Strong Growth at Lumos Networks Implied by Current Trading Levels
About nine months after first announcing its intention to split into two companies-a wireless operation that would retain the brand name NTELOS and a wireline operation comprised of the NTELOS wireline and FiberNet fiber operations-NTELOS announced last month that it intends to effect its separation on October 3, 2011.
James Hyde, Michael Moneymaker and the team have worked furiously over the past year to ensure that both sides of the business have attractive growth prospects and achieve better cost efficiencies in advance of the spin. New executives have been named for Lumos Networks—the recently announced brand name of the to-be-spun wireline business—and the company’s second quarter results press release and conference call were filled with discussion related to future growth prospects—although pro forma results for the wireline business in particular did not demonstrate substantial growth just yet…
Investors, nonetheless, appear to be bullish on the split. By analyzing the wireless and wireline segments separately, and comparing to the trading multiples of other public wireless service providers, I was able to back into an “implied” public value for what will become Lumos Networks…and it’s up there.
First, my analysis of the public wireless companies indicated that investors today are paying relatively modest multiples for standalone (non-AT&T and non-Verizon) wireless providers. Each of United States Cellular, Sprint, MetroPCS and Leap Wireless are facing intense competitive issues, most directly from the aforementioned dynamic duo of wireless iPhone fame. But so is NTELOS Wireless. Given that NTELOS derives much of its wireless business via its Sprint PCS wholesale arrangement—and more importantly, much of the anticipated growth is expected from that source—I figure the Sprint trading multiples should represent (at worst) a down side value proxy (Sprint has its own issues weighing on the share price). Sprint is trading presently for about 0.7x revenue, 4.7x cash flow and less than $500 per subscriber-it’s the cheapest of the four comparables.
But NTELOS Wireless, I believe, deserves better, if only due to its regional focus and the revenue upside it should enjoy as it penetrates its subscriber base with smartphones. Perhaps not dramatically better, but if I base the wireless division valuation on the mean of the four companies, and then the mean of the three values implied by the revenue, cash flow and per subscriber multiples, you get a wireless operation worth about $450m (public value). That implies more than a billion dollars for the Lumos Networks side of the scale, and multiples of 5.3x revenue, 10.6x cash flow and nearly $5,400 per connection. These are strong growth multiples!
If I take the high end wireless multiples and apply them to NTELOS Wireless’ recent performance, the indicated value is closer to $550m, which still implies Lumos Networks’ public value is nearly 5x revenue, nearly 10x cash flow and nearly $5,000 per connection. I guess Lumos Networks is “nearly” considered a growth story!
I’m only being partially facetious. There’s no doubt in my mind that Lumos, with its aggressive fiber deployment and backhaul initiatives, will enjoy relatively rapid growth over the next few years. But will that growth be strong enough to support today’s trading value? Or have I underestimated the value of the wireless business?
It’s hard to say just yet, but Standard & Poors said at the end of August that it expects to lower the rating of NTELOS (Wireless’) secured debt by one notch upon separation of the two businesses, “reflecting our view that despite the reduction of the term loan from the Lumos dividend, spinning off the wireline properties weakens recovery prospects for NTELOS' secured credit facilities." The press release added, “In particular, that view contemplates the potential scenario in which the Sprint wholesale services contract, responsible for a significant and growing share of revenue, either is not renewed in 2015 or is renewed under markedly less favorable terms. Accordingly, we expect to revise the recovery rating for the secured credit facilities to '3', indicating our expectation of 50%-70% recovery of principal in the event of a default from the current '2' recovery rating, which denotes 70%-90% recovery of principal. “
In other words, S&P doesn’t like NTELOS Wireless as well without the growth prospects of Lumos Networks.
Of course, investors holding the shares today will get to play both sides once the tax-free distribution occurs, presumably in a couple of weeks. The question is, will they continue to hold both pieces of the former NTELOS Holding Corp.?