Description

This is one of the cheapest “real” companies I’ve come across in a while. It’s a solid, well-managed business in a maligned industry with some potential for a takeout. It trades an average of $5mn per day, so it is invest-able as well.

United States Cellular (USM) is the 8th largest wireless company, serving 9% of population of the US, concentrated primarily in the mid-west and mid-Atlantic states. USM is 82%-owned by TDS (Telephone & Data Systems).

At quarter-ending September 30, 2001, USM provided service to 3.4 million customers. Its market penetration was 13.2%, ARPU was $47, and post-pay churn was 1.7%. Acquisition costs were $311. Given the above, one can see that there is significant present value derived from its customer base. Contrary to my general opinion of this industry, this is a relatively good business.

The company has a history of profitable operations and generates free cash in excess of $200mn per year, or 5% of market cap. USM trades for 5.5x EV/EBITDA (after adjusting for marketable securities), and $1,000 per subscriber. This compares with recent transactions of $3,000+ per subscriber, and I won’t even mention what other firms trade for on the basis of EV/EBITDA. Needless to say, USM is at a silly discount to comparable multiples and to private-market-value. The discount is likely due to the continued bear market in telecom and to TDS' ownership.

USM’s geographic coverage makes it a perfect fit for AT&T Wireless, Cingular, and Verizon. For now, however, TDS is not enthusiastic about selling. Assuming that TDS is the logical buyer in time, firm value can be estimated by considering a similar case in the UK a few years back. British Telecom was majority owner in a cellular operator co-owned by Securicor. The minority interest in Cellnet, the operator, was eventually purchased by BT for north of 10x EBITDA. This was a pre-blowoff multiple, and helps to provide a benchmark valuation. This EBITDA multiple equates to roughly $1,900 per sub, in fact accounting for the various discounts that should apply in this case. There are other similarities, so I use this multiple to calculate intrinsic value of USM at roughly $80. If by some miracle, TDS should change their mind and sell to an outsider, recent transactions imply a fair value of $120-$130. My target is $80, but either way is far in excess of the current $44 stock price.

Catalyst

Catalysts include a takeout by TDS or outside entity. However, at this price, I don’t believe a catalyst is necessary in order to initiate a position. This appears to be simply a mis-priced security. Management is decent, the balance sheet is fine, the company is profitable and generates cash, and the stock trades for a steep discount to intrinsic value. Catalysts tend to find companies like this.

Finally, for various reasons I haven’t mentioned TDS, but if you follow this story, then it makes sense to look at TDS.