Description

In a situation similar in several ways to IDT five or six years ago, recent changes in management commentary make me think that the Carlsons may finally be willing to realize some or all of the tremendous underlying value in USM shares.  With the buyside and sellside having largely given up on the situation, risk/reward appears attractive for a substantial potential gain.  This writeup focuses on USM, as it is the direct owner of the key strategic assets including the post-paid wireless subs, NY and LA Verizon partnerships, spectrum, and 4,000+ cell towers, and could benefit from low-float dynamics and potential buy-in from TDS.

Based in Chicago, Illinois, U.S. Cellular (“USM”) is a provider of wireless telecommunications services to customers with approximately five million connections in 23 states.  The company is a majority-owned subsidiary of Telephone and Data Systems, Inc. (NYSE: TDS, see good writeup by vinlin1060 in 2013), which owns ~83% of USM shares and controls ~96% of USM’s voting power.  USM’s equity and enterprise values are ~$3.0 billion and ~$4.1 billion, respectively, and trades at ~5x operating cash flow and ~0.9x book value. It is also noteworthy that the company's debt is fixed-rate and extremely long-dated, with ~1/3 maturing in 2033 and ~1/2 maturing in 2060-2064.

I consider USM to be a unique special situation investment, as a variety of factors make this situation underfollowed and broadly disliked:

Corporate structure.  USM shares exhibit moderate typical trading volume owing to the relatively small number of shares in the free float.  The fact that there are two publicly-traded securities – USM and TDS – both of which are largely driven by USM’s operations, creates additional confusion.

Management.  It seems that many investors have grown frustrated by the management and board, which are controlled by LeRoy Carlson Jr., Chairman of USM and CEO of TDS, and the Carlson family.  The management team has not appeared to be in a hurry to realize value here over the years (perhaps a huge understatement), despite owning numerous highly valuable assets.  Reportedly, Verizon made an offer to acquire TDS (and therefore USM) for $100 per share in late 2007, while today those shares trade for ~$27.  

Industry dynamics.  Wireless telecom has obviously become a highly-competitive industry.  Price and marketing competition, commoditized nationwide coverage, unlimited data packages and contract buyout offers are the norm.  AT&T’s recent purchases of DirecTV and pending deal to acquire Time Warner are noteworthy, as is the Charter/Comcast wireless partnership and their MVNO arrangements with Verizon.  T-Mobile is a worthy competitor as is Sprint.  While these dynamics are great for consumers, they are not so great for wireless companies.

While I far prefer to invest with management teams who are undeniably shareholder-friendly, economic animals, I presently own shares of USM for five primary reasons.

(1) Industry pressure.  As noted above, wireless industry dynamics are poor.  It is quite possible that they are now sufficiently poor so as to cause the Carlson family to act and realize shareholder value through one or more strategic transactions.  The New York Post reported in April 2017 that “U.S. Cellular won’t sell despite Gabelli’s pleas,” however this headline overshadowed commentary that the Carlsons were nearly persuaded to sell the company earlier this year. Since then, tax reform has likely made USM's hidden assets even more valuable.

(2) Valuable network and customer base.  USM has a high-quality, award-winning wireless network and primarily post-paid subscription customer base - 4.5mm post-paid subs - (the most affluent kind of subscriber).  Over 99% of its customers have access to 4G LTE speeds, and the company was recognized as the highest quality network in the North Central Region by J.D. Power.  The company prides itself on its strong customer loyalty (~1.3% average churn rate) and high-touch customer service.

(3) Latent margin capture opportunity.  Because an independent wireless provider incurs tremendous expense in advertising, customer service and billing/collection, and lacks scale purchasing power with smartphone manufacturers, there is tremendous opportunity for value realization via either (i) an affiliate relationship or (ii) an outright sale, in either case to a major wireless company.  There is a public data point in this regard.  Shenandoah Communications (Nasdaq: SHEN) is a Sprint affiliate, and enjoys wireless margins north of 50%.  By comparison, USM’s wireless margins are presently running in the mid-teens.  SHEN shares, as a result, have appreciated nearly threefold since 2012, while USM shares have been essentially flat.  I believe it is also likely that USM could grow its subscriber base more easily under the umbrella of a nationally-branded provider.

(4) Valuable underlying assets.  In addition to the wireless network and post-paid subscriber base, USM owns several extremely valuable assets that I do not believe are properly reflected in the company’s share price.

-- Over 600 licenses for wireless spectrum (cellular, PCS, AWS, 700MHz), which I estimate are alone worth $2.2 billion (3q17 book value) to $4.0 billion.  Certain of this spectrum may be non-core to the company’s operations.

-- Approximately 4,000 cell towers, which I estimate to be worth $0.9-1.3 billion, the low end of which is simply estimated construction cost of approximately $275,000 per tower.  While USM management has repeatedly called its towers “strategic,” other major wireless companies typically rent their tower space from tower consolidators such as American Tower, SBA and Crown Castle, which currently trade for ~20x EBITDA, or $1.0-1.6 million per tower.

-- Limited partnership interests in several wireless partnerships, including a 5.5% stake in Verizon’s Los Angeles SMSA and two of Verizon’s New York partnerships.  These partnerships are now distributing earnings, and USM’s total annual partnership income is now running at approximating $140 million, implying a likely value of $1.0 billion or more.

(5) Recent management comments.  On January 9th, the company’s Corporate Relations head Jane McCahon said “When we think about things like monetizing some of our assets, having it -- that have a very low basis, it could bring a new analysis around that. It certainly changes the economics of that.”  This was followed by USM CEO Ken Meyers stating “The towers have always been strategic. And the towers remain strategic and nothing that Jane was talking about would change the strategic nature of the tower. In the past, when we've looked at some of the partnership interest, as we've said, they've got an extraordinarily low tax basis. And so part of the challenge has always been looking at what one buyer may be willing to pay for them then tax affecting that and looking -- comparing that to just the value of the annuity that we've gotten from that -- those assets from day 1, right? To the extent that the tax wedge drops significantly, it perhaps changes how you look at some of those assets.”

In sum, net of debt of ~$1.1 billion, the theoretical net asset value of USM may be as high as $60-70 per share, or 70%+ more than the current $35 share price.  The shares appear priced to reflect the status quo, which investors likely expect to include ongoing duplicative corporate expense, increased competition and value destruction. USM almost certainly could realize tremendous value through the establishment of an affiliate agreement with one of the major carriers, monetization of some or all of the underlying assets outlined above, or through an outright sale of the company.

Disclaimer:  The author of this idea presently has a long position in securities of this issuer and may trade in and out of these positions without notice.  The data contained herein are prepared by the author from publicly available sources and the author's independent research and estimates.  No representation or warranty is made as to the accuracy of the data or opinions contained herein.  Please do your own research.

Catalyst

Potential catalysts include:

-- Monetization of Verizon wireless partnership assets, towers and/or spectrum

-- Affiliate agreement to improve wireless profitability

-- Buy-in of USM shares not presently owned by TDS to eliminate duplicative costs and confusion

-- Sale of company to a strategic buyer that would realize value for the entire package, including subscribers, partnership assets, towers and spectrum