CTCI is a pretty boring, run of the mill RLEC, so why am I wasting your time with it? The idea gets exciting when you consider that CTCI just completed asset sales for net proceeds of approximately $80 million on an enterprise value of $233 million without any impact on EBITDA, which the market does not seem to have recognized yet. After these divestitures, CTCI is trading at about 4x EV/EBITDA LTM versus its peers at 7.5x. I think there is conservatively 50% upside in CTCI.
CTCI was founded in 1897 by Lester Coltrane, forebear of current CEO, Michael Coltrane, who owns 5% of the company. It provides telecom services in three counties on the outskirts of Charlotte, NC: Cabarrus, Stanly, and Rowan. Concord, located in Cabarrus County, is a rapidly expanding suburb of Charlotte, but Stanly and Rowan Counties remain relatively rural, which means they are less competitive, but also less densely populated. The company has 18,500 miles of fiber optic cable, 109,871 ILEC access lines, and 48,714 lines in its other businesses, as well as 47,145 wireless subs.
CTCI operates 5 divisions:
The ILEC accounts for about 55% of CTCI’s revenue and 82% of EBITDA. Like most ILEC’s, CTCI has been experiencing access line attrition due to competing technologies. CTCI’s lines have been falling, but the rate of decline showed some signs of stabilization in ’05, although TWX’s entry could reaccelerate declines (I will address this later), and CTCI still managed to grow revenues in this segment in ’05. In 1Q’06 access lines declined 2.6%, which was disappointing, but revenue still increased 4%.
Wireless is 21% of revenue and 10% of EBITDA. CTCI operates as Cingular in its region, which means it owns and operates the wireless infrastructure itself, but uses the Cingular brand name, thereby getting many of the benefits of being a nationwide carrier. However, CTCI must pay Cingular for switching and roaming, so to that extent it still has some of the drawbacks of being a regional operator. Sub growth has been decent recently in the 7% range, while churn and ARPU are impressive at 1.4% and $65.23, respectively.
The CLEC chips in 11% of revenue and 2% of EBITDA. This is a very competitive market with CTCI going head to head with any number of players, like Sprint, AT, VZ, BLS, etc, so while lines are growing, pricing remains difficult. There is potential for growth here, but revenue will likely be flat at best for the foreseeable future. The good news is that there is a lot of operating leverage in this business, so in a few years it could be throwing off a lot of cash, up from essentially nothing now.
Greenfield is 6% of revenue and 1% of EBITDA. This is an initiative to become the incumbent telecom services provider in areas outside its core market through new network build. Greenfield builds mainly in BLS territory. Anecdotally, I have heard that BLS has been fairly unresponsive to developers around Charlotte, for both residential and commercial. This has opened a window of opportunity for CTCI to expand its footprint by installing infrastructure in new developments before BLS gets around to it. I expect that the integration with T will create more of a distraction for BLS, creating further opportunity for CTCI. This division has consumed a lot of capital over the past few years and will continue to do so, but I think that CTCI is on the cusp of reaping the rewards of its investments in the near future as growth in revenue, profitability, and cash flow should begin to ramp as the heavy investment phase ends. Greenfield currently has 15,324 lines in service, but has 54,000 marketable lines in new communities under development, so the opportunity is tremendous.
Internet and Data Services (IDS) is 7% of revenue and 6% of EBITDA. CTCI is actively transitioning its dial up subs to DSL, the pace of which seems to be accelerating. CTCI is spending capex aggressively to defend its position and now boasts one of the country’s fastest networks, offering DSL at 10Mbps.
In total, I model CTCI generating $53 million of EBITDA in ’06, down from $58 million in ’05. In general, this is a relatively stable business, but EBITDA should decline due to competition at the ILEC and the CLEC. EBITDA will probably continue to fluctuate over the next few years in the mid $50 million level, as competitive pressures in the ILEC and the CLEC are offset by the growth businesses (wireless, Greenfield, and IDS).
The two asset sales were its Clearwire wireless spectrum, which closed 4/5/06, so it is yet to be reflected in most people’s enterprise calculations, and its 22% stake in Palmetto MobileNet (JV with AT) to AT, which was announced on 3/16/06 and closed shortly thereafter. CTCI received $97 million pre-tax for Palmetto, which is now sitting on the balance sheet, but there is a large liability for income taxes payable of $37 million that partially offsets these proceeds. Add this to the $16 million in net proceeds from Clearwire and you get to an enterprise value of $233 million. Palmetto was accounted for under the equity method, so its sale does not impact operating results (although Palmetto did contribute $4-5 million of equity income annually). So the pro forma enterprise value looks like this:
Shares Outstanding: 19 million
Share Price: $14.60
Market Cap: $277 million
Cash $108 million
Proceeds from Clearwire: $16 million
Debt: $44 million
Income Taxes Payable: $37 million
Enterprise Value: $233 million
Due to the varying degrees of leverage of its comps and the large amount of depreciation inherent in these companies, I think that EV/EBITDA is the best way to value CTCI. Compared to its peers, CTCI is cheap, trading at 4.4x ’06 EBITDA and 4x LTM, whereas the average RLEC trades at 7.5x LTM EBITDA. CTCI also appears under leveraged versus the comps. CTCI has a 22% Debt/Cap compared to the RLEC universe at 50%.
The simplest way to value CTCI is based on the EBITDA of the consolidated company. It is conservatively worth at least 6x EBITDA, but could trade any where between 5-7x, realistically in the near future. Longer term it could potentially trade in line with the average RLEC’s, depending on how competition plays out in its territory. Based on ’06 estimates of $53 million of EBITDA:
5x EBITDA = $16.33
5.5x EBITDA = $17.73
6x EBITDA = $19.13
6.5x EBITDA = $20.53
7x EBITDA = $21.94
Another way of valuing the consolidated CTCI, and RLEC’s in general, is on a per access line basis. Private market values in recent years have been $3000+/access line, although they have been declining gradually. At an enterprise value of $233 million and with 109,871 ILEC access lines, CTCI is trading at an EV/ILEC access line of $2,125. Not too shabby. Even better when you consider that that is just the ILEC, so from this perspective you are basically getting the rest of the CLEC and Greenfield lines, as well as the wireless business, for free.
Still yet another way of looking at valuation is on a sum of the parts basis (based on ’05):
RLEC: methodology EBITDA
Comps 7.5x (ANK, AT, CTL, CZN, GNCMA, IWA, VCG)
CTCI mult: 6x
’05 EBITDA: $44 million
Value: $264 million
Wireless: methodology EBITDA
Comps 10.5x (DCEL, LEAP, RCCC, UPCS)
CTCI mult: 9x
’05 EBITDA: $5.6 million
Value: $50.4 million
CLEC: methodology EBITDA
Comps 9.2x (CLEC, MPE, TWTC, XOCM)
CTCI mult: 8x
’05 EBITDA: $1.3 million
Value: $10.4 million
Greenfield: methodology asset value (balance sheet numbers should be realistic since this is a new initiative. EBITDA not appropriate since it is still in its start up phase.)
Value: $29.5 million
IDS: methodology EBITDA
Comps 5.3x (ELNK, UNTD)
CTCI mult: 5x
’05 EBITDA: $3.4 million
Value: $17 million
Total CTCI Enterprise Value: $373 million
With a conservative discount to average peer multiples, CTCI would be worth $373 million, or $21.95/share. Breaking this analysis down further, if you take the value of the non-ILEC businesses and subtract them from CTCI’s enterprise value, $233 million - $107 million, this leaves the ILEC with an enterprise value of $126 million. Based on ’05 EBITDA of $44 million, it is trading at 2.9x. Granted, the ILEC EBITDA could very well decline in ’06, but that’s pretty cheap, and it’s not going to decline all that much. On the EV/lines metric, the core ILEC would be trading at $1,147. That’s real cheap, but again these lines have been declining at about 2.5%.
Valuing the whole firm on an access line basis, suggests even greater upside. I ascribe a $3,000 value to the ILEC lines. I value each wireless sub at $2,000, which, like the ILEC, is at the low end of private market values. I give a discount to CLEC lines because of the highly competitive nature and also to Greenfield because, although it is not that competitive, it utilizes some of the local incumbent's network elements, so I value these at $1,500 and $2,000. For a total of $505 million, or $29.01/share:
Segment lines/subs val/unit value
ILEC 109871 3000 330
Wireless 47145 2000 94
CLEC 33390 1500 50
Greenfield 15324 2000 31
Even if you don’t think the other businesses are worth anything (ok so the CLEC might not be worth much) it is hard to imagine much downside. Just based on the $44 million of ILEC EBITDA in ’05, CTCI is trading at 5.3x, which is still a discount to its peers, and which attributes no value to wireless, the CLEC, Greenfield, and IDS.
Alright, already. You get it. CTCI is cheap. But this only considers the status quo. The upside gets more interesting when you consider what they can do with this underlevered balance sheet. If CTCI were to lever up to 4.3x ‘06 EBITDA, the average leverage of its RLEC peers, it would add $184 million of debt to the balance sheet. This in addition to the available cash ($108 million less the $37 million income taxes payable) would mean that there is about $250 million available potentially for a special dividend or a buyback, which is pretty interesting considering CTCI’s market cap is $277 million. Even more interesting is the fact that management is pursuing acquisitions. Acquisitions usually scare me, but management is committed to only making accretive acquisitions and is focusing on private, family run, contiguous operators which would be easy to integrate, offer a lot of cost cutting opportunities, and sell relatively cheap (apparently there are quite a few of these in the Carolinas, which I was surprised to hear). Management has intimated that some of these opportunities could potentially double CTCI’s access lines. Under a scenario like this the stock could easily double.
Being overcapitalized is a high class problem to have, but not one without some risks. CTCI hired Stifel Nicolaus to explore its options and is committed to improving shareholder value. Management explicitly stated it is considering all of the following: a buyback, a special dividend, acquiring other RLEC’s in its region, and accelerating capex spending, so I expect this cash is going to be put to work relatively soon.
So why have we been granted such a great opportunity to invest in such a cheap, good company? I’m not exactly sure.
Is it possible that the market is not that efficient after all? It might be. This is a sleepy little company with little sellside coverage and a lot of local retail investors. I expect that it will begin to attract more attention after it reports 2Q’06 with all of the proceeds from these transactions and it becomes blatantly obvious how cheap this company is. Another potential catalyst is when management starts returning capital to shareholders or deploying the cash in other value creating ways. Also, management will be hitting the road (possibly for the first time ever) to meet with institutional investors in the next few weeks.
There is also competitive risk. The telecom services industry is highly competitive as it is, but CTCI also faces an emerging risk in TWX rolling out telephony in its regions. TWX has begun marketing cable telephony in the greater Charlotte area, but has yet to launch. It is reasonable to assume that access line loss could accelerate and pricing could deteriorate after this happens. However, I think at this valuation this risk is more than priced in. Furthermore, I believe TWX is only going to roll out telephony in certain segments of CTCI’s market that are more densely populated. For example, Stanly and Rowan counties would probably not be economical to launch telephony in, as they are still rural. This is a positive for CTCI because, although they have fewer lines in these areas, these counties tend to be much stickier due to a large percentage of the population being farmers (not to generalize, but I assume these guys are not so tech savvy), so their high margin ILEC access lines here are relatively safe. In the more urban Cabarrus County, CTCI has already cannibalized a lot of its high margin ILEC access lines, in an effort to remain competitive by offering bundles of telephone service with internet and wireless, and upgrading dial up lines to DSL. Furthermore, CTCI is on the verge of being able to offer video service, so it should fare about as well as any ILEC against cable telephony.
Another risk is that CTCI is accelerating its capex on broadband internet and video. Therefore, free cash flow could be minimal in the next year or two. Management has guided ’06 capex to a range of $35.5-39.5 million, up from $27 million in ’05. This is a double edged sword. This will make them more competitive in the face of new entrants, but the return on this capital is still uncertain. I would prefer to see management defend its incumbent position, rather than do nothing though. Management might not necessarily spend this extra capex and guided capex higher in order to telegraph their aggressiveness in upgrading plant. They have stated that the entire amount might not be spent in ’06 and that some could be pushed out into later years. Also, over the long term capex/rev should be around the 15% level, which is pretty normal for this kind of telecom company. Maintenance capex is minimal. Management considers the vast majority of non-ILEC capex to be growth oriented and about ½ of ILEC capex is dedicated to expanding enhanced services, so maintenance capex is roughly $10 million.
Another possible reason that CTCI trades at a discount to its peers is that it has a lower dividend payout than some of its peers, although CTCI’s dividend did increase 54% yoy. This is because CTCI actually has a lot of promising uses for capital, so I am not sure if this is really valid reason for a discount.
1. Putting the excess cash to work via acquisition, buyback, and/or special dividend.
2. Reporting 2Q'06 with all of the proceeds from asset sales on the balance sheet.
3. Management meeting with institutional investors in the next few weeks.
|Entry||05/04/2006 09:35 AM|
|Good idea. On yesterday's cc, FRP said there are a lot of M&A opportunities in the sector.|
|Entry||05/04/2006 03:37 PM|
|Spent some time looking, all I can say is it looks like you're right. At a minimum, the cash creates a nice catalyst soon.|
|Subject||re: Looks Good|
|Entry||05/05/2006 10:36 AM|
|john, dman thanks for the feedback. |
john, to your M&A point, CTCI's pipeline of prospects of privates in their region is supposedly promising.
as for CTCI being a target, i think it makes sense becasue it is so cheap, the assets are high quality and it could fit well with some larger players. however, im not banking on it b/c in talking with industry people and mgmt it does not sound like that is in the cards at this point, although mgmt has said they will consider any option with shareholders best interest in mind. frankly, i wouldnt support it at this valuation either.
an update on their marketing trip: oppenheimer is taking mgmt to philly on 5/10 and the westcoast 5/16. for some reason they have not scheduled ny, but im sure if there was interest they could add a visit on the back of their philly stint.
|Subject||Interesting idea, but I am bot|
|Entry||05/11/2006 04:10 PM|
|Interesting idea, but I am bothered by the lack of free cash flow. I have not looked at the comps, but based on the company's guidance, it is trading at 4.5x ebitda, but 12x ebit and 15.5x ebitda - capx. Given what is going on in telecom generally, and looking at the company's overall growth, how can you be confident that the $27mm of cap x ($37mm mid-point of guidance less your $10mm estimate of maintenance capx) is truly growth related, and not just money that they have to spend to stand still or keep them growing very modestly. Is it possible that their network needs more upgrading/more capx than some of the other RLEC's out there? What are the comps for other RLEC's, and do many of them also include a wireless business buried within?|
Thanks in advance for your answers.
|Subject||re:Interesting idea, but I am|
|Entry||05/12/2006 10:50 AM|
|Good questions. |
"Interesting idea, but I am bothered by the lack of free cash flow."
The heightened capex over the next year or two is a risk as I highlighted in the write up. I think longer term you can model capex at 15% of rev. It’s possible after this capex binge it goes closer to 10% for a short time as well.
"how can you be confident that the $27mm of cap x ($37mm mid-point of guidance less your $10mm estimate of maintenance capx) is truly growth related, and not just money that they have to spend to stand still or keep them growing very modestly."
You raise an interesting point here. The capex in wireless, Greenfield, and CLEC is definitely growth oriented, but the upgrading plant and offering enhanced services at the ILEC is arguably not growth capex since it, up to this point, has only served to stave off further access line attrition to some degree. The issue gets more complicated because the company offers bundle packages of wireless, wireline, and internet. This convenience to the customer is supposed to improve retention, but it makes it a lot more difficult to figure out what the economics of each individual business are because it is priced as a bundle, not separately, so you can’t discern what the return is for each division. Furthermore, the ILEC biz and IDS are pretty much inextricable from each other because it is not unreasonable to assume that every DSL line they add comes from losing an ILEC line at that household, so you also could argue that IDS is not really growth oriented either. A very conservative breakdown of EBITDA-maint capex might use the 14.9m of ILEC capex and the 1.2m of IDS, in that case from 2005. Mgmt has not provided much of a breakdown for 2006. Here is the 2005 breakdown:
ILEC $ 14,943
Total $ 27,099
"Is it possible that their network needs more upgrading/more capx than some of the other RLEC's out there?"
CTCI’s network is actually very modern. I can’t speak that intelligently about every other RLEC, but I would guess CTCI is on the leading edge. They have recognized the threat from cable and have prepared for it. As I also pointed out in the write up, being overcapitalized is a risk because of the potential agency problem it creates via the ability to overspend.
"What are the comps for other RLEC's, and do many of them also include a wireless business buried within?"
Most RLEC’s, like the ones I used for comps in the sum of the parts, do have wireless embedded in them. In my sum of the parts I was trying to give as much detail as I could without going into all the comps and completely dissecting them also, so you could go through the comps and disaggregate their businesses in the same way to get a better apples to apples comparison.
|Entry||07/20/2006 11:32 AM|
|This has been a great call but your upside numbers led to a $21 stock price. It appears as if this has caught too much momentum on the way up and would be a good short here at $26. Valuation is 2 multiple turns higer than it has ever been on EV / EBITDA basis. What do you think?|
|Entry||05/29/2007 02:22 PM|
|Once again, nice going fiftycent!|
|Entry||06/13/2007 10:19 AM|
|thanks max. forgot about your post. $31.50 is certainly a good price for this. im continually surprised by the valuations for M&A in this market, but pleasantly surprised in this case. looks like 9.75x EBITDA. the deal can be rationalized by the fact that WIN can basically gut CTCI's SG&A, so there is a lot of operating leverage in the acquired lines.|