Description
An
attractive long investment opportunity exists in General Communications
(“GNCMA”)—downside protection from a 17% equity FCF yield (if management
maintains the business) with an option on growth (driven by an imminent
wireless strategy that has potential to drive the stock by well over 100% in
the next two years).
General
Communications dominates the broadband data, cable video, and enterprise
voice/data business in Alaska,
a state that leads the nation in disposable household income. With the cable companies in the lower-48
states discussing potential avenues for being wireless providers to achieve a
quad play (video, data, voice, and wireless), one can look to Alaska where General Communications already
offers it. GNCMA provides downside
protection from a “normalized” equity FCF yield of ~17% and more importantly
significant upside from numerous likely catalysts which will drive FCF
growth. If one were to apply a 10%
equity FCF yield to the current business, that’s equivalent to GNCMA being at
~$15; this assumes, however, that management simply harvests the existing
business but that’s not their intention since they are well-positioned to seize
further growth.
One
can buy GNCMA’s cable business (assuming the telecom business that serves
carriers and enterprises is valued at 6x EBITDA) for an implied ‘08E EBITDA
multiple of ~4x or ~$1,500 per cable subscriber. If you prefer to value the telecom business
at 5x, then you’re buying GNCMA’s cable business at ~6.5x and ~$2,375 per
sub. There are numerous catalysts,
including management restoring its credibility, to drive equity appreciation.
GNCMA
is overseen by an owner-oriented CEO who effectively allocates capital and
seeks to optimize his capital structure; CEO Ron Duncan owns 3.5% of the
company, excluding options. Part of Ron
Duncan’s acumen stems from being mentored by John Malone who was a Professor to
Duncan at John
Hopkins. The stock has recently been
bought by John Stanton, an “insider” (Stanton and Duncan have been friends for
years) well-known in the wireless industry as one of the industry’s best
operators/investors (note that Stanton was COO/Vice Chairman of McCaw Cellular;
Founder/Chairman/CEO of Western Wireless; Chairman/CEO of T-Mobile USA and a Board
member at Hutchison Telecommunications and the recently sold wireless carrier
ALLTEL). Stanton’s basis is ~$11 with purchases made
at $8.69-$14.50 (the $14.50 purchase was of the super-voting stock he bought
directly from Verizon); he owns over 7% of the company. With regards to wireless at GNCMA, it’s not
currently contributing much to profitability but it is among the key growth
catalysts going forward.
In
May 2005, I submitted GNCMA to VIC. The
stock was trading at $8.09 then and it peaked at $16.10 on January 3rd
of this year. If you had the crystal
ball to buy when I submitted the idea and sell at the peak, then
congratulations on the double (vs S&P up 19% during that period). The stock has retreated and the risk/reward
is now more favorable to own GNCMA for another and likely larger long term
gain. For those of you who are not
familiar with GNCMA, I suggest you review my original submission for more
details regarding some important company background/competitive positioning but
let me reinforce the core tenets of the initial thesis below, highlight some
reasons why I think GNCMA is now a more attractive investment than in May 2005,
and contextualize the key issue that has recently transpired to propel the
stock’s decline.
Business Mix
Reported Segments (2008E); EBITDA Composition
Consumer: $54m, 22% margin
Network: $83m, 51% margin
Commercial: $19m, 19% margin
Managed Broadband: $9m, 31% margin
Source of Revenue (2008E); EBITDA Composition
Voice: $57m, 34% margin
Data: $85m, 44% margin
Video: $16m, 15% margin
Wireless: $7m, 10% margin
Valuation Snapshot
Equity
Value: $0.5B
Enterprise Value: $1.0
B
NOLs $128M
Based
on street EBITDA estimates, GNCMA is trading at ~6.0x ‘07E, 5.7x ‘08E, and 5.1x
‘09E EBITDA. Based on management’s
guidance for 2009, GNCMA is trading at 4.6x EBITDA. Note that one multiple point change (i.e., a
change in sentiment) to EBITDA multiple is ~$3 impact to the stock price (~35%
from current price). It is of course
more appropriate to focus on free cash flow.
GNCMA’s
downside protection is partially derived from its relatively unique set of infrastructure
assets that enable data, video, voice, and wireless traffic/service for
carriers (e.g, Verizon/MCI and Sprint), enterprises, schools/government, and
consumers. The company’s “normalized”
equity free cash flow yield is ~17%. I define
“normalized” equity free cash flow yield as estimated EBITDA of $162m in 2008
less interest expense of $36m and $50m in maintenance capex. I assume maintenance capex is $50m instead of
the $25m that is consistently communicated by management and also which is
described in their debt offering. If one
uses $25m, then the equity free cash flow yield is currently 22%. Based on $25m of maintenance capex coupled
with a 10% equity free cash flow yield, the implied stock price is ~$20. Since depreciation is ~$80m, one might
inquire how maintenance capex could be so much less. There is a significant difference in economic
and accounting life for a majority of the infrastructure-related assets
(specifically 9-11 year depreciable life versus 30 year asset life).
Another
way to assert the attractiveness of the current value is to frame valuation by
contextualizing the value of GNCMA’s cable subscriber footprint (i.e., the reported
consumer segment but excluding wireless) based on a sum-of-the-parts
approach. Based on the assumptions
applied below, the current value per cable sub is ~$1,500and ~4x ‘08E EBITDA. Yes, all the public cable system operators
(Comcast, Time Warner, Cablevision, Charter) are down significantly and
arguably some (if not all) of the larger MSOs are undervalued as well, but as
noted in the original VIC submission in 2005, I believe GNCMA deserves a
premium valuation to the lower-48 cable system operators because GNCMA doesn’t
confront the same competitive challenges for multi-channel video from either
the satellite providers (topography issues challenge satellite as an
alternative) or the Bell companies (i.e., there is no FiOS-like alternative
confronting GNCMA). GNCMA is
structurally advantaged to compete versus multi-channel alternatives in Alaska, one of the most
attractive states from a demographic and communication usage perspective. Regardless of whether you agree with me on
that assertion, the opportunity to own cable systems at ~4x ‘08E EBITDA and
~$1,500 per sub is compelling.
Assumptions
to derive “pure” cable multiple:
- Network Access /
Commercial / Managed Broadband businesses is valued at 6x EBITDA (or
$660m)
- For context, Bells
are valued at ~6x, RLECs at ~7x, and Alternative Carriers at ~10x
- GNCMA’s telecom
business (as described above) generates a majority of its EBITDA from
data-driven traffic among carriers, enterprises, schools/government; the
consumer telecom business is all cable telephony and in the
consumer/cable segment
·
Assume the current
consumer wireless business is valued at $1,025 per sub (or $68m)
- For context, this is
derived from $500 per sub ascribed to the 65% of subs currently on
Dobson’s network (i.e., MVNO) and $2,000 per sub assumed for the Alaska
Digitel subs (GNCMA bought 80% of Alaska Digitel in early 2007 for $30m
and the minority interest is captured as part of the net debt
calculation)
- ALLTEL was recently
acquired for 9x EBITDA and ~$2,200 per sub by private equity; note that “insider”
Stanton was on the Board of ALLTEL, which
bought Stanton’s
Western Wireless for 8.5x EBITDA and ~$2,100 per sub
- In thinking about
the current and expected wireless value (explained more below), it’s
important to note that a substantial part of the cost (30%) for a wireless
carrier is the backhaul/telco line connection which incidentally in
Alaska is enabled by GNCMA’s infrastructure; GNCMA will ultimately (when able
to compete using its owned facilities) generate a higher wireless margin
than ALLTEL’s 34% despite 12m subs at ALLTEL versus my estimate in 2010 of
150,000 subs at GNCMA (currently almost 70,000)
Among the Previous Key Reasons to Own
GNCMA that still hold
- Management continuity
and strength; CEO Ron Duncan is effective at allocating capital
- With the exception of
this year, each year’s capital spending since 2000 has led to at least
17% “return” and as much as 45% (“return” defined as incremental EBITDA
two years subsequent to the non-maintenance capex being incurred)
o
For example, in
2006, the company generated $15m more EBITDA than in 2005, after spending $88m
of “growth capex” in 2004 to yield a 17% “return”
o
For purposes of
calculating the “normalized” equity FCF yield at 17%, I use $50m but for these
purposes I use the $25m of maintenance capex communicated by management; the
“return” metrics are obviously higher if one assumes maintenance capex is in
fact $50m
- Attractive equity free
cash flow, at 17%, provides downside protection; if $25m is used for
maintenance capex, then the equity free cash flow yield is currently 22%
- Alaska is an attractive market (demographics,
communications service usage); barriers to entry are high, structural
competitive landscape advantages exist relative to cable/telecom
competitive dynamics in lower-48 states
- Disposable household
income is ~30% greater than the U.S. average
- Much of this
difference is generated from over $1B that is distributed from the Alaska
Permanent Fund annually to all residents
- General Communications
is among the most advanced at bundling cable/telco services, thereby
reducing churn
- 20% of calls to
Customer Service result in cross-sale
- 80% of Internet
customers up-sold to cable modems
- 75% of GNCMA’s
bundled customers are 75% less likely to disconnect/churn
- Private equity
interest was expressed at a price ~ 40% to the current stock price
- The appetite for
take-private still exists (I have recently received inquiries from major
private equity firms) but obviously the credit markets challenge this
potential outcome in the near-term (when the company was offered $12 a
couple of years ago, the CEO said he wasn’t a seller below $18 and I am
relatively certain he was negotiating to split the difference)
What happened to propel the recent
decline in the stock?
Weakness in Network Access was the main
culprit
In
the most recent quarter announced October 31st, the strength in the
consumer business (revenue grew 25% and EBITDA grew 39% yoy; there was strong
underlying demand across all consumer product lines but the main growth driver was
wireless, including the acquisition of Alaska Digitel) was overshadowed by the
company’s weakness in the Network Access segment. In Network Access, gross margin was down over
500bps based on scheduled rate reductions and some issues impacting comparability
(specifically $800,000 non-recurring fiber outage expense deemed recoverable
from the shipper that anchored into the fiber, thereby causing the outage) but
also because minutes grew at a slower pace relative to the typical seasonal
strength.
Network
access minutes decreased 14% yoy; the main issue was a market share shift that
the company is addressing. In Alaska, the Network
Access business has largely been a duopoly comprised by General Communications (since
its founding in 1979) and AT&T.
However, Alaska Communications also competes but its infrastructure is
only single-thread fiber and its ability to move traffic beyond the
Seattle-Anchorage corridor is currently limited. Nevertheless, Alaska Communications managed
to compromise GNCMA’s recent performance by taking network access share. Alaska Communications simply offered a lower
price and GNCMA (appropriately so in my opinion) refused to compromise its
pricing discipline. I believe the
company has a strong competitive position (with “monopoly” access to certain
parts of the state; the company reaches 20% of rural communities where there is
no alternative) and relationship with its carrier customers to address the
recent competitive issue.
GNCMA
management said the carrier customer who played the “game of chicken” with
GNCMA suffered as well since the reduction in traffic cost between Seattle and Anchorage
didn’t compensate for issues related to optimizing that traffic. In regards to its competitive response, management
will not provide details, in an effort to avoid compromising its strategy, but
they communicate that actions are being taken that within the next six months
will address the Alaska Communications issue to stabilize the carrier
business. There is some leap-of-faith
associated with accepting management’s comment in this regard but I ascribe
much weight to the CEO as being very capable and owner-oriented (he has
effectively built each of his businesses to a share of 30-70%, generated
attractive growth/returns, and is strategically thoughtful for how he manages
the business and allocates capital). Management
doesn’t expect this business to grow and has managed expectations accordingly. As noted above, the other issue was the
non-recurring $800,000 expense that GNCMA envisions getting back in
reimbursement; the company has incurred issues like this in the past and
although it can be an issue of legal expense and time, I view the expense as
non-recurring and another catalyst (albeit small) for investors to realize the
miss was somewhat less severe than reported.
Why is now an attractive reason to
invest in GNCMA?
Putting
recent tax-loss selling pressure aside, the key reason to invest in GNCMA is
the downside protection based on its current “normalized” free cash flow yield (management
is sitting on at least a 15% equity FCF yield and can pay a large
dividend/buyback shares but someone mentored by Malone isn’t likely to pursue
the high dividend yield path) and “asset value” coupled with option value from the
FCF growth prospects based on attractive returns that I envision will be generated
from recent and on-going investment by management.
If
management wanted to coast, they could retrench on trying to grow the business
and pay a large dividend plus buyback more shares (note that management has
repurchased 1.725m shares for ~$13 over the last 12 months). I believe management effectively invests its
capital as “returns” (defined above) have been 17-45% from 2002-2006. The concern is that trend was not evidenced
in 2007. From an overall perspective,
the attractive return profile didn’t hold in 2007 because of the unanticipated issues
described in the Network Access business (which declined from $91m of EBITDA in
2006 to $83m expected for 2007).
However, the return on $56m of growth capex spent in 2005 (i.e., $81m reported
capex less $25m maintenance capex) did in fact have its intended impact on the
consumer business (which grew from $27m of EBITDA in 2005 to $43m expected for
2007).
Much
of the capital recently invested by management has been directed to the consumer
segment to enable the statewide local telephony expansion (i.e., cable
telephony provided on GNCMA’s own facilities including digital local phone
service). The return on this investment
and other consumer investment (primarily cable modems and set-top boxes
providing growth/lower churn via cross-sale) has been very attractive and it is
the consumer segment (including wireless) that will be GNCMA’s primary growth
driver going-forward. Despite the
well-documented issues regarding the consumer, the fact is that spending on
multi-channel video, high speed data, and wireline/wireless communications is
largely non-discretionary.
GNCMA
is already a wireless carrier (among the key areas of growth for lower-48 MSOs)
with a telecom infrastructure advantage (as described above) but this part of
GNCMA could provide substantial upside.
In 2007, it is estimated that only $1m of EBITDA was generated; it is
captured in the consumer segment.
GNCMA’s wireless business of $1m of EBITDA compares to Dobson at ~$70m and
Alaska Communications at ~$63m.
The
wireless market in Alaska
(like video and other communication services) is much less competitive than in
the lower-48 states. The landscape is
essentially as follows:
·
Dobson (acquired
by AT&T for 9.6x EBITDA): 215,000
subs (plus ~35,000 are re-sale with GNCMA; MVNO for GNCMA)
·
Alaska Communication (ACS):
150,000 subs (estimated to generate $63.4m of EBITDA in ’07, or $423 of
EBITDA per sub based on 47% margin)
·
General
Communications: 70,000 subs (includes ~35,000
subs noted above)
GNCMA’s
management openly coveted Dobson’s Alaskan wireless business; note that this
business generated ~$70m in EBITDA, or ~$335 per sub, and this is without the
benefit of owning the backhaul/interconnection telecom infrastructure. You’ll note the more than 26% of EBITDA per
sub generated at ACS on 30% lower subscriber base; this is largely because of
the interconnection/backhaul costs that ACS doesn’t incur.
GNCMA’s
acquisition strategy was neutralized when AT&T announced its acquisition of
Dobson in June. Moreover, the
alternative path GNCMA management considered taking and still intends to take
(the build-approach) has been challenged from a timing perspective because the
re-sale arrangement with Dobson prevents General Communications from competing as
a wireless carrier with its owned facilities-based network. However, now that AT&T will own Dobson,
there is an event-driven catalyst.
AT&T
(like GNCMA) will benefit by eliminating ~30% of Dobson’s backhaul/interconnection
costs which came at Dobson’s expense and much to GNCMA’s benefit as part of the
Network Access business. There is a
win-win situation to this negotiation as AT&T wants to move all that
traffic to their network and GNCMA wants to compete on its own facility, some
of which still has to be built but much is already enabled by the acquisition
of Alaska Digitel and spectrum GNCMA had already owned.
Wireless is the substantial growth
catalyst. What is the potential value of
GNCMA wireless?
There
are currently 435,000 subs controlled by Dobson/AT&T, ACS, and GNCMA. Of the state’s 677,000 residents, the
wireless penetration is ~64%. It is
likely that 80% penetration will ultimately be achieved, thereby representing a
market of 542,000 subs (note I am making no assumption for population growth
going-forward to be very conservative).
GNCMA has achieved at least 30% market share in every business in which
it participates. I assume 150,000 subs
(i.e., 25-30% market share) in the calculation below (management thinks 200,000
is likely). At either 150,000 or
200,000, this obviously implies a share shift; I am confident it can be
achieved since GNCMA has a significant bundling advantage (video/data) versus
both ACS and Dobson/AT&T. As
evidence of GNCMA taking share, note that in each of the major local markets
the company has launched cable telephony, the company has achieved ~50% share
(i.e., taking share from ACS’ wireline business).
Management’s
approach to building its base of ~70,000 current subs hasn’t been a focused
effort (nor a significant contributor to profitability at just $1m this year) but
when one considers that GNCMA already has a billing relationship with a
majority of Alaskan households through cable/internet/telephony coupled with a
strong retail presence/state-wide brand, it’s not too much of a leap-of-faith
to embrace that this management team will increase its base from 70,000 to
150,000 wireless subscribers. If one
applies the same metrics that ACS is achieving on its 150,000 subscriber base,
that’s an additional $63m to be generated in EBITDA at GNCMA (note that I am
not assuming growth to ACS’ current EBITDA to be conservative and also in
recognition of potential concessions GNCMA might make to consumers to drive
share but this approach is indeed conservative in the context of the increasing
ARPU across wireless service providers because of advanced wireless
applications that consumers are embracing).
GNCMA
already has a substantial spectrum position—30MHz of statewide 1.9GHz spectrum
directly owned and another 30MHz of spectrum owned by the company’s 80%-owned
subsidiary Alaska Digitel. In 2008, a
substantial capital investment is assumed to enable the wireless strategy. Jefferies is the most negative and so I use
their estimates for capital spending at $236m.
Using the assumption above for GNCMA wireless (based on 150,000 subs) as
$63m being achieved in 2010 plus using the low 2009E EBITDA at $178m (note that
management is guiding ~$200m) less $17m of estimated wireless EBITDA in 2009,
this implies $224m of EBITDA in 2010.
Targeted
Upside in Two Years (assuming 150,000 wireless subs in 2010) is ~$18 (this
assumes no value ascribed to NOLs nor any change to outstanding shares): The methodology used is applying a 7x
multiple in ’09 to ‘10E EBITDA of $224m, subtracting estimated debt then of
$619m (note large capx plan to enable wireless will lead to negative FCF in
2008 but GNCMA’s credit facility has already been amended to address). If management were to achieve its 200,000
subscriber objective, that equates to an additional $2.75 of targeted value in
two years, thereby suggesting a value (if management achieves its ultimate
wireless vision) of almost over $20.50.
This might explain why Stanton
was willing to invest $20m last Spring at $14.50 and quickly bought more in the
recent unexpected miss in the Network Access business.
Key Risks
- Network Access
business doesn’t stabilize (the key risk is how irrational ACS is willing
to get)
- Outcome of the
AT&T/GNCMA negotiation to exit the re-sale arrangement (since both
companies appear to derive mutual benefits, I don’t think the risk is
substantial but one never knows how irrational a larger company might get)
- Return on capital
spending no longer evidences historical growth/return (the main issue was
Network Access but returns are being evidenced in consumer where majority
of capital has recently been directed; wireless is the key area of future
capital spending and the company is strategically well-positioned to
improve its share at a high margin)
Selected Catalysts
- Wireless strategy is
clarified (i.e., resolution of re-sale arrangement with AT&T) is
effectively executed
- Management restores
credibility with investment community (remember that one EBITDA multiple
is ~$3 of stock impact)
- stabilize network
access business profitability
- demonstrate
attractive returns on investment again
- Growth from construction
of a natural gas pipeline/other natural resource developments in Alaska/increased tourism to Alaska
- The population would
spike with natural resource project developments (pipeline highly likely)
4. Current FCF yield provides substantial downside;
management has been frustrated in the past and could retrench capx
program/harvest and/or pursue going-private (note Goldman Sachs funded Western
Wireless and knows Stanton
very well)
Catalyst
1. Wireless strategy is clarified (i.e., resolution of re-sale arrangement with AT&T) is effectively executed
2. Management restores credibility with investment community (remember that one EBITDA multiple is ~$3 of stock impact)
1. stabilize network access business profitability
2. demonstrate attractive returns on investment again
3. Growth from construction of a natural gas pipeline/other natural resource developments in Alaska/increased tourism to Alaska
1. The population would spike with natural resource project developments (pipeline highly likely)
4. Current FCF yield provides substantial downside; management has been frustrated in the past and could retrench capx program/harvest and/or pursue going-private (note Goldman Sachs funded Western Wireless and knows Stanton very well)