Description

If you believe, as I do, that having a line into the consumers home and a protected franchise is valuable, than New Ulm Telecom could be a very good long term holding. I wrote up NULM last year and the story will have evolved into a pure play RLEC story after the pending sale of Midwest Wireless to Alltel is completed. New Ulm is also participating in a group to buyout Hector Communications. The terms of this deal amongst the three parties buying Hector are unclear, but we can make some reasonable assumptions to triangulate around an implied EBITDA multiple.

Hector Valuation @ $36.50 Purchase Price

$ Millions

Mkt Cap on Takeout                            $159.1 (Diluted for Options)

HCT Debt                                            +$54.0

HCT Cash                                            -$45.0

HCT Other Investments                        -$9.0

MW Wireless Proceeds                        -$39.5

Implied Valuation                                  $119.6

EBITDA                                              $15.9

Multiple                                                7.5x

Synergies/Cost Savings             $2.0

Adjusted EBITDA                                $17.9

Implied Multiple                                    6.7x

NULM Pre-HCT

$ Million

Market Cap                                         $79.3

MWW Proceeds                                  -$57.0

Net Debt                                              $10.5 Adjusted for 1 additional Q of free cash flow

TEV                                                     $32.3

EBITDA                                              $8.5

Multiple                                                3.8x

NULM Post-HCT

Market Cap                                         $79.3

MWW Proceeds                                  -$57.0

NULM Share of HCT Purchase Price   $40.0

Net Debt                                              $10.5

TEV                                                     $72.8

EBITDA                                              $8.5

HCT Adjusted EBITDA                       $17.9

NULM Share of HCT EBITDA           $6.0

NULM Adjusted EBITDA                   $14.5

Multiple                                                5.0x

My assumption is that NULM is an equal 1/3 participant in the group buying out HCT. Additionally, I would note that it appears the HCT buying group is going to use debt to finance part of the purchase price. If you assume the new debt will be equal to the $54 million of debt currently on HCT’s books, it is possible that NULM will hold $15-$25 million ($3-$5 per share) of net cash on its books. If so, NULM clearly has no need to hold this cash and a buyback or large special dividend is still possible.

Additionally, as I have noted in other situations, NULM has enough borrowing capacity based on these numbers to pay out a dividend that is a large percentage of the current stock price, based on comps:

Net Debt/EBITDA

ALSK             3.5x

CBB              4.7x

CTL              2.1x

CZN              3.7x

CTCO             1.5x

IWA              3.9x

FRP              5.1x

VCG              4.3x

Average          3.6x

At 4x EBITDA, NULM could pay out an $11.25-$11.50 per share and maintain nice profitability. While I don’t necessarily expect this to happen, it shows the potential for value creation IMHO.

Protected Franchise

In my eyes, NULM (and the purchased HCT) markets are extremely rural and provide the company with a truly protected franchise. Reason being, it is very difficult for cable companies to compete in these markets because of the lack of density.

I believe truly rural markets for these services are FAR superior to dense urban markets. Reason being, the urban markets are far more competitive, and telcos are going to be fighting it out with the cables for the line into the house. I would guess that satellite companies will be in trouble on the margin (although they’ll still have their core users) as the cable and telcos offer triple and quadruple play (voice, video, internet, wireless) in a basket from one company. But rural telco companies in truly rural areas (not suburban) are often the ONLY line into the home. I believe NULM’s markets are as rural as it gets. To me, this should result in continued growth from DSL lines, taking share from satellite on television services, and marginal losses to VOIP (customers are more loyal and they will be receiving a bundled service offering), and some losses from network access. Even if they remain flat in terms of revenue and profitability, a real possibility, I don’t care, because at these levels I’m now coming to the conclusion that the company is priced to fail. At 5x EBITDA, less than 7x EBITDA-Capex and in excess of 10% FCF yield, I think the stock is a good bargain at these levels.

This thesis is further supported by the limited access line losses suffered by both NULM and HCT over the past 12 months. While HCT and NULM have lost virtually nothing in terms of access lines, other RLEC’s are losing 2-5% of their lines per month, while generating new revenue from unregulated services such as broadband (DSL) access and television services. HCT and NULM have also begun offering these services and will continue to benefit from increased broadband uptake and the offering of triple and quadruple play, but I believe the lack of access line losses supports my contention that they are rolling out these services in an environment that is far less volatile and competitive.

New NECA Laws

New NECA laws (NECA is an entity that is charged with disbursing government funds to the various telcos) going into effect over the next two years are focused heavily on providing funds to those rural telco companies that are truly rural, based on population size and density. This was designed to divert resources from those companies that have become more suburban in terms of their customer base as suburban sprawl has encroached on many formerly rural markets, increasing density and the number of potential customers. What this has served to do is weaken those companies that are now facing competition, while providing greater cash to those companies that are not facing much competition. While I do not have a sense for the numbers on this or the extent to which NULM will benefit, if at all, my belief is that this development will favor NULM (and the purchased HCT) and have a nice, positive impact on profitability.

Young, Aggressive CEO

Bill Otis, the Company’s CEO is in his 40’s and appears to want to grow the business aggressively. While we can argue about whether paying 6.7x EBITDA for HCT is good value, my belief is that it is. Otis has pushed NULM to be on the cutting edge of technology, rolling out broadband and video services before many of the other RLEC’s in the market. Additionally, the Company does not heap options or compensation on senior management. Otis made about $200K last year and his interest is aligned with ours as he owns about 4% of the Company. All evidence points to a management group interested in creating value.

Risks

Risks have been well documented on this site in the past – Voice Over Internet Protocol is a risk although it appears few are making money in the sector. Additionally, continued switching to wireless phones and other disruptive technology is also an issue.

Conclusion

My belief is NULM is the class of the broader group of RLEC’s with a protected franchise, a high probability of positive regulatory developments (NECA) and a young aggressive CEO. For these positives, we pay some of the lowest multiples in the group at around 5x EBITDA, 7x EBITDA-Capex and a 10%+ free cash flow yield versus the group at 6.5x-7.0x and 8.5x-9.0x. I would note that in this case I don’t care about relative valuations as I feel the stock is cheap on an absolute basis.

Catalyst