Description

The equity of Rural Cellular represents a special situation opportunity (almost a like a perpetual option), which I believe, has the potential for a 100% to 500% return over the next two to four years.   This is not a traditional value investment such as a cigar butt or a company selling at 50% of asset value, so I don’t expect it to appeal to all.  What I think makes Rural Cellular a attractive investment is what I anticipate to be improving fundamentals of its business in 2007, highly predictable cash flows and the high likelihood that the company will be purchased as part of the rapid consolidation that is taking place in the wireless telecommunications industry. 

 Rural Cellular Corporation provides wireless communications services primarily to rural markets in the United States.   As of June 30^th, 2006, the company served approximately 700,000 voice customers in Minnesota, and certain territories in the Northwest, Northeast and South.  Rural Cellular was founded in 1990 and is headquartered in Alexandria, Minnesota.

 Over the past few years many of the smaller regional or Tier two wireless carriers have been purchased by larger companies.  As examples,  Sprint/Nextel’s purchase its affiliates (including Nextel Partners, Alamosa, UbiquiTel,  Alltel’s purchase of  Western Wireless and Midwest Wireless.   Prices per sub have ranged from $2,500 to $4,300.   Multiples of EBITDA have ranged from 8X to 10X .  

 Rural Cellular is highly leveraged with debt of $1.36 billion at an average rate of about 9.0% with maturities from 2010 to 2012.   There are also preferred stock issues that total $510 million at dividend rates from 8.0% to 12.25%.  Accrued dividends on the preferreds’ equal $150 million.   Common stock conversion of preferred is not a factor.   The company has $170 million of cash which combined current level of operating EBITDA provides enough cash to run the business and provide a level of comfort given the high financial leverage.   The company also has an NOL of approximately $400 million. 

 I use a sale multiple of 9X EBITDA to demonstrate the potential value of the common stock.  The common is sensitive to changes in this multiple given the high leverage, (making for an exciting scenario in both directions).   Midwest Wireless, which was the most recent comp transaction, was sold at 9.5X to 10X EBITDA multiple (depending who you talk to it was a private company).   Midwest Wireless serves ½ of rural Minnesota and parts of Wisconsin and Iowa.  Rural Cellular serves the other half of rural Minnesota. 

 Below is a pro-forma table that demonstrates the potential value to the common in a sale. 

Management has been in place through the good times and bad.   My assessment and people I have talked to in the industry is that management is capable, hard working and honest.  The company could have more easily filed BK a few years ago when the stock was under $1 and cash flow was pressured by its high leverage and new roaming agreements with the majors at lower rates.   They stuck it out and worked through the problems (not only for their owe sake but also for all their friends and neighbors that invested in the company….the company is located is a town of 15,000 in central Minnesota).  Management also recognizes the realities of industry consolidation and understands that Rural Cellular will eventually be part of that dynamic. 

Operationally Rural is just coming out of a two period where they converted systems from analog to digital (2.5G technology).  The rollout took longer than anticipated and they had some operational issues which cost approximately 50,000 customers.  Currently 70% of customers have migrated to the new digital platform.  Digital customer churn is running in the range of 1.8% compared with an overall rate of 2.7%.  Churn will now start to come down with the majority of the migration is completed and service issues resolved.   Management has indicated that the worst is behind them and that they are optimistic that they will start to grow customers again off a current base of 700,000.  I expect by forth quarter that they will start to show net adds and that the process will accelerate in 2007.  I don’t think the street is anticipating that Rural will grow again.   Growing customers, revenue per customer (which is already occurring on the digital platform) and EBITDA, I think, will be catalysts to a higher stock price over the next couple years in advance of a sale. 

There are various scenarios on how Rural eventually gets sold.  Here is my best guess.  Its possible Rural Cellular could be sold in more than one transaction.  Minnesota is a logical fit for Alltel they purchased ½ the state in the Midwest Wireless transaction.  Rural’s territory would give them the other half.   They share the same CDMA technology in these areas.  Rural’s other markets in the Northwest, Northeast and South are all GSM technology.  The best fit for these properties would be other GSM carriers such as Cingular or T-Mobile.   I do not think that the risk of national competitors and current roaming partners building systems in there territory is likely.  It is to expensive and time consuming compared to buying in place assets. 

Disclaimer:  We own RCCC.  The information contained in this write-up is believed to be correct, but should not be relied upon.  
We undertake no obligation to update the write-up if new information arises at a future date.

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