OTEL - Otelco Inc.

[mwtorock]

oh my. i did not even this thread exists... good work.

[writser]

Otelco Q2 2019 results: link. I have only been following this name tangentially. Shares are down ~25% today, presumably due to 'the continued loss of residential voice customers and competitive pricing pressures on internet services'?

[Foreign Tuffett]

Anyone who follows this (I do not) needs to pay attention to "walk57" on Seeking Alpha. He is the prophet of rural telecoms. 

 

https://seekingalpha.com/user/5921521/comments

 

All hail walk57. He speaketh, we listeneth.

[Saluki]

Okay, oddly enough 15 years ago I used to represent a rural ILEC when I was an M&A attorney, so I know a tiny bit about the economics of these strange beasts.  (my info may be outdated, so take with a bit of salt).

 

It's very uneconomical to string wires long distances (even outdoors with a government right of way) so the government subsidizes a big chunk of the costs of service. If you've ever looked at your phone bill and wondered why 20% of the taxes are for a "Universal Service Fee" it's so that people like Ted Turner can get subsidized landline service on their ranches.  That's how a lot of these rural ILECs stick around. It's not profitable to run huge amounts of wire for few customers if you're competing on price.  So you've got the previously spent capex which you can continue to milk and get the subsidy too. It's a legal monopoly, but not a great one because your rates are set by the state public utilities commission.  You are required to let competitors hang their lines on your poles for a fee (there is literally a federal pole attachment act and the rate is determined by formula based on their costs in the FERC form 1, if i recall). So that helps with your cost if there is a cable provider in the area that wants to use your poles because they don't have government granted right of ways.

 

Rural customers in many cases can't easily switch to wireless or cable and use the copper phone lines for internet access with DSL (this may be dated info). It's slower than the other options, but it's the only option in some places.  Internet and other add on fees are not regulated by state PUCs (if I recall) so this can be a nice money maker for them (regulated monopoly pays for the cake and you get to sell the frosting for whatever the market will bear).

 

I invested in a ILEC once (when Embarq landlines was spun off from Sprint and it was too cheap to ignore) but I haven't invested in one since.  Companies that rely on subsidies that can go away at any time are scary.

 

 

[compoundvalue]

I have been riding this one from the low 4s to 18 and now half way back. My original thesis was that they’re  bound to pay down debt (was ~$120mm at the time) with practically all of their FCF over a minimal level of maintenance capex. At the time I figured that was ~$12mm. As the entire market cap was around $14mm, I thought that there’s a good chance of this compounding at 70% or so for a couple of years. It did that and more while revenue kept deteriorating at a modest rate. At some point this year they’ve announced a strategy change from aggressively reducing debt to increase capex in order to flip the revenue decline trend. This was announced alongside a management change with the CEO leading the turnaround and balance sheet improvement leaving at the end of this year to be replaced by the COO a fiber guy who was brought in to lead the current strategy. While the new strategy might or might not work, it has definitely led to some increased capital spending as well as SG&A. Now I think the story is very different and has more to do with the probability of the whole thing being bought out. There’s blood in the water given the accelerating revenue decline. There is also a ~40% shareholder with history of activism  - Ira Suchet. Finally, during today’s earnings call, there were two funds managers asking quite bluntly regarding strategic alternatives and capital allocation strategy  with one actually directly suggesting a sale as preferred course of action. So I think the question now is what are the odds of it being bought out and at what price, and in case it doesn’t whether these guys can turn the ship and how long does it take (with the former being the key variable in my mind).

[Spekulatius]

I own some NUVR, which has much lower debt levels and better metrics and demographics in their service areas overall. However, make no mistake, these are still organically shrinking business. At NUVR it is just disguised by acquisitions. I think the gains in this sector have been made.

FWIW, the subsidies from rural telecom/broadband act are guaranteed for 10 years. I don’t think they are likely to go away. basically the government pays for their Capex, provided they meet certain service goals. It’s a sweet deal.

[TBW]

I am long and wrong OTEL.

 

Still hopeful.  Way I think about OTEL is that it is a combination of old business, new business, and debt.  Old biz is declining, although latest results are bit misleading comp from previous year, at say $1mil per year.  OTEL does have the new funding regime, ACAM that will pay them $15.8mil per year for the next 11 years (and I agree likely there after).  So you have a company that is going to earn $15mil this year, I think next year, and then decline $1mil per year.  They will pay $4.4mil per year in debt repayments, which lowers interest costs, pay $5mil per year in maintenance capex, and the rest will go to new fiber initiatives.  So in 4 years times they will have ~$50mil in debt, and generate ~$9mil in free cash flow  from old biz.

 

The new biz over that time should pass close to 10k dwellings, and have over $30mil invested in it, what could that be worth?  I think a good bit.  Quite possible that this more than makes up for the $1mil decline the old biz is seeing.

 

If so then the current price of 4.4x ev/ebitda will be far too cheap. 

 

I do think that OTEL has about 1x turn too much of debt.  If they were 1.7x levered rather than 2.7x levered they would be able to shrink leverage no matter what.  But at currently level of debt new investments need to pay off for deleveraging to occur.

 

Some say that OTEL is rich relative to peers, like NUVR and LICT.  That is true, and I own both of those companies, however I think it is also true that all three are far too cheap and comparing OTEL to the cheapest things in the market is not the right way to think about this.  OTEL is riskier, but also offers a higher return if its works out.

[DTEJD1997]

Hey all:

 

Anybody still watching this?

 

Their revenue is trending down...but they are still making money and paying down debt.

 

Looks like they are kinda switching from paying down debt, to investing in their network and increasing speed and hopefully addressing customer churn/drop.

 

They are earning about $2.25/share and have some free cash flow.  At about $3/share, this seems like it might be a good speculation? 

 

Any thoughts?

[KJP]

Hey all:

 

Anybody still watching this?

 

Their revenue is trending down...but they are still making money and paying down debt.

 

Looks like they are kinda switching from paying down debt, to investing in their network and increasing speed and hopefully addressing customer churn/drop.

 

They are earning about $2.25/share and have some free cash flow.  At about $3/share, this seems like it might be a good speculation? 

 

Any thoughts?

 

As you note, Otelco increased CapEx well above D&A to try to stop the revenue/EBITDA decline trends they've had for many years.  So, FCF is trailing GAAP earnings by quite a bit.  It remains to be seen what the returns on that CapEx will be and whether they can reverse their revenue/EBITDA trends. 

 

Based on a quick, back-of-the-envelope look, OTELCO is trading at about 1 turn of EBITDA less than LICT (at $14k/share).  LICT has already been doing for years the CapEx investments that Otelco has just recently decided to do.  You can see that in LICT's broadband subscriber numbers over the years.  LICT also has significant FCF now, and it's allocated by Gabelli, who puts it all into share buybacks.  LICT is also unlevered (probably has significant net cash but the last press release was garbled).  So, I prefer LICT, but Otelco obviously has the higher potential upside if things work out because of the its leverage.

[KJP]

I've read that the Democrats are pushing to include additional rural broadband access funds in the Phase III stimulus.  I don't know if that ultimately will happen with Phase III or any follow on stimulus/infrastructure package, but that could help rural telcos like Otelco and LICT.  They already receive substantial federal funding under the ACAM program.