The Canadian telecommunications industry is one that has steadily evolved as a result of new regulations, technological innovations, increasing competition and a good number of other factors. Manitoba Telecom Services, Inc. (OTC: OTCPK:MOBAF), which for the sake of this analysis will be referred to as "MBT" or "the company", is an integrated national provider of telecommunications services in Canada. The company has over the past few years, been aggressively aligning its cost structure and in the process, achieving significant annual cost savings.
Early part of October witnessed a significant drop in the company's stock price which has dragged into the month of November and counting. Even in the face of this, I still believe the stock has significant run to make by in the next 12-18 months as investors realize that the circumstances that led to the drop in the stock price only had a temporary effect on the company's financial standing.
Overview of the company and its operations
MBT is a Canadian company headquartered in Downtown Winnipeg, Manitoba and is the leading provider of communications services in Manitoba and the fourth largest provider in Canada. The company has been in operation for over a century and has played a significant role in Manitoba's economic growth through its businesses.
MBT maintains two operating divisions which are MTS and Allstream brands. MTS is the company's business with focus on providing communications services to businesses and residential properties across Manitoba. Allstream on the other hand focuses exclusively on businesses, small, medium and large. It was acquired by MBT in 2004 as the company sought to dip its feet in various categories of telecommunication services targeting larger corporations and institutions. Its customers cut across several sectors including airlines, financial services, public sector and consumer goods.
Breaking it down
MTS is divided into six business lines which are:
- Wireless services: This line focuses on cellular, wireless data, paging and group communications needs of residential and business customers with its network coverage available to approximately 97% of residents of Manitoba. At 53% (496,749 subscribers), MTS has the largest, in-region wireless services market. With its combined 4G, 4G HSPA+, CDMA-EVDO and Wi-Fi hotspot networks, MTS is a market leader in Manitoba.
- Broadband and converged Internet Protocol ("IP") services: This line offers high-speed Internet and IPTV services to both residential and business customers who require IP-based connectivity. This service is utilized by approximately 84% of Manitoba homes.
- Unified communications, security and monitoring services: This line offers IP telephony products and services to business owners in Manitoba. It also offers IP-based security products and services to its national business customers, installation and monitoring of alarm services to residential, business and industrial customers. Finally, it offers customized information technology solutions known as Epic Information Solutions to business customers across Manitoba and Saskatchewan.
- Local access services: This line of MTS business offers voice connectivity and payphone services to residential and business customers in Manitoba.
- Long distance and legacy data services: The offerings from this line include outbound long distance calls, toll-free services, calling cards, audio conferencing, and dial-around services. These services enable the company's Manitoba residential and business customers to effectively communication with various destinations outside their local exchange.
- Other: Facilities rental, customer late payment charges, revenues earned from Allstream and other miscellaneous items are grouped into this line of MTS business.
Allstream is divided into five business lines which are:
- Converged IP services: Offerings from this line of business include IP-based networking and related products and services which are targeted towards national business customers.
- Unified communications, hosting and security services: This line of the Allstream business offers IP-related telephony products and services along with IP-based security offerings to its national business customers.
- Local access services: Offerings include business voice connectivity which is available to wholesale customers and national business customers as well.
- Long distance and legacy data services: This line's focus is one national business customers to whom Allstream offers long distance calling services and private line networks products to.
- Other: Grouped into this line are routing and exchange of wholesale long distance network traffic services along with customer late-payment charges and other miscellaneous items.
Strong corporate leadership
Operating, acquiring and managing businesses in the telecom industry has never been a simple feat as it requires to a large extent, a high level of knowledge and expertise in the industry. This is where the company's corporate leadership comes in. CEO Pierre J. Blouin is highly experienced in the telecom industry as he has held leadership positions in various telecom companies including Bell Canada, BCE Emergis and Bell Mobility. He is also a board member of the Conference Board of Canada and Manitoba Telecom Services Inc.
From 2005 when he became the CEO, MBT has achieved approximately $460 million in combined cost savings. Presently, MBT maintains annual cash savings of approximately $55 million which trend is expected to continue into 2020. All thanks to the company's strong corporate leadership. The rest of the management team have served in various leadership positions in various sectors, including Dean Prevost, President, Allstream.
Reasons for the dip in share price
At the close of market on May 24 2013, Accelero Capital Holdings, an Egyptian investment and management group with focus on telecom, technology and digital media investments, announced its binding agreement with MBT to acquire the Allstream business in a deal valued at approximately $520 million. By the following week, the company's shares which were trading at $32.45 increased to $35.10. It became a different drama however, when on October 7, 2013 MBT announced that the deal, which was expected to close in the second of 2013, was rejected by the Canadian federal government, citing "unspecified national security concerns" as the major reason. With the announcement of the failed deal (which would have created a formidable business unit if approved), the shares dropped to $28.47 and have been on the downtrend since then.
It is important to point out that management went into this deal for certain reasons, chief of which is in response to the federal government's stated policy objects of increasing foreign investment and driving greater competition in Canada's telecom sector. This rejection is therefore, extremely surprising and disappointing as management found it difficult to understand what actually was wrong with the intended deal.
The second reason for the continued dip is the announcement of the management's revision of guidance for full year 2013 with earnings now expected on the lower end of the initial guidance. As an investor, I believe this drop in share price is a unique buying opportunity, especially for the risk-tolerant investors.
MBT's financial standing
Currently, the company's once robust cash reserve has trickled down to a mere $509 thousand with a debt of approximately $1.05 billion and current ratio of 0.27. As the company looks forward to the events of 2014 that will significantly boost its cash position, it announced on November 19, 2013 that it has entered into a "bought deal" financing agreement with a syndicate of underwriters led by CIBC and Scotiabank. The initial agreement was for the sale of 7,150,000 common shares of the company and later upsized to 8,855,000 at $28.10 per common share.
The company expects net proceeds of approximately $238 million after deduction of the underwriters' commission. The proceeds will go into fulfilling future pension funding obligations and other general corporate purposes. According to management in the company's third quarter report, issuing equity is one of its alternative financing strategies for prepaying its solvency funding requirements and with this particular one, it will take care of solvency funding requirements up to 2016.
MBT makes a good deal
Manitoba Telecom makes a good deal for the following reasons.
Strong and sustainable dividend yield at 6%: MBT is a dividend play and the company's Board of Directors recently declared cash dividend of $0.425 per share for the fourth quarter of fiscal 2013 which amounts to annualized yield of $1.70. As at November 14, the company's shares crossed the 6% yield mark. Even with the decline experienced in the company's profitability as a result of the failed sales of Allstream, I still believe MBT can sustain the yield as there are several catalysts to further fuel the company's growth as listed below.
The stock is significantly discounted: In comparison to its industry peers, the company's stock is trading at a reasonable discount at 5.57x EV/EBITDA while its peers average is 6.75x EV/EBITDA.
Future outcome of the 700 MHz Spectrum Auction: With Canada's switch from analog to digital television, 700MHz and 2500MHz bands of spectrum were freed and auctions were planned for January 2014. The 700MHz band is especially important to carriers in Canada since it will determine how much they gain from the future "wireless Canada". With the spectrum being referred to by many experts as the "beachfront property" and "Cadillac" of spectrum, it will a huge part in the increasing availability of LTE networks in Canada. On November 7, 2013, MBT submitted its complete auction deposit. This puts it in a position to compete with other bidding companies including incumbents Bell Mobility, Rogers Communication and Telus Communication.
Although there is no guarantee that MBT will obtain spectrum, if it succeeds in doing so, it will greatly impact on the company's future earnings. This is especially as the 700MHz is cheaper for carriers to deploy with ease of reach to remote areas. With its ability to penetrate through thick walls, there will be a huge reduction in dead spots. Losing out in the bidding process might turn negative against the company but it should be considered that MBT has always delivered strong operational performance and investment returns and its earnings estimates for 2014 has nothing to do with the 700MHz spectrum auction and as such, losing out would not impact on the share price. If however, out of sentiment and it does, it would not be too much below the price the shares are currently trading on (~$27).
Potential takeover target: Presently, MBT makes a good takeover target and a strategic acquisition by any of the larger Canadian telecom companies will benefit investors. Even though this could happen, it would surely not be this period as all the potential acquirers are presently engrossed in activities related to the 700MHz spectrum auction. Given the company's current cost of incremental debt, a takeover would be financially beneficial to shareholders.
Catalysts that will continue to fuel the company's growth in the long term
- Steady revenue and EBITDA growth
- Shift in product mix towards growth services
- Annualized cost savings of over $55 million up to year 2020
- NPV of not paying cash taxes that will run through 2020 and valued at approximately $285 million or over $4 per share due to the negative impact of the failed Allstream proposed transaction
- Steady subscriber base growth
- Sole telecom provider in Manitoba bundling full spectrum of telecom services
- Forecasted growth in the IP market
- Steadily increasing ARPU
- Proposed expansion of the MTS FTTH network into additional communities in Manitoba
- Leading position in the Manitoba 4G LTE wireless network market
- Recent launch of domestic and international LTE roaming wireless service across urban centers in Canada and most of U.S.A.
Risks
There will be continued decline in wholesale revenue if more of the company's customers (national providers) chose to move their CDMA customers to their own HSPA networks.
There are outstanding pension and other litigations facing the company. Although MBT made it clear that the pension litigation would have no cash or accounting impact on the company as it awaits the decision of the Supreme Court of Canada, it is not clear how much liability will recorded in the class-action claims.
Inability of the company to obtain a spectrum in the January 14, 2014 700 MHz spectrum auction might impact on the share price.
Final thoughts
With the dip in share price, it should be an opportunity for investors to buy rather than an opportunity to sell. This is especially considering that the company presently yields approximately 6%. This yield is sustainable since even the revised low-end free cash flow guidance for 2013 will still be enough to cover the annual dividend. With little or no risk to the dividend yield, it should further mitigate this investment risk as investors wait for a market correction. Also, the company's achievement of annual cost savings of approximately $59 million and the cost reductions of 2014 resulting from this year's restructuring should also mitigate the lost revenues for 2013.
With the company's stock currently trading at 5.57x EV/EBITDA, it is significantly discounted in comparison to its industry peers average. The company's guidance for 2014 reflects continued improvement on management's strategic objectives and as such, more should be expected from this company's stock next year.
Added headwind is the projected growth in the IP and LTE markets with MBT positioned along with the top major players in Canada to gain from the impending boom. With its increasing free cash flow (increased 162% in Q3 compared to the same period a year ago), steadily increasing subscriber base, increasing ARPU and annualized cost reductions running into millions of dollars, MBT will surely sustain its growth in the years ahead.
As with every other investment, due diligence should be applied prior to investing in any company's shares including MBT.
Disclosure: I 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. (More...)
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