Description

New Ulm Communications



If you liked my previous recommendation of Hector Communications, read on. If not, you should probably stop reading as New Ulm is very similar to Hector in a number of respects.

New Ulm operates a Regional Local Exchange Carrier. The Company also has a hidden asset in the form of a minority ownership stake in a very profitable and growing wireless partnership, to which I believe the market is (errantly) not assigning much value. The ultimate outcome of the Hector situation should serve as an outline to New Ulm management and Board members on what the value of New Ulm would be in a sale of the Company. While no deal for New Ulm is imminent, it is obvious that this company should not be public (it trades on the OTCBB), and the continued consolidation in the wireline and wireless industry are likely to push NULM to go down the same path as HCT, eventually in my view. My work concludes that a conservative floor on a takeout price would be $20 with a high number of $30+ per share, while standalone value for NULM at these levels is also attractive.

New Ulm’s primary business is to operate a Regional Local Exchange Carrier (RLEC). The Company services approximately 17,000 access lines in rural communities in Minnesota and Iowa Dakota. The Company also owns a 10% interest in Midwest Wireless, LLC, a wireless operating partnership with 425,000 customers primarily located in fourteen rural service areas across Minnesota, Wisconsin and Iowa.

Valuation

In terms of valuing NULM, I have taken two approaches. The first is to consider a sum of the parts valuation. The second is to check this valuation against an all-in absolute valuation.

SUM OF THE PARTS VALUATION

RLEC Valuation

RLEC’s are still afforded reasonable multiples due to their ability to generate high margins and sizable cash flows. Additionally, RLEC’s are typically in less desirable markets for direct competition as new entrants cannot justify the cost to directly compete in the local telephone business. While revenues from long distance access and other phone related services are falling gradually due to the regulatory environment, wireless substitution and voice over Internet competition, the provision of DSL and Internet-related services have helped to cushion the fall.

EV/Revenue EV/EBITDA EV/Access Line
Centurytel 3.1x 6.1x $3,325
Citizens 3.8x 7.3x $3,652
Commonwealth 3.7x 5.8x $2,519
CT Communications 1.7x 5.4x $1,946
Fairpoint 4.4x 9.1x $4,179
Iowa Telecom 5.0x 8.5x $4,009

Average 3.6x 7.3x $3,271
Source: Baird, June 2005 “Spectrum” Report. These numbers are a bit dated but haven’t moved much.

For Hector I believed it reasonable (and conservative) to assign a range of values of $3,000 to $3,500 per access line as a low and high bound on the valuation. However, New Ulm’s profitability is lower than Hector’s due to inferior cost control. I therefore use a range of values of $2,500 to $3,250 per access line. I then spot-check these numbers against an EBITDA multiple:

Total RLEC Access Lines: 16,800
Value/Line (Low) $2,500
Value/Line (High) $3,250
Total RLEC Value (Low) $42.0 Million
Total RLEC Value (High) $54.6 Million
LTM EBITDA $6.7 Million
LTM EBITDA Multiple (Low) 6.3x
LTM EBITDA Multiple (High) 8.2x

I think these multiples are reasonable and serve as a reasonable place to begin valuing New Ulm. The high number is at the midpoint in terms of valuation on an EV/access line basis versus comps but results in a high EV/EBITDA number. I think this signifies the opportunity a strategic acquirer would have to reduce costs.

Midwest Wireless Investment Valuation

Midwest Wireless is owned by telecommunications companies located within the Midwest Wireless’ operating footprint in southern Minnesota, northern Iowa and west central Wisconsin. New Ulm is the largest active member of the LLC, with a 10% ownership stake. New Ulm actively participates in Midwest’s operations and has had a seat on the Board of Directors since its inception. In fact, New Ulm’s CEO is the Chairman of Midwest Wireless. The Company made a very nice acquisition of PCS licenses in 2001 for regions of Iowa, North Dakota and Minnesota from McleodUSA. Here is an overview of historic financials:

1998 1999 2000 2001 2002 2003 2004
Revenue $49.1 $58.0 $112.3 $140.5 $162.7 $179.6 $220.7
EBITDA $25.5 $40.1 $50.3 $59.0 $61.0 $74.7
Op. Inc $17.6 $17.5 $24.5 $28.0 $39.6 $38.2 $44.7
Net Inc $17.0 $16.0 $16.2 $16.6 $28.1 $27.5 $35.2
Net Debt$10.0 $28.4 $130.8 $159.8 $152.7 $183.7 $160.2
CapEx $11.5 $16.6 $28.0 $33.8 $31.9 $29.2 $33.8
Acq $0.0 $0.0 $96.2 $22.4 $7.4 $42.8 $0.0
Unit Red$0.1 $12.8 $0.0 $0.0 $0.5 $0.0 $0.0
MembDist$8.6 $6.8 $5.9 $8.2 $8.3 $9.5 $9.2

Since my HCT write-up, Midwest Wireless has reported continued growth in revenues and profitability. The benefits of the move in 2003 to switch its cellular network from TDMA to CDMA continue to accrue. If you recall, MWW incurred significant costs in 2003 and 2004 to make the switch. CDMA infrastructure offers the ability to drive more data to the phone, allowing cell phone providers to offer new high margin wireless services including camera phones, digital music and text messaging, as well as a much easier migration path to 3G technology. Midwest Wireless Q1 and Q2 numbers were as follows:

Q1 2004 Q2 2004 Q1 2005 Q2 2005
Revenues $48.4 $51.9 $58.5 $62.9
Operating Income$8.4 $10.8 $16.5 $20.3
Net Income $8.5 $7.8 $13.4 $16.2

Given that Depreciation and Amortization has been running at $7-$8 million per quarter, it appears that Midwest is on a run-rate for $110-$120 million in EBITDA for 2005. They currently have 425,000 subscribers. Additionally, these subscribers are in rural markets, making these assets much more attractive versus those in urban centers. After building a cellular network in areas like North Dakota and Iowa, a rural cellular operator like MW Wireless has a much more protected franchise with a lower threat of competition, because the economies of overbuilding a rural market are less attractive.

To place a value on this investment, I have looked at multiples of comparable companies as well as recent M&A transactions.

Comparable Company
EV/’05E EBITDA EV/Sub
Alamosa 9.3x $2,278
Dobson 8.4x $1,934
Leap 6.5x $1,137
Ubiquetel 9.2x $2,503
U.S. Unwired 11.0x $2,331
Average 8.9x $2,036
Source: Baird, June 2005 “Spectrum” Report.

Comparable Transactions

Date Acquirer Acquiree EV/LQA EBITDA EV/Sub
8/30/05 Sprint/Nextel Gulf Coast Wireless 8.6x
8/30/05 Sprint/Nextel IWO Holding 9.3x
1/10/05 ALLTEL Western Wireless 8.7x $2,042
12/15/04Sprint Nextel 8.3x $3,045
12/8/04 Alamosa Airgate PCS 9.3x $1,640
2/17/04 Cingular AT&T Wireless 10.5x $2,151
3/19/02 ALLTEL CenturyTel Wireless 10.1x $2,400
Average 9.3x $2,256
Source: Baird, June 2005 “Spectrum” Report, Sprint Press Releases.

Since my HCT write-up, two transactions have occurred that serve as a guide to value the wireless asset. Sprint acquired two properties at an average of about 9x last quarter annualized EBITDA. I would note that neither of these assets are growing as rapidly as MWW. Considering these valuation multiples and the strong recent results, I believe an 8-10x EBITDA multiple applied to Midwest is a reasonable assumption. Midwest should be generating strong cash flow at current levels of profitability, and I estimate the Company has paid down approximately $45 million of debt through Q3 ‘05 (last balance sheet I have seen published is as of 12/31/04).

Using EBITDA Multiple

($’s in Millions)
EBITDA (Low): $110.0
EBITDA (High): $130.0
Multiple (Low): 8.0x
Multiple (High): 10.0x
EV (Low): $880.0
EV (High): $1,300.0
Net Debt: $120.0
Equity Value (Low): $760.0
Equity Value (High): $1,180.0
Value to NULM @ 10% Ownership (Low): $76.0
Value to NULM @ 10% Ownership (High): $118.0

Using EV/Sub

($’s in Millions)
Current Subscribers: 425,000
EV/Sub (Low): $2,000
EV/Sub (High): $2,500
EV (Low): $850.0
EV (High): $1,062.5
Net Debt: $120.0
Equity Value (Low): $730.0
Equity Value (High): $942.5
Value to HCT @ 8% Ownership (Low): $73.0
Value to HCT @ 8% Ownership (High): $94.3


Current Total Enterprise Value

In order to compare our sum of the parts analysis to the current valuation, it is necessary to calculate the current total enterprise value of the Company.

$’s in Millions
Cash: $3.0
Debt $16.4
Net Debt $13.3
Market Cap $68.3
TEV $81.6

Conclusion

The sum of the parts looks like this:

$’s in Millions
Low High
RLEC Value $42.0 $54.6
MW Wireless Value $73.0 $118.0
Total TEV $115.0 $172.6
Less Net Debt $13.4 $13.4
Projected Equity Value $101.6 $159.2
Value/Share $19.88 $31.14
% Upside 49% 133%

STAND-ALONE VALUATION

My next step was to check the sum of the parts valuation against a stand alone look at the Company valuation. As mentioned in my HCT write-up, I tend not to use DCF’s as I think there are too many assumptions that go into triangulating around a value. I instead look at free cash flow yield and the potential for stability in cash flows. In the case of NULM, I looked at free cash flow inclusive of the free cash flow allocable to it from its ownership of MW Wireless. Based on the first six month’s result for MW Wireless, I would expect the free cash flow allocable to Hector from the investment for 2005 to be $3.5-$4.5 million, while free cash flow from the RLEC should be around $4-4.5 million, in line with LTM numbers. With a current equity market cap of $68.3 million, this puts the current free cash flow yield at 11% to 13%. I consider this to be an attractive valuation of a business such as NULM given its stable free cash flows and rural market focus. While one could argue that LEC cash flows are in a secular decline, I would argue that the wireless investment cash flow growth should counterbalance this issue in the future.

Another way to look at this is to consider the TEV/EBITDA multiple for the entire company using a “look-through” to allocate NULM’s proportionate interest in the EBITDA of Midwest Wireless. Using an EBITDA number of $120 million for Midwest Wireless, of which $12 million would be allocated to HCT and EBITDA of $6.7 million for the rest of the business, we have a pro forma EBITDA of $18.7 million. We then allocate an additional $12 million of debt to HCT (share of the MW Wireless debt), you have an all in EBITDA multiple for the business of 4.9x.

This is well below even the lowest valued RLEC comp. Considering RLEC’s are trading at 7x+ and wireless businesses (not many growing as quickly as MW Wireless) are at 8x+, current pricing of NULM appears too cheap.

CONCLUSION

A sale of HCT at the proposed buyout offer of $30.25 would imply a 6.3x EBITDA multiple, including the MWW value. Applying the same multiple to NULM results in about 50% upside. While you wait the Company has a nice dividend and a double digit free cash flow yield.

Catalyst

- Sale of Hector Communications, putting a stake in the ground for valuation of NULM
- Potential IPO or sale of Midwest Wireless
- Continued consolidation and HCT strategic transaction puts pressure on management to realize the value of the MW Wireless asset