Description

Metrocall is clearly something of a "buggy-whip" company (paging), yet looks interesting as a long investment at these prices if you believe as I do that the company could produce upwards of $40-50mm in annualized free cash flow. A July 1 announcement by the company somewhat exemplifies the co's cash generating characteristics: As of June 30, 03 all of the co's remaining $11.5mm principal PIK notes were volunatrily paid in full. That repayment retired in full the last remaining debt balance associated with the October 02 reorg. Since the beginning of 03, over $80mm aggregate principal of debt has been retired from cash flow. Some early indications were that this event might not take place until the end of Q3, so this was a nice data point.

MTOH is a one and two way paging company which came out of bankruptcy in October 2002. Though paging is clearly a mature/declining business, capex requirements are very small ($12mm or less annualized), and marketing and admin costs are on the decline. Something which should also insulate MTOH from immediate obsolescence with certain customer segments: Paging is cheap and is very reliable.

Corporate strategy to help offset the declining nature of the business include a push toward higher ARPU's, lower churn, and lower subscription acquisition costs. To achieve this, the company is exiting lower margin business, and focusing on business and government customers (i.e. utilities, park police) which have lower acquisition costs, lower churn, and higher revenues. The company is trying to manage the business "down" to a stable and flat revenue stream vs. the current declining trends.

MTOH's also has detailed plan toward expense reduction: This plan calls for a 25% reduction in managers, consolidation of call centers into one location, consolidation of fulfillment centers, and deconstructing a minimum of 250 transmitter sites which support under-utilized frequencies. All-in, the co expects $14mm in annullized expense redcution from lower benefit and compensation expense, though the total could be higher.

The current capital structure is as follows: $66.8mm in liquidation preference pfd stock (6mm shares o/s), 1mm shares of common o/s,and $11mm in unrestricted cash. Using somewhat conservative assumptions on expense control and sales decline, I think that the pfd could be paid off before the end of 2004.

With a market cap of $135mm, a pay-off of the pfd issue as early as Q3 04, and the realization of $40-50mm in annualized free cash flow, Metrocall will only be trading at 2.7-3.4x c.f. once the pfd is taken out. Downside should be limited given the large cash generating abilities and the success thus far in the turnaround. At 4x cash flow the stock would trade at $160-200/share, and perhaps it's not a stretch to assume a more generous valuation if there is further evidence of stabilization, expense reduction, or greater than expected cash flow.


RISKS: 1.Revenue decline/subscriber weakness do not offset higher ARPU and expense reduction plan. 2. Pricing pressure from more "robust" full service competitors.

Catalyst

Continued execution of plan; beginnning pay-down of pfd stock. (I would have listed misallocation of cash as a "risk", but it appears to me that the company extremely well managed from a financial perspective).