2023-08-11 11:53:35 ET
Summary
- TDS' Q2 earnings and announcement of strategic alternatives for US Cellular have caused the stock to skyrocket, but the financials and management strategy still raise concerns.
- TDS has lost money for two consecutive quarters and relies heavily on US Cellular for profitability.
- The company's exposure to lead cable lawsuits and its high valuation multiples make the current market cap and stock price unsustainable.
I am revisiting my Q1 thesis on Telephone and Data Systems ( TDS ) in light of Q2 earnings and the August 4th announcement that TDS was looking into strategic alternatives for the US Cellular business, in which it holds an 80% stake.
Looking back on my Q1 analysis, three key factors played a role in my sell recommendation. First and most critically, I didn't believe the financials could support the high 8% dividend yield over the next several years. Second, management's clearly articulated strategy for growth was in direct contradiction with their earnings guidance. Lastly, valuation multiples were significantly inflated, signaling an overvalued stock.
Since publication, TDS has skyrocketed more than 91% from $8.99 to $17+, largely since Q2 results and the announcement about US Cellular. TDS has lost money two quarters in a row and would still be unprofitable without US Cellular. Also, remember that TDS has lead cable exposure, not to the degree of AT&T ( T ) and Verizon ( VZ ), but still a risk they can't afford. And finally, valuation multiples are still elevated well above historical levels, and the $1.8+ billion market cap is not supported by the potential sale price.
With the share price up and the dividend yield cut in half, I believe investors should sell and exit their positions as the market overcorrected for the potential of a US Cellular sale.
Management Strategy Still Not Driving Profitability
Coming into 2023, management put forward the following strategies to drive growth.
TDS Growth Strategy (TDS Investor Relations)
Despite revising earnings upward, this strategy is still not playing out in the financials. TDS Telecom's revenue guidance ranges from flat to 4% growth versus 2022, and EBITDA guidance ranges from down 7% to up 1%. Neither of these shows that strategies to "Drive Revenue" or "Optimize Cost Structure" are playing out.
Even worse, TDS Consolidated has been unprofitable for two quarters in a row based on Q2 earnings . Net income of -$19 million was down $37M from the prior year quarter and down $10 million sequentially from Q1 2023. The net income loss is driven by lower operating income at all business units (decreased revenue at US cellular, higher costs at TDS Telecom, and lower revenue recognition in other). Below EBITDA, TDS is getting crushed by higher interest expenses.
While there has been a lot of buzz around the potential sale of US Cellular or some of its assets, TDS Telecom is also struggling. While management dodged the question during the earnings call Q&A , they led analysts to believe that TDS would continue as a standalone entity.
Q2 Profitability By Segment (TDS Investor Relations)
While revenue was largely flat year over year, operating expenses spun out of control, leaving only $7 million in operating income for the quarter. This doesn't leave much wiggle room with US Cellular assets out of the picture.
Can't Afford Lead Cable Lawsuits
Following the Wall Street Journal report on lead cables used by telecom companies, most of the heat has been focused on Verizon and AT&T. However, management noted in the Q2 earnings call that TDS has 10 miles of lead cables and is just beginning to assess the next steps.
Considering that 3M recently reached a $10.3 Billion settlement over forever chemicals in the ground and water, even 10 miles of lead cables could cost TDS significantly, both from lawsuits or fines and the investment to replace the cables. While AT&T and Verizon have much more exposure, they also have much more cash. TDS ended Q2 with only $293 million in cash, dropping $106 million from the previous period. Compare that to Verizon's $4.8 billion and AT&T's $9.5 billion as of the last report.
With the dividend already squeezed by profitability, significant capital commitments, and preferred share payouts, TDS would likely need to cut into shareholder returns or future investment to offset the lead cable impact.
Current Market Cap Not Justified
Following the recent run-up, TDS' market cap is over $1.8 billion. Tangible book value sits at -$766 million, and net PP&E less long-term debt and leases (my proxy for the potential of an asset sale) sits at $1.2 billion. Recent tower deals have generated ~20% premiums, putting the high end at $1.4 billion if all assets were sold.
Looking at the quant rating, which gives a Hold recommendation, Growth, profitability, and revisions all get low marks. Valuation and momentum get high marks, but only because we are a few days out from the announcement. Adjusting for the spike on August 4th and 5th, the quant rating would look more like a hold to sell.
TDS Quant Rating (Seeking Alpha)
Valuation multiples continue to be elevated as well. With negative earnings, P/E can no longer be reported. EV / EBIT of 143.78 is 800%+ above the sector and 300%+ above historical, factoring in the toll higher expenses and depreciation took on the Q2 earnings.
Even the bulls at Citi (brokering the deal) have set a price target of $16 / share, well below today's pricing.
Across every measure, the current market cap and stock price do not appear to be justified.
Upside Potential
TDS' best upside potential is a bidding war for assets between competitors that delivers value well above book value. I believe that is a stretch in the current telecom environment. Verizon and AT&T are facing down an EPA investigation and unknown liability related to lead cables. While T-Mobile has more cash on hand, they only recently finished the Sprint integration and are now building out new 5G spectrum. Dish Network is the 4th option, but they have their own cash flow issues .
While I believe US Cellular assets will find a buyer, I don't think there will be enough competition to drive prices up as much as they would have been 1 or 2 years ago.
Verdict
In summary, despite the initial spike in valuation, multiple growth and profitability metrics indicate that TDS is overvalued. With negative earnings, a valuation multiple significantly higher than the sector average, and pricing above expectations even from optimistic analysts, the current price appears unsustainable.
While a bidding war for TDS' assets could provide some upside, the current telecom environment makes this unlikely. Major competitors like Verizon, AT&T, and T-Mobile face challenges, while the potential fourth buyer, Dish Network, faces cash flow problems. The sale of US Cellular assets is likely; however, the competition is not expected to drive the price significantly.
Given these factors, I believe investors should sell and exit their positions. I feel that the current market cap and stock price are not justified by the company's performance or the potential sale price, and are further at risk from lead cable liability.
For further details see:
Telephone and Data Systems Can't Deliver On Valuation