NTELOS (NASDAQ:NTLS) operates a branded regional wireless service covering ~6 million people in western parts of Virginia and West Virginia. The company also has an agreement with Sprint (the Strategic Network Alliance, aka "SNA") to be the exclusive roaming partner for an area covering 2 million people within this region, where Sprint does not currently have their own network. The map below shows the area that NTELOS covers. The lighter colored purple area is the region covering the SNA with Sprint.
Click to enlarge images.
Summary of Contract with Sprint
This contract was originally agreed on in 2004 and later amended to the current version which became effective July 31, 2007. This amendment also extended the original July 2011 expiration to July 31, 2015. Under this contract, Sprint pays a variable fee based on the amount of voice and data usage of its customers within this 2 million person region. As mobile data usage has exploded in recent years with the proliferation of smartphones, so have Sprint's payments. In 2008, the first full year of the current agreement, Sprint paid $104 million. In 2013, the amount rose to $168 million, a 62% increase from 2008.
Source: NTELOS earnings releases under "SNA revenues."
Sprint Doesn't Seem Happy with the Current Contract
Many bulls on shrug off this contract renewal risk as an issue too small for Sprint to care about relative to their broader nationwide plans. Compared to the $8 billion of capital expenditures Sprint guided for 2014, $168 million may not seem that significant. However, Sprint did have open disputes with NTELOS over the fees it was paying which started in the fourth quarter of 2011 and remained outstanding for nearly two years until the parties ultimately settled with Sprint paying NTLS <$10 million in September 2013. If Sprint is willing to argue over less than $10 million, then they should definitely care about trying to reduce the ~$160 million they've paid the past couple of years.
It's also worth noting that Sprint renegotiated the current contract in July 2007, four years before its original expiration date of July 2011 ahead of 2G to 3G network upgrade cycle. is currently in the process of its 3G to 4G upgrade cycle, but Sprint has not pre-negotiated any extension for 4G access with only a little over a year left until the July 2015 expiry. Perhaps this is further indication that Sprint is looking to move in a different direction in this region rather than keep the current agreement as is.
Current Contract Likely Loss-Making for Sprint
My analysis suggests that Sprint is actually losing money on its subscribers in the area at the current level of fees it is required to pay. While does not disclose the specific number of subscribers Sprint has in this region, I estimate Sprint has 300k subscribers here if I apply their national penetration rate to this 2 million person region. Sprint had an average of 47 million postpaid and prepaid retail subscribers in 2013 (pg. 38 of the Sprint 2013 10-K). The census bureau estimates the U.S. population was 316 million on July 1, 2013, which I assume was the average population for the year.
47 mil / 316 mil x 2 mil = ~297k
While T-Mobile does not have a presence here, this is still a four-player market with as a third competitor to Sprint along with AT&T and Verizon, so it is still reasonable to assume Sprint has a similar market share to their national average. Additionally, the overall mobile phone user penetration in this very rural area is likely less than the national average so my assumption is likely on the conservative side (i.e., Sprint could have less than 300k subscribers here).
Until the fourth quarter of 2011, used to disclose how much of the fees received were related to "travel" customers (Sprint customers traveling through the region) vs. "home" customers (Sprint customers that live in the region). The rate charged for each type of customer is the same, but the distinction is important to understand the subscriber economics of the "home" customers to Sprint. Historically, the "home" fees were ~2/3 of the total usage fees paid. There is also a minimum revenue component of $9 million per month for Sprint in the contract, but they have been well above the minimum since 2011.
In 2013, Sprint paid $168 million to NTLS. Backing out the one-time settlement payment of $9 million, the total was $159 million. Assuming 2/3 of this payment is allocated to the estimated 300k "home" subscribers, Sprint paid on average $29.39 per subscriber per month.
$159 million * 2/3 ÷ 300k subscribers ÷ 12 months = $29.39 per subscriber per month
This $29.39 fee equates to 58% of Sprint's 2013 retail average revenue per user (ARPU) of $50.89 (pg. 39 of Sprint 2013 10-K) which is much higher than the 31% Sprint's current cost of service is as a percentage of service revenue.
Source: pg. 37 of Sprint 2013 10-K.
Assuming Sprint's equipment subsidy and SG&A costs for this region are similar to their national average, just to reach EBITDA breakeven on these subscribers would require Sprint to reduce the fee they are paying by 17%. If Sprint wants to make just a small profit on this contract (5%-10% EBITDA margin), the fee cut would need to be cut ~25% - 35% as shown in the table below.
NTELOS Valuation on Reduced Rate Contract
A reduction in the rate of the current contract with Sprint would have a very negative impact on NTLS's implied share price. If I assume a 25% rate cut and 5.5x normalized EV/EBITDA multiple (near the average multiple of where NTLS has traded since the end of 2012), the downside to the current price is almost 50%.
The chart below shows 's recent trading EV/EBITDA trading range.
Also of note, a reduction in the fee would likely force a significant dividend cut and take away the luster of the yield play in NTLS stock currently.
Of course, if Sprint ultimately decides to walk away entirely and build their own network or roam with Verizon, that's obviously much further downside to the story.
Risks and Mitigants to short thesis
Risk: If it's acquired.
Mitigant: No other wireless carrier is likely to acquire until the Sprint contract is resolved. For the same reason the bulls argue that Sprint has bigger fish to fry, it is highly unlikely they would be willing to spend almost $1 billion in enterprise value (i.e., some premium to the current ~$700 million enterprise value) to acquire whose valuation is largely dependent on the subsidy Sprint is providing.
Risk: If it finds another wireless carrier for a wholesale partnership.
Mitigant: AT&T and Verizon already have a network presence in this region and wouldn't need to partner with NTLS. While T-Mobile is not in this region, their 3G network runs on GSM, an incompatible technology with NTLS's CDMA network. While 4G LTE roaming for data with T-Mobile is a possibility, it wouldn't make a lot of sense (and would likely be very complicated) for T-Mobile to only be able to partially roam on NTLS's network as opposed to have full roaming compatibility with AT&T.
While the Sprint contract has been a great windfall for in recent years, it is highly unlikely to continue under the current terms if at all. The announcement of a reduced contract or Sprint deciding to walk away entirely would have very negative ramifications for share price and dividend.
Disclosure: I am short NTLS, either in my personal account or in accounts managed for others. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.
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