It's not every day that stock analysts move a big market cap stock, so when they do it's worth taking note.
The stock in question is Manitoba Telecom and the analysts are from TD Newcrest. They argued in a report released Monday that MTS should sell its wireless division and use the money to buy back stock. Investors seem to like the idea because the idea added $45-million to MTS's market value in two days. The stock hasn't seen that kind of love in a dog's age, to use the mot juste.
At first blush it's hard to believe that selling the wireless division could be a good idea. MTS earns about 50 cents on every dollar of wireless revenue while its wire-line business is stagnant. Why would investors want the company to sell its crown jewel and keep the dregs?
The analysts make a convincing case.
At its heart is the notion that MTS is never going to be swallowed whole by a larger phone company. For years the company has been cited as a potential takeover target, but a takeover hasn't happened yet, largely because MTS has assets that other telecom companies don't want.
Unpalatable Assets
Its wire-line business is one such unpalatable asset. The most likely buyers, Telus and BCE, don't want any more wire lines because offering traditional land-line phone service is a dwindling business. Wireless properties earn a higher value in the stock market, so adding ye olde telecom assets isn't appealing.
MTS's other unpalatable asset is Allstream, a company that provides phone solutions to businesses and tries to compete with the big telcos on price. MTS paid $1.6-billion for Allstream in 2004 and the division is not worth a small fraction of that now.
The only part of MTS that buyers would covet is its wireless business. So, the idea goes, sell it to them.
The analysts figure MTS's wireless division has a little more than half of the market share in Manitoba. They also argue that one of the national wireless providers - BCE, Telus and Rogers - would get cost and strategic synergies from purchasing the unit. The TD Newcrest team estimates that based on the valuation of other wireless deals, MTS's wireless division would fetch $1.6-billion.
The analysts think that MTS would have to get rid of Allstream to make this deal palatable to shareholders. They value Allstream at $480-million but in their analysis they applied a fire-sale price of half that.
Debt
Total net proceeds, after transaction costs and paying off some of MTS's debt to bring it to a conservative level, would allow the company to buy back a lot of stock. The remaining shares, the analysts figure, would earn a little more than $4 each in free cash flow, most of which could be paid in dividends since the company would have essentially no growth prospects to invest in.
Depending on what yield the new shares would trade for (see table), the stock would be worth between $38 and $50. It's just over $28 today. Even at the low end of the stock price estimate it's a very good return, and it's not like this analysis depends on a multitude of vague assumptions. The case holds water.
The only obvious fly in the ointment is the effect of a wireless divestiture on bundling. Telecom companies package services together - Internet, TV, land lines and cellphone service - and offer them at a discount to attract customers. So losing wireless might hurt MTS's market share.
But analysts argue that whichever company bought the wireless assets would enter into some sort of marketing agreement with MTS - similar to what BCE does with Bell Aliant - that would allow the Manitoba company to keep offering wireless. So the bundling problem doesn't seem to be an obstacle after all.
The only thing missing is a bridge from the theoretical to the real. One assumes that this report is aimed at making investors money and getting some advisory fees for TD Newcrest, which is probably presenting soon to MTS's board of directors.
It's a very compelling case if you read the report, and the market seems to approve. There's value in MTS and this is the best idea about how to unlock it that we've seen in a long time.
Unlocking value
Wireless sale: $1.56-billion
Allstream sale: $240-million
Less transaction costs: -$90.2-million
Net proceeds: $1.71-billion
Debt reduction: -$469.2-million
Share buyback: $1.24-billion
Free cash flow/share after buyback: $4.03
Dividend/share: $3.22
Stock price assuming yield of:
6.50%: $49.56
7.50%: $42.95
8.50%: $37.90