The fortunes of Telephone and Data Systems (TDS) rely primarily on the fortunes of wireless carrier United States Cellular (USM). That’s because USM is a subsidiary in which TDS owns an 82% stake. Unfortunately, USM has been an underperforming company as compared to its peer group and that has pulled TDS’s stock down ~25% YTD and the yield up to 3.6%. But before investors think the stock may have bottomed out and offers “value” here, it may be prudent to think again.
Source: Seeking Alpha Charting Tool
The drop in TDS’s stock price appears rational. As the corporate organization graphic below shows, TDS’s primary asset is its 82% ownership stake in U.S. Cellular, with its other two assets being smaller entities with not a lot of upside:
I say not a lot of upside there because its cable operations are primarily in central Oregon, and in spot rural locations in New Mexico, Texas, Utah, and Colorado. That is not a particularly growth-oriented footprint.
Meanwhile, U.S. Cellular is facing pricing pressure from peers Verizon (NYSE:VZ), AT&T (NYSE:T), and a resurgent T-Mobile (NASDAQ:TMUS) post the Sprint merger. That’s because U.S. Cellular is the fourth horse in a three-horse race. After the T-Mobile/Sprint merger, the “big three” (T-Mobile, AT&T, and Verizon) now control over 90% of the total U.S. wireless market with the size and scale that enable them to put pricing pressure on much smaller U.S. Cellular.
That size and scale advantage will likely make the transition to 5G more difficult for U.S. Cellular in comparison to its peers, not to mention that USM has a small geographic and relatively low-population footprint to begin with (see graphic above).
As a result, six-month revenues have stagnated yoy for TDS:
Source: Q2 EPS report
As can be seen, over the first six months of 2020, U.S. Cellular revenue accounted for 77% of TDS’s revenue and was basically flat yoy, as was TDS’s total revenue yoy.
To make matters worse, there seems to be a lack of financial controls at TDS. I say that because there’s an inordinate amount of high-priced debt on the books, and in August the company took on another $500 million of Senior Notes due in 2069 at a rate of 6.25%. In a near-zero interest rate environment, a rate of 6.25% for 50-year debt is an eye-opener and in and of itself shows signs of distress. Indeed, interest expense in Q2 was already $38 million and the new Senior Notes will add an estimated $7.8 million on top of that. That said, it is likely the company will pay off the debt obligation that comes due next year and have a ~$350 million left over to invest back into the business. That will give the company a 5-year run with no maturing long-term debt:
Still, almost all of TDS’s debt is significantly above 6% – and that seems like a high bar to hurdle in order to offer decent returns to ordinary shareholders.
Summary and Conclusions
TDS currently trades at a P/E=13.6 and a forward P/E=11.6 and has a current yield of 3.6%. While that valuation and yield may look attractive to some investors, TDS’s business appears to be stagnating and the relatively expensive long-term debt profile is unattractive. There are simply better opportunities in the market for growth and income. Despite the drop in TDS’s share price, I recommend investors avoid the shares.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: I am an engineer, not a CFA. The information and data presented in this article were obtained from company documents and/or sources believed to be reliable, but have not been independently verified. Therefore, the author cannot guarantee their accuracy. Please do your own research and contact a qualified investment advisor. I am not responsible for the investment decisions you make.