Description

Montana Power, a former energy and utility conglomerate, is nearing completion of a plan to divest all energy-related assets in order to focus on its telecom operations. It has been especially easy as a value investor to ignore everything hi-tech these these past few years, but MTP is indeed a very special situation.

The oil, gas, and coal businesses have already been sold, and the sale of the electric utility is expected to close in Q3. (more on this later) The sale of these assets will raise a total of $1.3 billion pre-tax, leaving MTP at year-end 2001 with no debt, $275 million of cash, and a profitable nationwide fiber-optic network. So while some energy assets and revenue are still reflected on the books, it is better to look at MTP as the stand-alone telecom company it will soon be. (The new company will be called TouchAmerica, symbol TAA)

MTP’s (telecom) competitors all share similar problems resulting from the hi-tech growth explosion during the late 90’s. All took on heavy loads of debt in order to grow at all cost. MTP was ridiculed as too conservative when it prudently ignored the rich capital markets and funded profitable growth out of free cash flow. Management has followed a strategy of just-in-time expansion, meaning before a network expansion is made, they already have secured enough contract business to cover half the cost of the expansion.
And through smart planning, MTP’s fiber optic network is not only the most profitable, but also the cheapest and is one of the most technologically-advanced. According to the company, MTP’s 26,000-mile network cost $2900 per fiber mile, compared to $6100 per mile for Broadwing’s next-cheapest network. Additionally, as a relative newcomer to this industry, MTP doesn’t have to deal with expensive updates to legacy systems and old technology.

Now for some numbers:
At $10 per share, and approx. 100M shares outstanding, market cap is around $1B. Using year-end 2001 numbers of $275 million of cash and no debt (as a result of final utility sale), EV is $725 million. Management predicts $670 million of revenue, as well as an improvement on last year’s 20% EBITDA margin. To be conservative, assume only $600 million of revenue and no margin expansion. That gives us a conservative EV/EBITDA of 6.0, which would result from even a sub-par operational performance. By simply meeting management’s expectations, EV/EBITDA is 5.4. Once the telco is fully independent, growth will be 20-25% for several years, and margins should expand moderately as network traffic is normalized. A conservative DCF with zero terminal growth gives a value in the $20 range.

By comparison, fellow telco Qwest has EV/EBITDA of 13.1, while more direct competitors (LVLT, BRW, WCG) all have negative EBITDA. These companies also have significant debt.

So how is this a special situation stock? There is concern that the Montana Public Service Commision (PSC) is meddling with the rate pass-through structure dictated by Montana law for the electric utility. Theoretically, an order extending the time the PSC can dictate low power prices could lower the sale price of the utility, or endanger the transaction altogether. The PSC’s tough stance is simply a political response to the recent energy problems in the west, and has no legal basis. MTP and the NorthWestern Corp. (the utility’s buyer) have several steps to oppose any regulatory changes, as well as the courts as a last choice. In all likelihood, the PSC situation will delay the sale by 3-4 months, which should now close in Q4 2001.
And even if the PSC is succesful in extending its regulatory power, the utility is still very saleable, mainly due to the recent settlement of an unprofitable, long-term power supply contract to a large silicon producer in the state. (see 6/26 press release)

Catalyst

Best long-haul fiber-optic network for dirt cheap. Final energy asset sale should close in Q4 when regulatory dust settles. Very little downside for a future 20% grower with no debt and a pile of cash.