Description
After declining almost 30% from the highs in September, Leap's stock has recently started to gain some traction. I feel that the stock can trade into the $30 range next year, given the company's strong cash build and current valuation. Management’s goal is to increase the company’s cash position by $30M per quarter. The Company also maintains a portfolio of wireless towers and unused spectrum. The sale of these assets would lead to further cash buildup for debt reduction and refinancings, thereby increasing the stock price.
Leap Wireless operates in 20 states, providing unlimited local wireless services through its Cricket subsidiary. The company operates as a low-cost alternative to traditional local phone service, catering to low-income households and younger subscribers. The majority of these subscribers use the Cricket service as their primary or only phone service. The plans are basically month-to-month, with no long term contract commitments. Leap filed for bankruptcy in April 2003, after incurring substantial debt to built its network and subscriber base. As a result of the restructuring, old vendor debt holders received 96.5% of the new equity and $350M of 13% senior secured notes (7-yr), old noteholders received 3.5% of the new equity and old equity holders received no recovery. During the restructuring, the company vastly improved its cost structure, as it renegotiated vendor contracts and made several changes to its product offering. Its cost tructure is one of the lowest in the industry.
RECENT GUIDANCE
In September, Leap lowered financial guidance for fiscal year 2004. This news was particularly negative coming off a second quarter that generated record levels of EBITDA and gross margins. The new guidance was as follows:
Revenue: $820M – $840M
EBITDA: $215M – $230M
Net Adds: 50K – 100k
Churn: 3.8% – 4.2%
This guidance has several implications to operating performance. If net adds for the second half of the year comes in below 70K, then the company would at best breakeven in terms of subscriber growth for the rest of this year. This would obviously imply higher churn for the second half, up from around 3.5% for the first half of 2004. In addition, given that current run-rate EBITDA is in excess of $240M, the new EBITDA guidance suggests an increase in Cost Per Gross Add (CPGA), in the range of $180 up from first half levels of $140.
The increase in CPGA will most likely be the result of increased handset subsidies, a program that LEAP had rolled out to select customer regions. I believe this increase in CPGA will be largely normalized by the end of the fourth quarter, as they correct this program. With a more normal CPGA rate and even modest (~70K annual) net adds, the company should be on track to easily generate $250M+ of EBITDA in 2005, as it takes advantage of its fixed operating cost base.
OTHER ASSETS
Leap owns two valuable assets that could potentially be sold. The first is a portfolio of 140 wireless towers. In recent transactions in the industry, wireless towers have been sold for up to $180K per tower, implying a value of $25M for Leap’s towers. Secondly, Leap has unused spectrum in various markets, which could be worth $100M–$150M. Monetizing part of all of these assets would have a positive impact on the stock. If we incorporate this into the valuation, Leap seems extremely cheap on a cashflow and subscriber basis.
Total Secured Debt: $390M
Cash: 180M
Stock Price: $22.00
Shares Out: 60M
Equity Value: $1,320M
TEV: $1,530M
Less: Asset Sales ~$125M
Adjusted TEV: $1,405M
2005 EBITDA: $250M
Capex: $80M
EBITDA Multiple: 5.6x
Per Sub: $940
The regional wireless carriers trade in the range of 6x-8x 2005 EBITDA and $1200-$2300 per sub. The sprint affiliates trade higher, but hey have roaming capabilities, which Leap does not currently offer (but is planning to roll out in the near future).
Catalyst
- Attaining normal levels of CPGA
- Potential assets sales and subsequent de-levering
- Debt refinancing
- Continued quarterly cash build
- Potential IPO of MetroPCS (same business model)