UZF - Why I Sold My US Cellular Baby Bonds

2023-04-04 09:05:19 ET

Summary

• US Cellular is a regional cellphone carrier.
• The company has continued to run free cash flow positive despite earnings headwinds in 2022.
• The cost to remain competitive through wireless license auctions has me concerned.

United States Cellular Corporation ( USM ) is a regional cellular phone carrier. The company’s stock has far underperformed the S&P 500 over the last five years. Some of the company’s debt trades as baby bonds, which have a symbol ( in this case UZD ) and trade on an exchange. Until recently, I held UZD until I reviewed the company’s latest financial report.

After a year of growth in 2021, the company’s revenues were basically flat in 2022. Unfortunately, US Cellular’s expenses jumped by $150 million, due to increases in SG&A and cost of equipment sold expenses. The net result is a steep decline in operating income to $69 million. While nearly generating the earnings to cover interest expenses last year, this year’s interest expense of $163 million was not sufficiently covered by operating income.

US Cellular’s balance sheet showed few significant changes in 2022. The company was able to build its cash position higher and did invest in its capital assets at the rate of depreciation. One item of concern is that the company increased its long-term debt by $400 million to nearly $3.2 billion while shareholder equity remained largely unchanged at $4.5 billion.

Where I became concerned about my debt investment was when I reviewed US Cellular’s statement of cash flows. Operating cash flow increased by $30 million to $832 million in 2022 and the company did have positive free cash flow after spending $602 million on capital expenditures, but the company also spent $585 million on licenses. License spending is what drove the company to borrow more than $400 million.

Since the end of 2020, US Cellular has invested $2 billion in wireless spectrum assets. Wireless spectrum assets are acquired by an auction process where the US government sells rights for companies to transmit signals. The auctions are open to all telecom companies , therefore US Cellular is competing with the resources of AT&T, Verizon, and T-Mobile to keep its smaller territory relevant.

While US Cellular has generated free cash flow in each of the last three years, they’ve needed to borrow $1.6 billion to win their wireless spectrum auctions. The acquisition of spectrum is going to get more expensive as borrowing costs have risen dramatically, and US Cellular only has less than $900 million in liquidity to support additional license purchases.

One thing US Cellular does not have to worry about in the short term is maturing debt. The company essentially has no maturing debt until 2026. This will help the company escape higher borrowing costs due to refinancing, but it does not help my position in the baby bonds because they mature several decades later.

After careful review, I determined that US Cellular needed significant amounts of capital to keep its network current through maintenance and the auctioning of licenses. I was not comfortable holding a security that matured so far out into the future with these uncertainties. While a buyout from one of the big three cell companies would change the landscape of the company’s debt, I was not willing to hang my hat on a single transaction and opted to sell my holdings.

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