2023-11-17 09:20:37 ET
Summary
- Telephone and Data Systems Preferred Shares offer a better combination of yield and upside potential compared to its ordinary shares.
- The company operates in the telecommunications industry, providing wireless products and services, cable and wireline broadband, TV, and voice services.
- TDS is considering the potential sale of its stake in UScellular, which has led to a share price rally.
Telephone and Data Systems Preferred Shares (TDS.PR.U) currently offer a better combination of yield and upside potential compared to its ordinary shares, being the best way to play the potential sale of its stake in UScellular Corp (USM).
Business Overview
Telephone and Data Systems (TDS) operates in the telecommunications industry, providing wireless products and services, cable and wireline broadband, TV, and voice services to some 6 million customers across the U.S. Its current market value is about $2.1 billion, being a small-cap company by this measure.
Its business is split among wireless services, provided through its 84%-owned subsidiary UScellular, and broadband, video, and voice service through TDS Telecom. As seen in the next graph, its wireless business is the largest one by far, generating 77% of the company's revenues in 2022.
Revenue (TDS)
Its core business is to provide telecom services in underserved rural and suburban communities, especially in the broadband segment, being a key distinctive factor to other larger players in the industry, such as AT&T ( T ) or Verizon ( VZ ).
In the wireless segment, it has some 4.7 million customers, operating in 21 states across the U.S., and owns more than 4,300 towers. Most of its customers have postpaid packages, and over the past couple of years, TDS has lost customers due to strong competition in the marketplace. Its annual churn rate has been around 1.2-1.3%, which is acceptable considering the challenging operating backdrop in the wireless segment. While the company has been losing customers on a net basis, it has been able to increase the average revenue per user, which was above $50 per user in 2022, an increase of 4% YoY.
This means that TDS is focusing more on profitability than customer growth, which seems to be a sensible strategy considering the inflationary environment over the past couple of years, and fierce competition from larger carriers in the wireless industry.
In broadband, video, and voice, it serves some 1.2 million customers in selected regions across several states. In these areas, the company has expanded its fiber network to gain an edge over competitors, specifically in areas that historically have used copper and coaxial cable technologies. In this segment, the company has been able to gain customers due to its network expansion, a trend that is likely to persist in the coming years.
The company's growth strategy is to reinvest earnings in business growth, while also using favorable funding conditions from state and federal programs, to expand its network both in wireless and broadband. This means its strategy and business profile are not expected to change meaningfully over the near future, with the company's growth being mainly organic and in its core business of wireless and broadband services.
Financial Overview
Regarding its financial performance, contrary to larger telecom companies that have seen top-line pressure due to fierce competition from T-Mobile US ( TMUS ), which has gained some market share in recent years to its larger competitors, TDS has reported a relatively stable top-line over the past few years, by focusing on a different niche market.
In 2022 , its total operating revenues amounted to $5.4 billion, an increase of 2% YoY, with both wireless (revenues of $4.16 billion) and other segments ($1.02 billion) increasing revenue by 1% YoY, while other revenues increased by 11% YoY to $224 million.
Due to the inflationary environment, TDS' operating expenses increased by 4% YoY, to nearly $5.3 billion, which means its business margins declined during the year, and the company was barely profitable on an operating basis. Indeed, its operating income was only $122 million, a decline of 53% YoY, showing that the company's operating margin is quite low at only 2.3% of its revenues. Its net income was $72 million in 2022, a decline of 62% YoY, the lowest level since 2019.
Despite relatively low GAAP earnings, its adjusted EBITDA was $1.257 million in 2022, representing an adjusted EBITDA margin of 23.2%. This significant difference comes mainly from the fact that the company has significant fixed assets and annual depreciation, which is a non-cash expense, amounted to $929 million in 2022.
Nevertheless, TDS' adjusted EBITDA margin is somewhat lower than compared to its competitors (AT&T at 39% for instance), showing that TDS's profitability level is not particularly impressive. Its operating cash flow in the last year was $1.15 billion, a slight increase compared to the previous year, which it used to finance its investments in expanding the company's network. Indeed, TDS' capital expenditures were $1.16 billion, thus its free cash flow was slightly negative in the year.
During the first nine months of 2023 , the company's operating momentum remained somewhat weak, given that revenues declined by 5.1% YoY to $3.8 billion, due to weak equipment sales in UScellular. Other revenues were stable compared to the same period of last year, but the challenging economic environment had a negative impact on smartphone sales, impacting TDS' revenues in the period.
Expenses declined by 4.4% YoY, as the company had good control over fixed expenses and variable costs related to equipment sales declined more or less in line with equipment revenue, thus the impact of lower revenue on the company's profitability was contained. Nevertheless, on a GAAP basis, TDS reported a net loss of $45 million in the period, while its adjusted EBITDA was $819 million.
More important than its operating performance, was the company's announcement in August that it reviewed strategic options for its UScellular business, including a possible sale, an event that led to a huge share price rally in the day.
This is an important asset for the company, but the potential to monetize its stake was well received by the market, even though a transaction may not happen in the future. In its most recent earnings call, its management only said that the process is active and ongoing, but no further details were shared with analysts and investors.
Regarding its dividend , TDS has a very good history, given that it has delivered a growing dividend for the past 49 years. As shown in the next graph, its annual dividend has grown consistently over the past twenty years, which is a great achievement by TDS.
Dividends (TDS)
In 2022, TDS paid to ordinary shareholders some $89 million in dividends, representing an increase of 3% YoY. Beyond that, it also distributed $69 million to preferred shareholders, which represents the total capital return of $158 million in the past year. In addition, the company also repurchased shares in an amount of $40 million, further enhancing its total shareholder remuneration policy.
However, TDS does not generate enough earnings or cash flows to finance this capital return policy, which has been possible to pursue by increasing its debt load. Indeed, its net debt increased to more than $3.7 billion in 2022, an increase of 27% YoY. Its net debt-to-adjusted EBITDA ratio was 2.97x (vs. 2.13x in 2021), an acceptable ratio within the telecom sector, but TDS needs to maintain leverage at a reasonable level and is not generating organic cash, which could put in jeopardy its dividend in the future.
Conclusion
Telephone and Data Systems does not have any moat within the telecom sector and its operating performance lately is not particularly impressive. A potential sale of its stake in UScellular could be positive for shareholders, but this seems to be already priced in given that TDS' ordinary share is trading at more than 6x adjusted EBITDA, at a premium to its historical average of 4.5x over the past five years.
Furthermore, if the company decides to maintain its stake in UScellular or performs a dividend cut, there could be significant downside ahead. Therefore, a better way to play a potential deal, that would transform its balance sheet, is through its preferred shares, which are currently yielding above 10% and trade slightly above $15, offering a better good combination of yield and upside potential compared to ordinary shares. Its U series has a 6.625% dividend and a call date of March 2025, making it a good way to play TDS right now.
For further details see:
Telephone And Data Systems: Play Its Potential UScellular Sale Through Its Preferred Shares