• Cheap Valuation. GLN trades at 0.4x sales, a single digit P/E multiple of last year’s earnings, and a mid-single digit multiple of our estimate of forward earnings, on a business that is growing both top- and bottom-line at 20-30% per year. Free cash flow approximates EPS, so the company trades at a nearly 20% FCF yield on our NTM estimate.

• Excellent/Aligned Management. GLN’s management has repeatedly built and sold successful retail businesses. The team is one of the best we’ve seen in the retail space both operationally and with respect to disciplined capital allocation. Management is strongly aligned with shareholders via ownership of ~40% of outstanding shares.

• Growing Business w/ Good Moat and Strong Secular Trend. Over the last eight years GLN’s revenues have grown from $94M in FY2004 to an estimated ~$675M in FY2012, with EPS compounding at 30% per annum. As described in more detail below, the business has a nice moat in its core Canadian business as well as a strong tailwind from two long-term secular trends.

• Highly Differentiated View on Future Earnings. The consensus Bloomberg EPS estimate for FY2012 is $1.09 and the consensus EPS estimate for FY2013 is $1.24. We believe that over the next twelve months GLN will earn ~$1.70 in EPS. We lay out our math below.

We believe GLN’s substantial earnings power has been masked by one-off events over the last four quarters that should reverse in the next four. As this happens, we think the stock will re-rate on a significantly higher EPS number. Our target price is $25-30+ per share over 12-18 months.

Business Overview

Glentel is a cell phone retailer operating approximately 545 mall-based wireless stores in Canada and the US. In Canada, Glentel operates a multi-carrier model via three brands: WirelessWave, Tbooth Wireless, and Wireless, Etc. In the US, Glentel owns 81.5% of Diamond Wireless, one of six Verizon National Premium Retailers.

Glentel’s business benefits from twin secular trends: (i) the increasing penetration of mobile phones in Canada and the US, and (ii) increasing sales of smartphones as a percentage of mobile phones sold. Mobile phone penetration in the UK today is ~120% (1.2 cell phones per person); in the US it is 97% and in Canada it is 78%. Less than half of cell phones are smartphones. Mobile penetration is increasing in the US by 2-3% per year and in Canada by 5% per year, rapidly expanding Glentel’s customer base. But it’s the switch to smartphones that is the even bigger driver: smartphone sales are 2x as profitable to Glentel because they involve the sale of a voice plan and a data plan, rather than just a voice plan. As a result of these continuing trends, Glentel’s same-store sales comps have averaged ~11% since 2005.

In Canada, Glentel is the country’s largest multi-carrier wireless retailer. Unlike in the United States, where most consumers visit single-carrier stores to purchase phones (for example, a Verizon store or an AT&T store), in Canada consumers can visit one of Glentel’s 330+ locations and not only have their choice of phone (iPhone, Droid, etc.) but also their choice of carrier (Rogers, Bell, Virgin Mobile, Fido, Solo, SaskTel, Chat-r, etc.). Consumers like choice, and that’s what Glentel offers.

Glentel’s Canadian business has a strong competitive position that has repeatedly deterred others from entering the market. In our view, there are two key reasons why Glentel’s positioning is so durable:

1. Real Estate. Canadian malls are incentivized to increase mall-wide sales as they are paid a percentage of their tenants’ revenues. Malls are reluctant to add new wireless retailers as they are already saturated (every carrier wants its brands and sub-brands to have stores in each mall); incremental wireless stores merely shift sales around rather than adding to a mall’s overall sales level. An inability to secure real estate – and especially good real estate – is a very real barrier to entry that would likely prevent a serious competitor from entering the market over any reasonable time period. We think it would take a decade or longer to re-create Glentel’s real estate position in malls organically.
2. This Business is Hard. The mobile phone business is difficult. Best Buy (NYSE: BBY) tried for years to develop its mobile phone business and eventually gave up, instead asking Carphone Warehouse (LSE: CPW) to help them build Best Buy Mobile. Inventory management (new phones launch every month and the retailer takes on inventory risk), carrier relationships, manufacturer relationships, appropriately designed sales incentive systems – all of these make it a complex business to master.

Once mastered, we think this is an excellent business. Glentel is very slightly working-capital negative (working capital is essentially funded by the carriers) so it does not require incremental working capital to grow / throws off significant cash. The business achieves high-IRR’s on new locations, with cash-on-cash payback periods often less than a year. This is particularly so with respect to the US operations, where we note the recent trend of Verizon Wireless “gifting” existing corporate stores to Glentel – a superior operator – in order to increase sales and activations (how the carriers really make money). In 2011 Verizon handed over more than 20 US stores to Diamond Wireless; in every instance year-over-year same-store sales improved by at least double-digits within 90 days.

In the United States, Glentel owns an 81.5% interest in Diamond Wireless, a Verizon reseller with 215 stores located across the US. Glentel purchased this interest roughly two years ago and retained prior management to continue running the business. Diamond is in rapid growth mode and expects to add 60 stores this year.

Why the Stock is Cheap

As noted above, we think this business is excellent. Glentel is rapidly compounding the top and bottom line, comps are in the double-digits, the company throws off enormous free cash flow and doesn’t require incremental working capital to grow, management is excellent and aligned with shareholders, there’s net cash on the balance sheet, etc. So why is the stock cheap?

The answer is that while the business is outstanding long-term, over the short-run there is significant quarter-to-quarter volatility. This is primarily due to cell phone release schedules and competition/promotions between the carriers; the iPhone launching at the end of one quarter or the beginning of the next can meaningfully impact on results.

Over the last four quarters a series of one-off events have masked substantial underlying growth in Glentel’s earnings power. In our view, the set-up is excellent: the sell-side and consensus seem to now view Glentel as structurally broken. Going forward, we believe a combination of easy comps and mean-reverting margins will allow the company to outpace consensus estimates:

• Q3 2012 vs. Q3 2011. In Q3 2011, the release of the iPhone 4S was delayed from the end of Q3 into the beginning of Q4, causing GLN’s EPS of $0.36 to miss consensus expectations of $0.39. This year the iPhone 5 launched at the end of Q3 2012, which means there should be a huge comp on top of an easy compare. It’s also worth noting that numerous media outlets have reported that the Samsung Galaxy S-III, launched on the last day of Q2 2012 in Canada, is selling extremely well in Q3. Consensus EPS for Q3 2012 is $0.30, even though (i) GLN’s store count is 13% higher than a year ago and (ii) the iPhone launched the last weekend of the quarter.

• Q4 2012 vs. Q4 2011. In Q4 2011, Glentel’s Canadian margins experienced a 300-400bps margin compression as the company failed to meet “stretch bonus” targets set by the carriers. Each month, carriers pay Glentel cash bonus payments based on activation levels compared to the prior year; Glentel rarely misses these targets. However, in Q4 2011 this happened: while sales at WirelessWave and Tbooth Wireless were strong, a meltdown in the relationship between Costco (Glentel’s 80+ Wireless, Etc. locations are in Canadian Costco stores) on Christmas Eve 2010 meant that Costco stores were no longer able to sell Apple products during the iPhone 4S launch in Canada in Q4 2011. While Costco stores are still unable to carry iPhones, the easier comp means that we expect Glentel to achieve its stretch bonus targets in Q4 2012 and margins should mean-revert.

• Q1 2013 vs. Q1 2012. In Q1 2012, based on our discussions with folks in the industry, the competitive environment in Canada was extreme. The “Big Three” Canadian carriers (Rogers, Bell, Telus), sent a message to new carrier entrants by aggressively competing on plans and pricing. One individual called it the most competitive environment in 30 years. As a result, the Big Three matched promotions throughout the quarter, including going to one-year plans from the more-typical two-year plans. One-year plans defer profitability for Glentel: GLN is paid half as much for data and voice activations on essentially the same hardware sale (so margins compress dramatically), but GLN can then expect to see an uptick in customers one year later. Q1 2013 is the one year later. We expect the worst quarterly margins Glentel has seen in nearly five years to reverse with a strong comp in Q1 2013.

• Q2 2013 vs. Q2 2012. In Q2 2012, no new phones were launched (until the Samsung Galaxy S-III on the last day of the quarter) and carrier advertising was dialed back to near nil in anticipation of the Samsung launch and the iPhone 5 launch. As a result, GLN’s comps were -17% in the quarter. This “re-set” will provide an easy comp for GLN in Q2 2013, even if there are no new phone launches at that time.

Canada drives most of GLN’s profitability. That being said, there is also a story in the US. Over the last year, Verizon has squeezed its re-sellers by not properly reimbursing for increasingly expensive hardware and via promotions that have significantly hurt re-seller margins. As a result, many Verizon re-sellers have been driven into lossmaking and Diamond Wireless EBIT margins have fallen from 8-10% to 3-5%. The cynic in us says that the move was to force consolidation amongst re-sellers (if that was the goal, it worked). After loud protests from re-sellers, which now make up the primary distribution channel for Verizon Wireless, we expect margins to normalize over the next few quarters back to the 7-8% range.

What We Think GLN Actually Will Earn

We believe GLN will earn $0.43 in Q3 2012, $0.58 in Q4 2012, $0.32 in Q1 2013, and $0.35 in Q2 2013. These figures are based on the following assumptions:

• Normalized Canadian EBIT margins are 11.5% in Q1, 12.0% in Q2, 15.0% in Q3, and 16.0% in Q4.
• Underlying comps in Canada are 8% and in the US are 5%. Adjustments of no more than 200bps are made to account for weak/strong comps.
• Store growth in Canada is 7-9% per year, and in the US the company opens 60 stores in 2012 and 40 stores in 2013.

The forecasts in greater detail:

Q3 2012:

• Canada: 330 stores, 10.0% comps, $119.5M revenues, 15.0% EBIT margin, $17.9M EBIT.
• US: 230 stores, 5.0% comps, $56.3M revenues, 4.0% EBIT margin, $2.3M EBIT.
• Consolidated: 560 stores, $14.7M EBIT, $9.7M net income, $0.43 EPS vs. consensus $0.30.

Q4 2012:

• Canada: 335 stores, 8.0% comps, $130.1M revenues, 16.0% EBIT margin, $20.8M EBIT.
• US: 250 stores, 5.0% comps, $69.4M revenues, 5.5% EBIT margin, $3.8M EBIT.
• Consolidated: 585 stores, $19.2M EBIT, $12.9M net income, $0.58 EPS vs. consensus $0.38.

Q1 2013:

• Canada: 340 stores, 8.0% comps, $105.0M revenues, 11.5% EBIT margin, $12.1M EBIT.
• US: 260 stores, 5.0% comps, $65.4M revenues, 7.0% EBIT margin, $4.6M EBIT.
• Consolidated: 600 stores, $11.2M EBIT, $7.2M net income, $0.32 EPS vs. consensus $0.16.

Q2 2013:

• Canada: 345 stores, 10.0% comps, $101.9M revenues, 12.0% EBIT margin, $12.2M EBIT.
• US: 270 stores, 5.0% comps, $64.2M revenues, 8.0% EBIT margin, $5.1M EBIT.
• Consolidated: 615 stores, $11.9M EBIT, $7.7M net income, $0.34 EPS vs. consensus $0.24.

One could think of this as a margin-reversion story with large underlying top-line growth. These NTM estimates imply a 12-month Canadian EBIT margin of 13.8%, below 14.2% in 2009 and 14.3% in 2010 but above 13.0% in 2011. In the US, the EBIT margin forecast is 6.2%, below 8.9% in 2010 and 8.0% in 2011 but above the LTM margin of 5.4%.

Based on these figures, GLN trades at a single-digit multiple of last year’s earnings and a mid-single digit multiple of our estimate of forward earnings. GLN’s stock is at $14.50 per share. The company has ~$2.00 per share of net cash (calculation: $45M cash & equivalents, $17M long-term debt, $12M non-core assets under agreement to be sold = $40M net cash, on 22M shares fully diluted), so the EV is ~$12.50 per share. FY2011 EPS was $1.28, and our estimate of forward EPS is $1.70 per share, so GLN trades at 9.75x FY2011 earnings and ~7.3x NTM earnings.

Free Options

There are a few “free options” here that we do not include in our forecasts:

1. Apple Stores. At the end of 2011, GLN purchased a three-store chain of Apple re-seller stores in Canada. GLN is now ramping up these stores: we expect GLN to open 3-4 additional stores in H2 2012, and as many as 50 stores over the next five years. Each box should do $5-10M in top-line sales. This growth is not included in our estimates.

2. Target Partnership. At the end of 2005, GLN signed an agreement to operate the wireless retail stores in all Canadian Costco’s. Over the next 2-3 years GLN ramped from a standing start to 70+ locations. With Target’s entrance into Canada, we believe Target is actively looking for a partner to run its in-store wireless retail. GLN is widely rumored to be a finalist for this role.

3. Acquisitions. GLN has a history of making savvy and accretive acquisitions. With $50M+ available to deploy, we think it’s just a matter of time before GLN adds another leg or two to the story via M&A.

4. Sale of Business Division. GLN owns a small legacy communications business with LTM revenues of ~$30M. Glentel recently agreed to sell certain assets of this business to SBA Communications for $12M. We value this business at zero, and assume it generates zero EBIT in our model (LTM EBIT is ~$1M). Any further divestments would be “value found” based on our assumptions.

Risks

As in all investments, there are risks to investing in Glentel including (i) large volatility in quarter-to-quarter earnings, (ii) competition amongst carriers, (iii) assumptions regarding smartphone growth, (iv) trust that capital will be deployed effectively in M&A, and (v) liquidity risk in the shares. GLN management is non-promotional and currently does not host earnings calls (although this may change in the future), which may preclude the business from receiving an outsized multiple.

Conclusion

We view GLN as an asymmetric and timely investment with valuation support, clear catalysts, and a business increasing its earnings power over time.  Assuming the stock trades at a teens multiple on $1.70 of NTM earnings and more than $2.00 of EPS in FY2014, we believe upside is 2-3x over the next 12-18 months.

Disclaimer

NOTE (1): DISCLAIMER. The author of this posting and related persons or entities (“Author”) currently holds a long position in this security. Author may buy additional shares, or sell some or all of Author’s shares, at any time. Author has no obligation to inform anyone of any changes to Author’s view of GLN CN. Please consult your financial, legal, and/or tax advisors before making any investment decisions. While the Author has tried to present facts it believes are accurate, the Author makes no representation as to the accuracy or completeness of any information contained in this note. The reader agrees not to invest based on this note, and to perform his or her own due diligence and research before taking a position in GLN CN. READER AGREES TO HOLD AUTHOR HARMLESS AND HEREBY WAIVES ANY CAUSES OF ACTION AGAINST AUTHOR RELATED TO THE NOTE ABOVE. As with all investments, caveat emptor.