Description

United States Cellular (USM) written up about a year ago by ad188, I think, is the cheapest domestic wireless carrier in a beat up out of favor industry.

First, if your looking to make money on a trade, move on to the next idea, I think this one will take some time to play out but has the potential (over the next three years) to double in value.

For those that know the company, I know wall street analysts (and many others I’m sure) think they made a stupid acquisition in Primeco. More on that later. No-one likes this company now; which is often one pre-requisite for breeding a good value idea.

US Cellular is the 8th largest wireless company, serving 14% of population of the US, concentrated primarily in the mid-west and mid-Atlantic states. USM is 82%-owned by TDS (Telephone & Data Systems). US Cellular is a regional operator, competing mainly with competitive local and regional calling plans. US Cellular has a decent balance sheet (a rarity in this industry) and very good operating management. US Cellular ranked #1 in customer service (in a recent Yankee Group survey) and has a historical churn rate of 1.8% – one of the lowest in the industry.

I think for purposes of analysis it makes sense to look at US Cellular two ways. First, by adjusting out the acquisition of Primeco – which occurred in fall of 2002. Primeco was purchased for $600 million had only $19 million of EBITDA at the time of purchase, and negative EBITDA now with US Cellulars’ start up costs.

US Cellular without Primeco acquisition:

Book Value: $2.39 billion or $27.75 share. US cellular is also one of the only pure cellular companies that has a history of profitability (on a GAAP basis) earnings were as high as $3.28 cents per share in 1999, with $1.1 billion of retained earnings (most pure domestic cellular companies have negative retained earnings).

Net debt is $700 million and equity value is $2.2 billion for enterprise value of $2.9 billion. EBITDA for 2002 of $670 million (adjusted for $30 million of marketing expenses for launch of Chicago - Primeco). That puts the current EBITDA multiple at 4.3X, pre Primeco. Other public domestic cellular companies are trading in the range of 7X to 10X EBITDA (including regional carriers). One would expect it might trade at some discount given its controlled by TDS and the Carlson family, but I think the gap here is to wide. Besides most companies, regardless of the industry, start to look cheap at 4X EBITDA.

Primeco Acquisition:

In August 2002, US cellular purchased the assets of Primeco including is 20 megahertz PCS license covering a population of 13.2 million in the Chicagoland area. The purchase price was $610 million financed with new debt and the monetization of US Cellulars’ 10.24 million shares of Vodafone ($160 million provided on forward contract with collars). I cannot say that their skill at managing financial assets such as Vodafone is on par at all with their level of operational management, but the damage there is already done, with no other assets on the balance sheet like it or as significant to screw up.

If you add $450 million of net debt for the acquisition with no incremental EBITDA from Primeco you get a multiple of 5.0X.

Is there future value in the Primeco acquisition?

US Cellular has made good acquisition decisions in the past. Chicagoland is a natural fit with their existing footprint. They already operate in areas contiguous to the territory purchased from Primeco: mainly to the west and northwest of Chicago. This area includes Milwaukee the 25th largest metropolitan area. US cellular holds the number one market position in Milwaukee which, like Chicago, has a number of competitors including the national carriers.

US Cellulars’ top management knows the Chicago market very well. Besides being headquartered there, Jack Rooney president of US Cellular came from Ameritech, where he ran their wireless operations - including the Chicago market. Jay Ellision, EVP of Operations, experience includes ten years at Ameritech directing their operations and distribution efforts. Mike Irizarry EVP of engineering, oversaw Verizons’ implementation of CDMA in its Chicago and broader Midwest markets.

At the time of acquisition Primeco had 330,000 customers 40% of which were pre-pay. US Cellular dropped that side of the business. They are starting from a low base and will need to grow their market to make sense of the acquisition.

US Cellular ended 2002 with 4.1 million subs. With an EV of $3.35 billion it equates to a value per subscriber of $817. Network conversion to CDMA 1XRTT is going well - ahead of schedule and the company expects the cost to come in at the low end of previous estimate of $400 to $450 million, with 70% of their markets now converted to CDMA. Total conversion to CDMA 1XRTT will be complete by end of 2004. Peak year for CAPX was 2002 at $728 million. Will start to decline going forward. 2003 estimated at $600 to $630 million.

Other 2003 guidance:

Revenue $2.4 to $2.5 billion - up 15%

Subscriber growth 310,000 - up 11%

EBITDA $695 to $720 million - up 12%

Primeco not expected to have meaningful impact on EBITDA until 2004.

So, even without a contribution from Primeco – $700 million EBITDA on $3.35 billion EV (which includes new debt for Primeco) equals a multiple of 4.78X. If you assume even moderate success for Primeco (say $60 million in EBITDA by 2005) and continued growth in the rest of business at current rates (EBITDA is growing at 12%) you get to $1.05 billion in EBITDA by 2005 (three years). Put a multiple of 7.0X on that number for EV of $7.350 billion. Debt levels, based on declined CAPX should be at or below current levels. Using the current debt level of $1.105 billion leaves an equity value of $6.2 billion or $72.00 per share. That’s how I get to at least a double ($51.00) in three years, with a margin of safety.

TDS, the parent of US Cellular is another way to play this and is also worth a write-up.

Catalyst

Catalyst:

Time (the most important catalyst here)

Some positive news out of Chicagoland market as the business moves forward there for US Cellular.

Coming positive changes in industry regulations and M&A activity (at least that’s what many insiders say is coming in 2003 & 2004).