Is it Time to Bottom Fish Metro PCS?

While trolling through a list of stocks that came public in 2007, I came across Metro PCS (PCS) and was impressed enough with the chart pattern to decide to dig a little deeper and see how the story has unfolded since I last analyzed the company. The stock made an impressive run immediately after pricing the IPO at $23.00. Within a few short months, the stock had hit a high above $40. Investors were excited about growth prospects as the company began to expand the number of cities it offered service in. The expectation was that the company would be able to ramp its number of subscribers quickly and consistently as each city came online effectively competing against large carriers such as Sprint (S), Verizon (VZ) or AT&T (T)

The business model employed by PCS is different than the typical minute based plans offered by competition. Essentially, customers at PCS pay a monthly fee for unlimited use of the phone with no regard to minutes used. The firm does employ different tiered packages but those are based on whether a user wants to be able to use the phone outside the metro area of his plan or whether the user needs additional value added services such as texting or data. Management has pointed out that they do not attempt to fill the needs of every demographic but instead to fill a niche of customers who are looking for a stable monthly expense without the hassle of monitoring minutes used. An interesting statistic is that 85% of the firms customers use their service as the primary phone line, bypassing the traditional land line model.

The stock has experienced a very rough 2 quarters falling from its high in June above $40 to its current price near $16. The decline is largely due to concern over how a slowing (or possibly contracting) economy will affect the company. Since most of PCS’ customers fit into the lower end of the earnings spectrum, it is logical to assume that PCS may have a more difficult time landing new customers if employment levels decline. Management combats this assumption by stating that in depressed economic times, they expect to win market share as their plans are more affordable and offer stability compared to their competition. Also, phone service is one of the last items that a consumer would be willing to cut if budget issues become tight. This may be true, but it is difficult to see how such an environment will benefit PCS instead of just hurting it less than the larger carriers.

Looking forward, management has laid out plans to add 1.25 -1.52 million net subscribers in 2008. This is an attractive growth rate but the numbers were somewhat dampened when management also stated that they believed an economic slowdown could result in 23-30% reductions in net additions during the fourth quarter of 2007. While the fourth quarter (and the first quarter as well) are strong seasonal periods for additional customers, any difficulty during these periods may continue to pressure the stock once the numbers are reported. Also it appears a bit naive to think that the economic slowdown will only impact fourth quarter numbers as the lingering effects of a housing downturn and lower credit availability should dampen consumer spending (especially on the low end of the income scale)

Despite its incredible drop, the stock is now trading at nearly 30 times this year’s earnings. Coincidentally, this years consensus numbers are equivalent to the 2007 consensus numbers (the company is scheduled to report the fourth quarter on Feb 27). Multiples in this level are reserved for growth companies and while PCS has shown growth in the past, it is definitely bumping up against some challenges that could lead earnings to be flat for some time. $16.00 per share appears to be a steep price to pay at this time considering the risks and challenges present.