Alaska Communications (ALSK) is an 820 employee Telecom company that operates in Alaska and is the leading provider of Ethernet and other data services in the state. With its recent purchase of a 33% stake in AWN (Alaska Wireless Network), 
The company describes its business as:
Headquartered in Anchorage, Alaska Communications today serves the fastest growing segment of users - data dependent consumers and enterprises - and leverages its legacy as a local telephone company to support its wireless and enterprise data network.
Alaska Communications participates in the consumer market primarily through its wireless data and voice product line. The company's network coverage extends from the North Slope to the Southeast panhandle, complemented by data and voice roaming partnerships in the Lower 48 and Canada, enabling us to offer nationwide plans identical to those offered by the biggest brands in the industry.
The company participates broadly in the enterprise market; specializing in serving data needs - whether wireless or fixed. Its fixed data services are delivered over a statewide Metro Ethernet and MPLS network; its data hosting centers; its submarine fiber networks connecting Alaska to the Lower 48; and through professionals who deliver managed services. The professional services product line was recently augmented through an investment in and partnership with a leading IT services in Alaska that, like Alaska Communications, also extends its services to the Lower 48.
ALSK has a $93 million market cap, currently trades for $1.92 per share and has averaged nearly 600,000 shares per day of volume over the last 3 months. The 52 week range of the stock is $1.55 to $3.90.
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Alaska Communications Takes A Couple Of Big Hits
Since peaking in mid-August at just below $4 per share, after a substantial beat of Q2 earnings estimates and closing the AWN deal, ALSK has been absolutely crushed over the past three months. The 50% free fall to below $2 per share was largely driven by two events, while a third dark cloud hangs over the Alaskan telecom, pinning it down to book value levels.
In August, news hit the wire that ALSK would be considering issuing common shares in order to repurchase its 6.25% convertible notes that are due in 2018. An 8-K was filed in Mid-August, reporting that Alaska Communications had issued just below 700,000 shares in order to facilitate a portion of the bond buy-back. The corporate action sent the stock spiraling down by over 30%, ultimately landing around the $2.50 mark by mid-September. ALSK then filed another report highlighting the issuance of another 1.2 million common shares. This time around, the stock was largely unaffected, as the cumulative 1.9 million shares represented about 40% of the roughly 4.75 million shares that ALSK would consider issuing as part of its bond buying program, a figure that the market had likely already priced into the stock.
Once early November rolled around, ALSK's stock was sent reeling once again, falling over 20% more, leaving the $2.50 level that it had hovered around for a couple of months, ultimately settling at the $1.90 mark. Despite ALSK reaffirming full-year revenue guidance of $340 to $350 million, EBITDA guidance of $105 to $110 million and free cash flow guidance of $20 to $25 million, the market seemed to be spooked and sold off. Part of the problem was likely that the earnings story wasn't all good, as there were some areas of the business which experienced revenue declines.
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Courtesy of Yahoo! Finance
The biggest declines were in the wireless and backhaul areas, as retail service revenue declined $1 million year over year or 5.5%. Foreign roaming revenue fell much more considerably, declining by $13.3 million, although this was largely expected as roaming revenue moved to AWN. Adjusted EBITDA also decreased during Q3, although again somewhat expectedly as a result of closing the AWN deal. As a last bit of negativity, free cash flow was adversely impacted by higher levels of capital spending which was associated with the typical summer build season, but ALSK went on to say that capital spending which had initially been targeted to be around $50 million for the year would likely come in lower than expected.
Overall and generally speaking, aside from these declines which were mostly expected, it was difficult to find a clear negative catalyst in the earnings. Wireline revenues which are a major focus of Alaska Communications increased to $50.1 million which represented an increase of 1.2%. This figure was driven by a 17% increase in business and wholesale revenue, and an increase of 21.3% in consumer revenue. Another major initiative of ALSK is its debt reduction, and the company's progress was evident at the end of Q3 as total net debt has been decreased by $134.2 million over the course of 2013, to $404.4 million. ALSK's 1/3rd ownership in AWN should help the company to continue at its considerable rate of deleveraging.
That being said, as previously mentioned, there is one dark cloud hanging over ALSK, and that is the emergence of Verizon as a competitor in Alaska. Verizon is obviously a formidable opponent and the company's entrance into the wireless Alaskan market has worried many investors, and has led to analysts reducing upcoming quarterly revenue estimates by about 10% relative to Q3 2013. This ongoing and increasing concern has pushed ALSK back down to trade at book value levels.
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ALSK's Punishment Creates Opportunity
ALSK trades right at book value ($1.93) and 50% below the levels it reached in August after an impressive Q2 earnings release and after closing the Alaska Wireless Network deal. Although ALSK traded for as low as the $1.60's earlier in 2013, after dividend cuts and debt concerns sent the stock steadily barreling down over the course of a couple of years from its $11 level in 2011, I believe the $1.93 book value now represents a solid floor for the stock. This is the case given that the current book value is largely driven by the recent payment of $100 million from the AWN deal, pushing book value per share up from just $0.20 after Q2 to its current level of $1.93. This is the theoretical liquidation value of ALSK and represents what shareholders could expect to receive in the event of the bankruptcy. I believe for this reason that book value represents a fair floor for ALSK, especially given that the stock hovered in the $1.60 to $1.80 range for much of the first half of 2013, or 8x Q2 book value compared to the just 1x book value that the stock trades at now.
In the below quarterly income statement, you can see where "Special Income" drove net income for the quarter, which ultimately padded retained earnings which can also be seen below.
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Courtesy of MSN Money
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Courtesy of MSN Money
The AWN deal will improve ALSK's competitive position in the wireless market, and the preferred distribution structure will mitigate the risk that is associated with the decline of wireless revenue as a result of the Verizon entry and CETC reforms. Additionally, the free cash flow generated from the AWN investment will allow ALSK to continue its steady pace of debt reduction, consistently decreasing its default risk and allowing the stock to become a more attractive investment.
Lastly, short interest began to decrease considerably earlier this year when ALSK fell below $2.00. In January, the stock posted one of the largest percentage decreases of short interest among the NASDAQ, falling 28%. This shift likely highlights a change among institutional investor sentiment and signals a potential turning point for the stock.
As for ALSK's upside, while I believe that it is highly speculative to assume that the company can return to a $5, $7, or $10 level as some would like to expect, I do believe there is upside to be had over the next 12 to 18 months, in the 35% range. Longer-term appreciation to even higher levels will largely be a result of how the competitive landscape plays out in Alaska, and the ability of Verizon to expand organically in the state.
After the Q2 announcement, ALSK's trailing twelve months cash flow per share was $1.76, which equated to a 2.15 Price/FCF ratio. After Q3, and since ALSK's substantial fall, the company now trades at a Price/FCF of 1.18, despite fairly steady ttm FCF. 2013 fiscal free cash flow currently sits at $1.15 per share, but analysts expect a -$0.21 for Q4 in order to stay in line with company guidance. At ALSK's previously Price/FCF level of 2.15, FY 2013 cash flow of $0.91 would result in a price of $2.02. However, with FCF estimated to be around $1.18 in 2014, using the same 2.15 ratio gives us a price of $2.50.
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Similarly, ALSK saw Price/Sales ratio cut nearly in half has the stock sunk on competition worries. At the end of Q2, ALSK was trading at a Price/Sales of .47, using ttm revenue of 389.7. By the end of Q3, with ttm revenue of 376.7, the stock was trading for a measly .25 Price/Sales ratio. Full year 2013 estimated revenues of $355 million which is in line with guidance at the company's previous Price/Sales ratio would equate to a price of $3.43. Although I believe this to be an aggressive estimate, even with 2014 full year revenue estimates of $292 million, ALSK would be worth $2.80 per share using its previous .47 Price/Sales ratio. This price (and revenue) level seems very reasonable given that it is in line with a low, competition hampered Q4 revenue estimate of $74 million by analysts, and is also in line with company guidance.
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The leveling off and settling of competition worries which is likely highlighted in 2014 revenue estimates, as well as further deleveraging and increased free cash flow in 2014 which could reignite a dividend payment will likely begin to change investor perception and allow ALSK to revert back to Price/Sales and Price/FCF ratios of earlier this year. This is the level to which the market took the stock after Q2 earnings and after the close of the very valuable AWN deal which will help ALSK to compete in the increasingly competitive wireless market in Alaska. I believe this is a fair value given the difficult competitive landscape ahead and even with expected decrease in revenues, given the risk mitigation steps that ALSK has taken and continues to take with the AWN purchase and debt reduction. Also with the company's focus on broadband growth and businesses sales, and the increasing importance of connectivity whether through phone, internet, TV or movies, I believe fair value for Alaska Communications is $2.60 per share which represents 35% upside over the next 12 to 18 months.
Lastly, although Verizon will present new challenges for Alaska Communications, it seems that the sell off that manifested itself mostly through dramatic reductions in Price/Sales and Price/FCF ratios has been overdone. LEAN business changes such as process improvement, waste elimination and expense management will help ALSK to maneuver and stay ahead of the curve among increasing competition. ALSK's focus on its resilient Ethernet network will continue to drive business among Alaskans for the entrenched local telecom provider, as ALSK was the first company in Alaska, the second in the U.S. and the third in the world to become a Certified Ethernet 2.0 carrier through the Metro Ethernet Forum. Substantial growth in the Alaskan telecom market will present opportunity for ALSK to continue to expand its core broadband business, and will also add at least incrementally to AWN's wireless revenues even with new competition from Verizon. This is especially the case given the 300+ cell sites that ALSK has access to through the AWN deal, compared to the 9 that Verizon had constructed by the end of summer. Although Verizon is penetrating some of the larger markets in Alaska at this time, they are far from having the same extensive network that is boasted by AWN, and the telecom giant has already cited issues with cell construction and development in more rural areas of Alaska.
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Conclusion
Given the overarching trends and the rapid rise of online and on demand media in the US, I believe that ALSK is positioned well, especially given that it operates in the largest state in the US where connectivity among people is often critical and highly appealing across the state's vast landscape. Additionally, geographical location and weather prevents market penetration by satellite operators which further secures ALSK's position and will help them drive their broadband services which is one of their key initiatives.
Additionally, ALSK's purchase of a 1/3rd stake in Alaska Wireless Network will help to mitigate some of the risk in the wireless market that has developed as a result of competition from Verizon. Furthermore, the initial payment of $100 million from the deal, as well as follow up payments over the next several years will allow ALSK to continue to move forward on its second major initiative which is to reduce debt. The company has been very successful in its deleveraging program thus far, and as the company continues to reduce debt and free up cash flow, it could look to reinstate its dividend which would be highly appealing to investors.
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Although it is likely that revenues will fall to some degree over the next year as a result of the previously mentioned competition in the wireless space, it appears that ALSK has been oversold and that markets have over-reacted to the potential incremental loss of revenue in the wireless segment. Even with the revenue reductions, ALSK seems to have about 35% upside with minimal risk, assuming that this loss in wireless revenue is as substantial as predicted. However, as the competition plays out over the next year or two, Verizon could find it difficult to grow organically in the challenging environment that is Alaska, which could lead to the mobile giant looking to leverage the already expansive wireless network of AWN and its over 300 cell sites, especially if prices remain relatively low.
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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...)
Additional disclosure: This article expresses the opinion of the author and is not a solicitation to buy or sell any security. Before making any investment decision you should always consult your personal financial advisor.
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