Danger Zone: United States Cellular (USM)

Worrying Acquisitions and Spending

USM has recently resorted to growth through acquisitions, a method that generally dilutes shareholder value. USM recently paid $92 million to acquire spectrum, tower assets, and subscribers from Airadigm Communications, which is shutting down its wireless operations. USM will also pay a fee for each customer it acquires from Airadigm. USM is growing by acquisition (into markets that drove another company out of business) while losing customers in existing markets. This strategy bodes poorly for the business’ ROIC and cash flows.

USM is burning through its cash, with just $392 million on hand at the end of 2013. Accounting for the $92 million paid for Airadigm, this leaves the company with around $300 million, a 46% decline in cash since 2011. USM has been repurchasing shares, $3.8 million’s worth in 1Q14. Subscriber loss accelerated in the most recent quarter. USM lost 80,000 customers in 1Q14, up from net losses of 2,000 in 1Q13. At this rate, the company will have burned through its dwindling pile of cash in a little over 4 years.

Expensive Valuation

Despite these warning signs, USM is priced for high growth. The stock’s current price of $40/share implies that the company will instantly achieve pretax margins of 8% (from -4% currently) and that it will grow revenue at 14% compounded annually for 5 years. This is an awfully optimistic turnaround for a company that is shedding subscribers and exiting markets. USM’s poor competitive position relative to carriers like AT&T and Verizon make me even less confident that it can achieve this kind of growth.

If USM remains unprofitable, it should trade close to its tangible book value of $19.00/share, or a 52% downside.

Looking forward, if subscriber loss continues and financial losses widen, there is no reason for USM to continue trading this high after its buyback program ends. Expect the company to earn a loss in 2014, and with no gains from sale of assets to mask its unprofitability like in 2013. If the company does somehow manage to increase profits, it will be through slashing selling and promotional expenses as it has done in the past, further accelerating the decline of its subscriber base.

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Disclosure: David Trainer and André Rouillard receive no compensation to write about any specific stock, sector, or theme.

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