Canada is still growing; 45% of Rogers subscribers now use smart phones and this rate of penetration continues to climb to AWI’s benefit.  Furthermore, even in the core markets of Toronto and Vancouver there is room to expand to other locations that fit their demographic profile, particularly in the Peel and Halton regions.  The Fido operations are also fairly nascent and the company expects to add to the existing base of 6 stores.  Finally, there are two huge Asian themed malls that are expanding and AWI has already reserved 3 additional spots in them.  They will be adding a store in the second phase of Pacific Mall in Toronto and adding two stores in the second phase of Aberdeen Square.  These store openings, however, are further away and not expected until 2013-2014.

5)  The company is highly unlikely to do anything wasteful with its cash.  While it’s obvious that the company has had an excessive amount of cash on the balance sheet for many years, they have thus far resisted returning it to shareholders in any form.  While this is disappointing, the flip side of this is that they haven’t done anything stupid with it either -- they’ve simply just let it build steadily every year.  Consider this: from 2006 to today the company has had cumulative net income of $7.8 M, has not issued equity, and over that same period the net cash position has increased by $8.9 M!  And while the company hoarded its cash and got leaner on working capital they managed to grow revenues by 50%.  

Insiders own around a quarter of the company so they are clearly well incented not to do anything foolish with the company’s cash.  While I obviously hope management eventually considers a special dividend, at the moment I expect them to continue just letting the cash pile up; shareholders will realize the value of that cash when they sell the company to a larger wireless dealer like Glentel.

6) Although the company’s economics are partially dictated by the commission structure put in place by Rogers, over which they have no control, the unit economics are strong.  PP&E is modest and the stores actually have negative working capital.  As a result, the company overall has essentially no capital invested -- certainly much different than a typical retailer!

Valuation

In the trailing 12 months the company has had revenues of $25.8 M, EBITA of $2.2 M, and EPS of $0.14.  By the end of Q1 2012, after the company has anniversaried the commission reduction, I expect TTM revenues of $23.8 M, EBITA of $1.5 M and EPS of $0.09-0.10.  I think the company should be worth at least 11x this trough EPS level, which after adding the $0.96 in cash yields a share price of $2.00.