Tessco: Avoid Due To AT&T Risk

Jan.19.12 | About: TESSCO Technologies (TESS)

Tessco (NASDAQ:TESS) is a small cap U.S. company focused on efficiently providing equipment to wireless operators, often serving as an intermediary to ensure efficient reliable inventory management and service. The equipment Tessco provides spans from the network components costing tens of thousands of dollars to much cheaper in-car phone chargers, but the core of the business is strong relationships with U.S. suppliers to help manage their supply chain.

Tessco is attractively valued, management hold a significant stake, have a buyback plan in place and revenues for the first 9 months are up 13% on last year, with EPS up over 40%.

Cheap on valuation

Tessco is cheap across most value metrics.

Metric Value Comments
Price to book 1.5x $86M of book equity from Sept '11
Price to earnings 10.0x $12.71M net income TTM
Price to cashflow 7.6x $16.7M CFO-capex TTM
Dividend yield 3.47% $0.15 per quarter (~30% payout rate)
Click to enlarge
Market cap 1/18/11=$127.7M, data from Google Finace/SEC filings

Potential Loss of AT&T Relationship could cost a $0.92 in earnings

"Approximately 47% of all of our mobile devices and accessory products sales for fiscal year 2011 were generated from the sales of accessory products to AT&T Mobility" ... and from Tessco's Q3 2011 report ..." As we have previously disclosed, our major tier one carrier customer has indicated that, over time, it expects to continue to explore business model changes in an ongoing effort to lower total costs. Notwithstanding the recent expansion of the relationship with this customer, it should be noted that this relationship, like those with most of our other customers and suppliers, contains no ongoing purchase or sale obligations and is terminable by either party upon relatively short notice. Further, any future business model changes by our largest customer put our supply chain business with this customer at risk. Absent this supply chain relationship, we could, however, maintain the ability to sell our proprietary products to this customer."

For fiscal 2011, sales to AT&T translate into $146M of revenue, or 25% of total revenues.

However, this business is lower gross margin, making the impact slightly less. Assuming AT&T is similar margin to the rest of the segment, the gross margin impact is $27M or 20% of total gross margin, if we assume that 10% of SG&A could be removed if the AT&T business declines that would save $12M. Net the EBIT hit would be roughly $15M.

If AT&T does ultimately reduce its business with Tessco and that leads to a 75% decline in business between AT&T Mobility and Tessco, then that is a probability weighted $7.3M post-tax or $0.92 of EPS.

Given that earnings are forecast to be approximately $2/share this year that would be a 50% earnings decline.

So in this theoretical world, what would the numbers look like?

If the AT&T Business Were To Decline ...

Metric Value Comments
Price to book 1.5x $86M of book equity from Sept '11
Price to earnings 23.6x $5.4M net income TTM est.
Price to cashflow 13.6x $9.4M CFO-capex TTM est.
Dividend yield 3.47% $0.15 per quarter (~80% payout rate est.)
Click to enlarge
Market cap 1/18/11=$127.7M

Note: these are projections based on scenario analysis, not current numbers


There are a lot of things to like about Tessco and the current valuation is attractive, but the AT&T decline, if it happens, could significantly hurt the stock.

Of course, the best thing about the AT&T decline is that it hasn't happened, and if it does not yet the stock should rally given growth and valuation support, but with so many other stocks out there, I would avoid this potential risk which the current attractive valuation is not enough to offset.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.