Description
Like duopolies? Like a CEO who thinks about capital allocation effectively? Like FCF expected to grow by over 40% from ’05 to ’06 with an implied equity FCF yield at over 10% (based on stock at $8.09 and ’06 residual cash flow of $47.3m) growing double digits. Like a stock that should have downside protection because of its unique collection of assets, relatively stable customer base in one of the more attractive markets in North America (from both a demographic perspective and in regards to demand for communication services), plus potential private equity interest at a price more than 50% to the current stock price? If these parameters appeal to you, then I suggest you consider General Communications (GNCMA) as an investment?
Summary Thesis
The Alaskan communications market is one of the strongest in the U.S. in terms of consumer spending on communication services and above-average market demographics. General Communications dominates the cable and broadband business in Alaska, with market penetrations of 90% and 80%, respectively. The Company is the second largest long distance carrier, and has over 20% share of local lines as Alaska’s only significant CLEC. It is the largest provider of internet access with 60% dial-up and 80% high-speed market share. Though a well-documented list of competitive issues in both long distance and cable exists, the competitive issues in Alaska are considerably less than in the “Lower 48”. Barriers to entry are high since the Alaskan market is an unattractive economic proposition for new facility-based entrants. The large geographic area of the state, coupled with the presence of both major metropolitan areas and small, dense clusters of population deters new facilities-based communications providers. DBS competition is modest (penetration in Alaska is less than 10% versus ~20% in the Lower 48) because of spotty satellite coverage and inclement weather. Long distance is virtually a duopoly in Alaska where General Communications has ~45% share and competes primarily with AT&T, a company that is probably distracted for numerous reasons. In regards to Internet data services to the consumer, in the Lower 48, cable share is typically ~65% and declining but in Alaska the split is 75% in General Communications’ favor. Almost everyday we read about the bundling of services by telecom and cable operators as they compete to drive penetration, ARPU, and reduce churn; General Communications is the most successful bundler of services in the cable/telecommunications industry. The Company is well-managed (approximately two decades of management continuity at the senior level) and led by CEO Ron Duncan who prioritizes his focus on generating increasing amounts of FCF. It’s worth noting that Duncan’s mentor is John Malone (who taught Duncan when Malone was a Professor at John Hopkins). If you’re a fan of Malone (as am I), then you can impart that Duncan has been mentored well and has a lot of intelligent resources available to him. I believe the Company is at an inflection point to generate an increasing amount of FCF with mid-single digit EBITDA growth coupled with a reduction in capital spending. With the possibility of increased defense and energy exploration activities in Alaska, General Communications is well-positioned to benefit from a growing Alaskan economy. The Company has demonstrated its view of value by recently buying over 500,000 shares at $9.92 in Q1’05. Given my impression that the CEO understands intrinsic value and the Company has repurchased stock at over 20% above the current market price, I believe VIC members should consider owning GNCMA based on the Company’s implicit view, private equity perception, and my thesis as described in more detail below.
Financial and Valuation Snapshot
Rev in 2004 was $425m and EBITDA was $139m ($135m excluding $4m MCI credit); in 2005 Rev is estimated at $434m and EBITDA is estimated at $144m (excluding $3m MCI credit, EBITDA growth is forecasted to be ~7.5%)
EBITDA composition: 49% data/Internet, 35% voice, 25% cable (video distribution), 16% carrier voice, 6% local voice, 4% retail voice
Equity: 56.3m shares at $8.09 è $455m Equity
Net Debt: $450m (3.2x ’04 EBITDA) è $905m Enterprise
NOL ($179.2m valued at 30% or $54m) è $851m to calculate EBITDA multiple for overall company
(when discuss implied multiple for long-distance business below, I do not value NOLs since I assume such value is embedded in per sub assumption I’m making for cable systems)
EBITDA is estimated at $143.5m in ’05 and $151.5m in ’06 (both estimates are IBES and appear reasonable)
Based on these estimates and GNCMA at $8.09, the stock is trading at 5.9x ‘05E EBITDA and 5.6x ‘06E EBITDA
With 136,100 cable subs at the end of Q1’05, the imputed multiple of the long distance business is 5.0x (assuming value per cable sub at $3,750) and 4.6x (assuming value per cable sub at $4,000); these ‘06E EBITDA multiples for GNCMA’s long distance business compare favorably to over 6.5x average EBITDA multiple for AT&T and MCI (obviously not great comparables for variety of reasons and especially in light of acquisition premiums but good for context; stability of GNCMA’s long-distance business is much greater than either AT&T or MCI and therefore is arguably worth more on a multiple basis); North American Telecoms trade at ~6x ‘06E EBITDA (if GNCMA’s long distance were accorded this multiple and $4,000 per cable sub, GNCMA would be trading above at more than 25% to its current price)
Value per sub at $3,750 implies that cable is valued at 7.9x ‘05E EBITDA (7.1x ‘06E EBITDA)
Value per sub at $4,000 implies that cable is valued at 8.4x ‘05E EBITDA (7.6x ‘06E EBITDA)
I apply the EBITDA of cable, Internet access, and local voice to calculate “all” EBITDA associated with cable. This isn’t a perfect calculation but a rough estimate for the EBITDA that is primarily associated with the Company’s cable subscribers. For context, public market cable operators (excludes over-leveraged Charter) are trading at 9.8x ‘05E and 8.6x ‘06E EBITDA. Recent private market transactions are shown below:
$3,400 per sub and 15x LTM EBITDA (Adelphia transaction with Time Warner and Comcast)
$4,400 per sub and 13x FY EBITDA (1.8m subs received by Comcast in exchange for ~$8.1B in cash and stock to Time Warner)
$3,340 per sub and 9.4x FY EBITDA (Insight transaction with The Carlyle Group)
$4,090 per sub and 9.3x FY EBITDA (Cox family going-private of Cox Communications)
Note that lower per sub multiples (i.e., Adelphia and Insight) reflect increasing capex requirements coupled with suboptimal margin (for Adelphia); one private equity group told me they think GNCMA footprint is worth $4,250-4,500 per sub because of the favorable competitive environment in Alaska and evidence for favorable results from bundling of advanced services
Unlevered FCF in 2006 is estimated to be $82m (i.e., ~9.6% FCF yield), up over 20% from $66.7m in 2005, and then grow double-digits. This growth is largely based on an assumed reduction in capital spending while EBITDA grows at ~5-7% per annum. The Company expects capital spending to be $80m this year and $70m next. Such spending is for growth initiatives including penetrating more subscribers for advanced services. In its loan agreement last year, the Company identified maintenance capex at $25m.
Bullish Arguments
Competition in Alaska is relatively favorable
As described in the summary thesis, the competitive dynamics in Alaska are much more favorable than in the Lower 48. Instead of three major long distance providers, there are only two. MCI and Sprint rely on General Communications for termination. Given the cost to build-out infrastructure to and in Alaska, there’s no risk that either MCI or Sprint will pursue a standalone effort in Alaska. There is some risk that either/both could migrate their carrier contract (in aggregate, these two contracts represented 16% of ’04 revenue at GNCMA) to AT&T or Alaska Communications (currently ~5% of the total Alaskan long-distance market) but I ascribe a low probability that either would embrace AT&T for termination since AT&T is their main competition. Furthermore, though I’m not an engineer and therefore I cannot adequately opine on the quality of the infrastructure at AT&T or Alaska Communications versus General Communications, I have been told that better infrastructure (i.e., latency, redundancy) exists at General Communications and therefore is preferable from a quality perspective for both MCI and Sprint. Long distance pricing pressure challenges are well-documented but rate of decline in Alaska is less because of virtual duopoly market profile. This is demonstrated by a comparison of EBITDA growth for ’05-’06 of GNCMA’s long distance (forecasted by Stifel Nicolaus to decline by 2%) versus estimates for AT&T (forecasted by Morgan Stanley to decline by 18%) and for MCI (forecasted by Morgan Stanley to decline by 18%).
With regards to local voice services and Internet access, General Communications competes primarily with Alaska Communications. Alaska Communications (ALSK) has been challenged historically by a contentious relationship with the regulatory authority of the state, deficiencies in customer satisfaction, excess financial leverage, and management turmoil. General Communications took advantage of the situation as evidenced by General Communications now serving nearly half of the local access lines in Anchorage and about a quarter of the local access lines in Fairbanks and Juneau. With new management in place at Alaska Communications, ALSK has renewed its focus on customer service and has adopted a more compromising stance with the regulatory agency in Alaska. Though ALSK has improved its competitive position, General Communications operates with several advantages—better infrastructure, better customer service, more attractive service bundle, and a better capital structure. In regards to the latter, Alaska Communication’s recent decision to pay a substantial dividend, representing ~75% of FCF, makes it unlikely that ALSK will compete irrationally with GNCMA.
DBS competition to cable is modest because of spotty satellite coverage and inclement weather. Management at General Communications estimates that two-thirds of homes in Alaska cannot position a dish to receive a satellite signal because of mountainous terrain.
Alaska is an attractive market with unique characteristics and high barriers to entry
Alaska was never part of the Bell system. Long distance and local have always been separate. Approximately 60% of Alaska’s 675,000 residents are clustered in Anchorage (representing over 40% of Alaska’s population), Fairbanks, and Juneau. Alaska’s median household income is among the highest in the nation (during 2000-2002, Alaska’s average household income was 28% higher than the U.S. average). Alaska Permanent Fund is the largest source of income for the state; distributes more than $1B annually to Alaskans from a fund valued at over $30B. Telecommunications spending per capita is over 30% higher than all other states and penetration of high-speed Internet access is double that of the national average. Alaska has the highest household computer penetration rate and is second in household penetration for Internet access. Attractive market growth catalysts position the state for sustained growth. This includes the potential for increased defense spending (i.e., missile defense project) and energy exploration activities (potential drilling in the Alaska National Wildlife Refuge). Deployment of a natural gas pipeline from Alaska’s North Slope to the Lower 48 has been proposed to supplement natural gas supplies in the Lower 48; GNCMA is the most logical operator of remote telecom operations if the pipeline is approved.
Most advanced in cable/telco industry at bundling services
General Communication’s results evidence higher bundling ratios than any cable/telco participant. Over 50% of its subscribers receive three or more products and represent over 70% of its revenue. Bundling services improves customer retention, drives incremental revenues, and reduces costs. Churn reduced by over 55% with two-product bundles and by ~80% with three and four-product bundles. Approximately 20% of calls into Customer Service result in cross sale. The Company is now engaged in a reseller arrangement for wireless service with Dobson Communications. Thus far, the reseller arrangement hasn’t been too effective. The Company is not shy with regards to their intention to eventually buy Dobson’s Alaskan business. As noted in the WSJ yesterday, cable operators are looking to partner with wireless service providers to leverage existing customer relationships and further reduce churn.
Potential for a going-private transaction provides both downside protection and upside potential
There is no shortage of consolidation activity in both the telecom and cable landscape by strategic and private equity players. Since I’ve shared my idea about General Communications with several private equity firms, I know that several private equity firms have visited Ron Duncan in Alaska or met with him in NY. There isn’t a shortage of private equity capital and nor is there a lack of interest among private equity firms interested in pursuing the right collection of telecom or cable assets. Private equity capital is attracted to the relatively predictable cash flow dynamics that both can provide, the underlying asset value and EBITDA that can be leveraged, and an assertion that cable capital spending will decline as a majority of network upgrades are complete. Most recently, private equity interest is substantiated by the numerous firms which sought to acquire Adelphia, The Carlyle Group’s pending acquisition of Insight Communications, the going-private transaction of Cox Communications by the Cox family, and Goldman Sachs’ investment in rural cable operator Cebridge. There are numerous others involved in cable/telecom or an interest to get involved; this includes Quadrangle, Abry, Providence, and Cerberus. My contacts in private equity lead me to believe that interest exists at ~$12.50 per share but Duncan expects $15 or more and is not in a rush to sell the Company. Nevertheless, though Duncan appropriately takes a long-term view of the Company’s stock price and in fact recently expressed a view on the Q1’05 conference call that he refuses to follow Wall Street’s “flavor of the day” (i.e., enhanced income securities or payout of 75% of FCF to provide a significant annual dividend like ALSK), at the current price he might become frustrated with being a public company and exercise the option to take the Company private to enjoy the fruits of his labor without the pressure of “Mr. Market”. My point is it would be very easy for Duncan to secure the capital himself if he were interested to engage in a MBO. Alternatively, he could engage private equity firms in a hotly-contested auction.
Share repurchase activity is demonstrative of CEO’s view of intrinsic value
Though it is easy to identify numerous situations in which share repurchase activity by companies is destructive, this is when company management teams are poor capital allocators and lack a credible view of their company’s intrinsic value. When ascribing a view about a CEO’s effectiveness as a capital allocator, there is always lots of judgment being made. After spending some time with CEO Ron Duncan, I am convinced that he is an effective capital allocator. He is maniacally focused on driving free cash flow but of course without compromising the quality of the business for the long term. Since it began its stock repurchase program in 2004, General Communications has purchased a total of 4.6m shares (including Class A shares purchased from MCI) at an average cost of $8.62. The Company purchased 504,200 shares at an average price of $9.92 during the first quarter of 2005.
Ability to capitalize on VoIP
Though below plan thus far, largely because of a challenge to secure enough equipment for multi-dwelling units, cable telephony provides an additional opportunity on the bundling front. Management estimates a three-year payback on its capital investment.
Potential upside in wireless
Alaska has low wireless penetration (at less than 50% compared to Lower 48 at ~65%). The relatively under-penetrated Alaskan wireless market combined with the relatively high cost of network build-out (i.e., economic barrier to entry) makes wireless an attractive potential growth segment. Alaska’s wireless market benefits from limited competition, with only two facilities-based carriers compared to four majors (based on wireless consolidation) in most markets in the Lower 48. As noted, the wireless reseller arrangement with Dobson has gone poorly to date but I expect execution to improve and for General Communications to ultimately own Dobson’s business at a fair price.
Growth opportunities as competitive local exchange carrier
GNCMA’s CLEC business is focused on three population centers (Anchorage, Fairbanks, and Juneau) since there is sufficient population density and commercial activity to support a facilities-based competitive effort there. The Company began offering local voice service over the incumbent’s (ALSK) copper lines via UNE-P and UNE-L in Anchorage in June 1997, in Fairbanks in May 2001, and in Juneau in March 2002. Service supported by the Company’s own Class 5 switches. General Communications goal is to control 45-50% of the local market. In Anchorage, the Company is near that goal but only half way there in Fairbanks and Juneau.
What are some concerns?
Alaska is an attractive market but impediment to greater growth is limited market size
Though General Communications has considered acquisitions in the “Lower 48” from time-to-time to transfer their best practices to under-performing properties, they have yet to seize upon a purchase (i.e., disciplined to not overpay). Although Alaska is one of the most attractive markets to serve from a regulatory, competitive, and demographic perspective, GNCMA’s customer base is limited.
Absence of near-term catalysts
There are multiple ways to win with General Communications but there isn’t a specific near-term catalyst. We will have to monitor traction in VoIP, wireless, and capital spending.
Alaska Communications has improved and could take one of GNCMA’s long distance carriers as a customer
General Communications had it easy for a long time as ALSK floundered. There is no doubt that execution at ALSK has improved and there is a possibility that ALSK could take either Sprint or MCI eventually away from GNCMA. The carriers represent 16% of GNCMA’s revenue (the amount of profits isn’t available).
Catalyst
Continued success at bundling advanced services
Improved execution of VoIP and wireless
Increased defense and/or energy exploration activities (i.e., announcement of pipeline project)
Additional share repurchases ($5m per qtr currently)
Takeout (the card Duncan will ultimately and easily play if stock performs poorly for too long)