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ILEC 3Q11 Quarterly Results: Shenandoah Telecommunications

Stock Price Falls 35% in 3Q11 as Costs Rise

Investors have punished the stock price of Shenandoah Telecommunications (Nasdaq:SHEN) of late, driving its price down 35% during 3Q11 to close at $11.14 (and more recently trading closer to $9/share). While Shentel has turned in acquisition-fueled top line gains in recent quarters, rising costs have outpaced the gains in revenue, and on its 3Q11 conference call, management signaled more cost concerns in future quarters.

In 3Q11, revenues at Shentel increased $9.4m YoY, or 17.7%, to $62.7m, thanks to a $4.6m jump in cable revenue and a $3.5m increase in wireless prepaid revenues associated with an increase in Sprint prepaid customers. The cable gains however remain inflated by acquisitions as only two months of Jet Broadband revenue are in included in the 3Q10 totals and Shentel’s 4Q10 purchase of cable assets from Suddenlink is not factored into the YoY comparison.

While Shentel reported decent top line growth in 3Q11, rising costs and capital expenditures were the hot topics for analysts in its 3Q11 conference call. Shentel’s  earnings fell 25% YoY to $3m in 3Q11 as operating expenses jumped 42.8% YoY during the first nine months of 2011, compared to just a 34.6% rise in revenues. Shentel has spent $20.9m on capital projects during 3Q11, a 34.9% jump YoY, and is on pace to spend $77.6m through the end of the year. A majority of its 2011 capex to date, $26.m, has been spent to upgrade the systems it acquired from JetBroadband in 3Q10. Despite the acquisition and upgrades, Shentel reported a steeper operating loss in its cable segment in 3Q11 of $6.4m, down 2.1% YoY.

With upgrades to cable systems in its West Virginia and Maryland properties set to continue through 2012, analysts on the earnings call expressed concern about the growing cable operating expenses. Shentel’s ceo Chris French attributed the rising cable costs, and the delay in expected JetBroadband synergies, to redundant expenses that he expects to go away in 2012. “Because in 2011 we have some duplicate expenses where you had facilities that Jet had in place that we needed to turn down while we were bringing up our own facilities so there will be some economies showing up in the 2012 results.”

Management however warned analysts that the rising programming costs that have been hitting cablecos and ILECs alike will likely hit Shenandoah’s cable segment in the near future. With regards to the cost of content, coo Earle Mackenzie commented “it’s just become very pricey. We’re in the process of negotiating a retransmission agreement that has been in the press. The broadcasters were asking for significant increase over prior years.  We’re starting to break that out on the customer’s bill and so the customers can see the amount that that he is being charged or we’re paying for retransmission fees. We think that will be helpful to educate the customer that free TV is not really free.”  Shentel’s “don’t kill the messenger” argument is understandable, but a tough selling point to customers when relatively cheaper OTT video options have flooded the marketplace.

When Mackenzie finished fielding questions on rising cable costs, analysts moved onto Shentel’s wireless segment, where it is expected to invest significant capital to fund tower upgrades as part of Sprint’s network modernization plan, referred to as Network Vision. “On the wireless side, the big impact will be Network Vision as we’ve been under discussions or in discussions with Sprint for the last several months about modifying our contract in order to be able to do Network Vision. And assuming that everything moves as we anticipate, we should be able to get started next year on that Network Vision upgrade and we anticipate that the range of the project will be somewhere in the $100 million to $120 million to do Network Vision in our footprint.”  Shentel later added that the company may need to take on additional debt to fund the tower upgrades. Sprint recently set an aggressive target for its Network Vision plan, potentially forcing Shentel to increase its wireless capex more rapidly than it had planned. 

While investing in its wireless network is not a cause for concern, the worry is that Shentel already has significant capital projects ongoing, and that layering on significant wireless spending could spread the company too thin. Add in the fact that Shentel’s wireless margins have already been pinched in 2011 by increased handset subsidies for prepaid customers and a 35% jump in wireless fees paid to Sprint, and an additional $120m in costs might spell more trouble for Shenandoah's bottom line looking ahead.