Description
This is an idea for the RLEC and micro cap investors out there. Dman and others have done an excellent job of defining the space and the opportunities with HCT, NULM, CTCI, and WWVY. I will shamelessly piggyback on their valuation work.
As I see it, NORSB stands out because it can be argued that, in buying the stock for $66, you are buying the RLEC business for roughly 2x EBITDA and at a valuation of less than $750 per access line. If that’s right, and if market values are closer to the 6-8x multiples and $2,500-3,000/line estimates that have been discussed in the other writeups, then there’s a substantial amount of upside potential in NORSB. While a catalyst isn’t as apparent as it was with HCT, for example, a $1.30 regular quarterly dividend provides a nearly 8% yield while you wait.
NORSB is, logically enough, the Class B common of North State Telecommunications Corporation. There’s also a Class A stock (NORSA) that holds all the voting rights, but it trades even less frequently and at a significant premium. My fund owns only the Class B, though of course we may purchase or sell either stock at any time and without notice.
NORSB is a typical RLEC, tracing its roots back to 1895. It serves an estimated 112,000 access lines in a north central part of North Carolina, just south of Greensboro. Headquartered in High Point, NORSB offers the usual combination of long distance, internet, wireless and other services in addition to its local access services.
As with many of the comparable companies, NORSB has been growing slowly as local access business gradually declines and newer competitive services become more important to the business. Nonetheless, margins are excellent and cash flow is very strong. In the three years of 2003 to 2005, revenues grew as follows: $103 million, $104 million, $107 million. EBITDA in those years was: $45.3 million, $45.8 million, and $44.0 million. Net income (and per share) was: $21.1 million ($8.28, including a one-time gain), $18.1 million ($7.16), and $17.2 million ($6.92).
In the March 2006 quarter, revenue declined slightly to $26.1 million from the year-ago $26.4 million while net income dropped to $3.9 million ($1.59) from $4.9 million ($1.95). Management attributes the earnings decline to various “transition” issues including higher depreciation on equipment for new services, expenditures on a new billing/back office system, higher promotional costs, and increased competition.
Earnings in the first quarter of 2006 improved modestly from the fourth quarter and EBITDA was $10.6 million. I expect EBITDA to remain relatively steady at approximately $42 million for the full year 2006.
This clearly isn’t a growth story, and the earnings weakness may well account for the recent decline in the stock price. But now consider the valuation, which I see as four major components, as follows:
1. Market equity value $167 million at $66 per share. There are approximately 1.5 million Class A shares and 1.0 million Class B shares outstanding. Additionally, there is $2 million of non-convertible preferred stock which is slowly being redeemed.
2. Net cash and securities $46 million (excluding the Alltel partnership discussed below). Because the company does not provide a quarterly balance sheet, these are 12/31/05 figures. There was no debt outstanding at that date.
3. Investment in Alltel partnership approximately $38 million. NORSB owns 18% of Alltel Communications of North Carolina Limited Partnership. This is a wireless partnership with, logically enough, Alltel Corporation (NYSE: AT). NORSB’s basis in its investment is approximately $13 million and NORSB’s share of 2005 earnings was approximately $3.6 million. At 15 times earnings – which is hopefully somewhat conservative – and assuming a tax rate of 38% on the value in excess of the basis, NORSB’s investment would be worth $54 million before tax and $38 million after tax. The pretax value equates very roughly to three times the partnership’s annual revenue.
4. Local access and other core businesses $83 million. This is the residual of the market value, minus net cash and securities, minus the estimated market value of the investment in the Alltel partnership. With approximately 112,000 access lines and $42 million of annualized EBITDA, the market is valuing NORSB at less than $750 per line and 2x EBITDA.
As you will find, NORSB is a thinly traded stock and financial disclosure is limited. I have been able to obtain very little information regarding the stock ownership, other than that the Class A is apparently controlled by descendants of the early owners and managers. Nonetheless, stock periodically becomes available and patient investors can develop positions over time.
NORSB has an active stock repurchase program and acquired $1.8 million of stock in 2005. The quarterly dividend was recently increased from $1.25 to $1.30, providing an annual yield of nearly 8%. Earnings and free cash flow will likely remain somewhat depressed as NORSB invests in a new back office system, an expanded fiber network, and other upgrades. However, I believe the current valuation and yield provide an attractive opportunity.
Catalyst
1. Improved earnings and free cash flow following completion of current investments.
2. Increased dividends over time.
3. Continued stock repurchases.
4. Long term: sale of part or all of company.