Description

I think the current equity price of Metro PCS, creates an opportunity for a potential return of  100% to 250% over the next two years.  The stock is currently near its 52 week low having sold off on increased competitive pressures in the pre-paid wireless space.  I think this is an excellent point to start accumulating shares in the company.   

I will not go into a lot of detail on the background of the company as jriz1021 did a very detailed write up on PCS in July 2008.  In addition, Leap, a complimentary prepaid wireless provider, was written up a couple of times on VIC recently.  I encourage anyone interested in the idea to review previous write-ups on both companies. 

In recent times, PCS had been growing at a roughly 30% rate based on the ramp up in many of their markets.  PCS is reaching a more mature state in many of their markets, with the exception of a large growth opportunity in the Boston to New York corridor.

Moreover, increased competition including Sprints Boost offering (which was covered in recent Leap write-up) and various prepaid offerings form Verizon, AT&T and T-Mobile (talked about in other write-ups and message strings) has cast a large black cloud over PCS.  I just do not think things are as black as the market thinks here, if one can look ahead. 

PCS still has a very good business.  They are a low cost provider based on their focus on urban markets which gives them an advantage on costs per user and gross adds over postpaid national providers.  They are building out a 4G LTE Data network that will be complete by end of 2010 with speeds up to 10X of EVDO.  This launch will put them as a leader in 4G data network space. 

This network will not only provide a buffer to the ARPU pressure on the voice side of the business but also have potential value for additional devices and revenue opportunities beyond its own cell phones.  Additionally, the prepaid market is not fixed.  It is likely to grow as a percentage of the total market over the next several years.  Current prepaid market share overall is approximately 17%.  This is one of the lowest prepaid shares compared to other countries.  Johnv928's VIC write-up on Leap in August 2008 has significant data on this dynamic. 

The business is no longer going to grow at 30% but the other side of that is it will begin to generate free cash flow.   PCS has the potential, in a couple years, to generate 20% plus yield on the current market cap from a significant lowering of CAPX needs based on no additional major market build-outs and completion of the 4G data network across its market by the end of 2010.  .

I think PCS's EBITDA will grow over the next couple of years at a 20% to 25% rate based on the ramp-up of its investment in Northeast markets (New York and Boston).   PCS's core mature markets include 63 million pops with a penetration rate of approximately 9%.  Applying that same metric to the NE markets produces the potential to add an additional 2.25 million subs.  Currently PCS has 666 thousand subs on the NE, so a net addition of 1.5 million or so.  Those additional 1.5 million subs represent growth in PCS's overall subs of 25%. 

It also represents the potential for an even larger percentage increase in EBITDA since the NE market is in early stage of ramping up.  The company breaks out EBITDA for this segment. In addition, thru third qtr of 2009, it lost $173 million in EBITDA and I estimate total EBITDA loss of year at $200 million.  In a more mature state two years out PCS run rate might look something like this:  At 7% market penetration, ARPU of $40 and a margin of 30%, EBITDA would be $230 million, or a net change of $430 million.  PCS's current EBITDA margin on its "seasoned" markets is around 40% so you can be more aggressive with assumptions if you like. 

PCS's current EBITDA run rate on its core markets is approximately $1.2 billion, even though this has some growth potential remaining, my assumption is to leave EBITDA flat going forward given the more competitive landscape.  I think ARPU and subscriber pressure will be offset by the potential of the 4G data network.  Adding $230 million of EBITDA from NE market brings total EBITDA to $1.43 billion.  The current PCS EV of $4.7 billion, produces an EBITDA multiple of approximately 3.3X.  I think this leaves a large margin of safely for things not playing out as well as anticipated.    

Private market multiples for wireless assets in recent past have been in the 8X to 10X range.  While these multiples may be possible, I am assuming that they come down in the "new normal" environment and fact that wireless is becoming a more mature business.

 Giving the business 7X multiple, I arrive at a future value of PCS of $10 billion.  Making some assumptions about cash build over two years, I arrive at a potential share price of approximately $23.00 compared to the current price of $6.30.

There has been a lot written about a Leap and PCS merging.  It certainly makes sense and I believe the wireless space will continue to consolidate in the future.  My thesis does not change if this were to occur.  I think a combined PCS/Leap would be positive and present the same if not better investment potential given the current market valuation of both companies. 

Below is a pro-forma PCS valuation analysis supporting the numbers described above:

Risks:

The biggest risks I see are:

The significant marco economic uncertainly going forward and a scenario where we have unemployment going significantly beyond current levels. 

Competitive and pricing pressure that is beyond rational for extended periods by competitors. 

Catalyst

Low current valuation.

Business moving from user of cash to free cash flow positive

Growth in NE markets  significantly grows overal EBITDA going forward.