Six Reasons to Buy MetroPCS

The massive drop in stock prices due to concerns about the consumer spending environment and the broader economy has created some interesting long opportunities among companies that should be well-insulated from economic woes.

Dallas-based MetroPCS (PCS) is one of these. The company is a provider of unlimited wireless communications service for a flat-rate with no signed contract. MetroPCS owns or has access to licenses covering a population of approximately 149 million people in 14 of the top 25 largest metropolitan areas in the United States, including New York, Philadelphia, Boston, Miami, Orlando, Sarasota, Tampa, Atlanta, Dallas, Detroit, Las Vegas, Los Angeles, San Francisco and Sacramento. As of Q2 2008, the company had 4.6 million subscribers, up from 3.6 million in Q2 2007.

Reasons to invest

1. Customer base is somewhat insulated from economy

Wireless communication has quickly become a basic need, right next to food, water, shelter and housing. There are a lot of things people will give up before ditching their main connection to the rest of the world. Importantly, on MetroPCS’s Q2 2008 earnings call, management stated that approximately 60% of subscribers do not own landlines, making it highly unlikely they will churn.

Also, in tough economic times, people may choose to “trade down” from Verizon (VZ) or AT&T (T) to a cheaper, commitment-free MetroPCS plan.

Thus, PCS’s addressable market may actually increase as the economy contracts, and, at the very least, should be secure. Even though its customers are typically lower income with poor credit, the low price point, flexible service plan and lack of credit risk make the MetroPCS offering quite attractive. Furthermore, the new family plan offering will diversify the customer base to “safer” demographics which should have a positive effect on customer lifetime value and churn.

2. Compelling service offering in difficult times highlights attractive unit economics

MetroPCS plans run from $30-$50 per month, dramatically lower than the national carriers. It is able to do this for a few reasons:

1. Lower-end phones and low subsidies decrease subscriber acquisition costs
2. Regional footprint decreases network costs and allows for targeted advertising
3. Less spectrum requirements
4. Prepaid plan limits credit exposure

Despite the relatively low ARPU, MetroPCS’s customer economics are extremely compelling. At its current churn levels, a typical customer is worth between $800 and $1,000 while costing approximately $135 to acquire.

3. Launches of NY, Philadelphia, Las Vegas and Boston will drive growth

PCS’s growth strategy is simple – buy licenses in large metropolitan markets, build network infrastructure, market the product and acquire customers cheaply. It has successfully executed this in over a dozen markets, achieving penetration rates in excess of 12%.

The company entered Las Vegas in Q108 and Philadelphia in Q208 – both significantly ahead of schedule – and plans to enter the New York and Boston markets within the next 9 months. These new markets will almost double the potential customer base, and should provide a tremendous avenue for continued revenue growth.

Moreover, as these markets mature, the strong cash flow dynamics of mature markets will begin to shine through. Maintenance capital expenditure requirements are relatively low, and customer acquisition costs decrease with lower churn.

4. ‘Houdini’ is undervalued

MetroPCS launched MetroFlash – a product that allows owners of CDMA phones (read: Verizon and Sprint (S) customers) to have their phones reprogrammed for compatibility with the MetroPCS network. This is based on Houdini software licensed from the founder of quasi-competitor Pocket Communications.

Wall Street has ascribed no gross subscriber addition uplift to this announcement, which is a mistake. Combined with the reasons outlined above, this product has the potential to allow PCS to substantially exceed estimates.

5. Analyst estimates are conservative

After a slight miss on gross subscriber ads in Q2, the stock fell substantially on concerns that PCS’s customer base would be disproportionately affected by an economic slowdown. Analyst estimates were revised downwards. I believe this is incorrect. In addition to the reasons listed above, the launch of new markets (Las Vegas, Los Angeles, etc.) typically coincides with high gross adds and high churn.

Instead, Q2 showed low churn and lower-than-expected gross adds. This was likely due to the Tax Relief Check hitting consumer wallets in Q1, which artificially increased Q1 performance and created difficult Q2 comps.

Now, with estimates revised downwards, PCS looks poised to beat projections on both gross adds and churn. Clearly, this will be mitigated to a certain extent by the macroeconomic challenges facing the company, but I believe this risk is already priced in.

6. Downside is limited by asset value

MetroPCS holds significant PCS and AWS spectrum assets and network assets.

PCS auctions over the past 10 years have yielded average prices of about $1.25 per MHz-POP for large metropolitan environments (1-2 million) and $2.75 per MHz-POP for urban environments (2+ million). This implies a value of $2.5 billion for MetroPCS’s PCS spectrum.

AWS auctions over the past 10 years have yielded average prices of about $0.33 per MHz-POP for large metropolitan environments (1-2 million) and $0.65 per MHz-POP for urban environments (2+ million). The January 2008 AWS auction is a good benchmark. This implies a value of about $660 million for MetroPCS’s AWS spectrum.

By my calculations, MetroPCS’s spectrum assets are worth north of $3 billion (however, MetroPCS carries them at $2.4 billion on its balance sheet). Add this to $1.1 billion in cash, $2.3 billion in network equipment and other PP&E, and $300 million in other short- and long-term assets, and MetroPCS is trading close to book value.

Risk factors

1. iPhone could change the game

It is hard to ignore the recent success of converged mobile devices, most prominently the iPhone. If consumer demand shifts significantly towards these, MetroPCS will be in trouble. The company does not offer feature-rich smart phones, and its network is not optimized for them (though its current customers have very high MOUs).

2. Significant debt burden

MetroPCS is financed with $3 billion in debt, and requires a substantial amount of leverage to continue growth. This primarily consists of $1.4 billion in 9.25% Senior Notes due in 2014, a $1.6 billion Senior Secured Credit Facility at an annual rate of 7.17% through 2011. The interest burden from these was $109 million in the first half of 2008.

With $1.1 billion in cash, liquidity is not a concern, yet access to capital could impact ability to sustain growth. This concern will be accelerated if the company decides to purchase significant new spectrum.

3. New network builds consume all free cash flow

PCS is in an aggressive expansion phase. Until the major builds in New York and Boston are completed, expansion capex will consume most of the company’s free cash flow. Additional purchases of spectrum will also consume cash.

In the first six months of 2008, PCS generated $331 million of operating cash flow, and spent $389 million on PP&E.

Still, maintenance capex is relatively low after the initial 18 month network build, leading to attractive long term cash flow characteristics.

4. Competition

MetroPCS competes with major national carriers such as Verizon, AT&T, Sprint and T-Mobile, and regional carriers such as Leap Wireless (Cricket) and Pocket Communications.

However, MetroPCS’s service offerings are sufficiently differentiated from national carriers by price point, service offering, billing method and contractual commitment that it faces little direct competition in its low-end segment. Regional carriers often do not attempt to compete directly due to significant first-mover advantages and far higher ROI’s in non-competitive markets.

5. Core market growth may be slowing

Almost all of recent subscriber adds have come from MetroPCS’s expansion markets, suggesting that additional penetration into core markets may be limited. Out-year estimates from the Street do not suggest significant expansion in these markets, but would still cause downside pressure on long-term projections. However, growth in expansion markets has been ahead of expectations. This suggests the attractiveness of the PCS offering in a difficult market, which will provide support if issues within the core markets persist.

Valuation

Simply put, MetroPCS is cheap.

At Friday’s closing price of $13.90, the company trades at 8.6x and 6.5x consensus 2008 and 2009 EBITDA, respectively, while growing EBITDA by over 30% (if you believe Street estimates). Leap Wireless, the best public comparable, trades at 10.4x and 8.0x, respectively, while growing EBITDA at a slightly slower pace (LEAP also has worse unit economics). Verizon and AT&T trade at an average of 5.4x and 5.0x respectively, while growing EBITDA at an average of 7.7% (and dealing with difficulties in wireline and triple-play).

A conservative discounted cash flow analysis using a 15% discount rate yields values of $20.29 to $24.96, implying upside of 46% to 79.6%.

Disclosure: I am long MetroPCS.

Comments

[TexasMeat:]

I agree with most of your points, especially the undervaluation of "MetroFlash". With discount, secondary handset markets (eBay) there will be solid demand for this tool.

IMO the company is less insulated from the economy than the article states. There is a reason that the company's beta is significantly higher than Verizon, Sprint, or other wireless companies. If the economy worsens, those without contracts are more likely to drop service than those with contracts. As for an AT&T customer breaking their contract to move to MetroPCS? Prolly won't happen. The switching cost is too high. They will have to pay to break the contract, pay to purchase a new handset, pay a new activation fee, and give up some of their coverage area. All just to save a few bucks a month by switching carriers. It won't happen. They will just move to a cheaper service plan. As for the lower-income MetroPCS customer, they can cancel their contract easily and are more likely to go without a phone during hardship.

Just my $.02

2008 Sep 29 11:21 AM

[ItFollowsMe:]

Me, being a "lower-income MetroPCS customer" you speak of, I have to correct you that going without a phone during hardships is no different than a middle-class customer or upper-class customer. We obtained our phone immediately after our home was flooded and we lost everything so we could stay in touch with family. The appeal to no contract and QUICK activation with cash in hand was what brought us to MetroPCS. Considering I was an AT&T wireless customer for years prior to the flood that took my home and vehicles, I have to say that the cost, the plan, the contract and the phone I was sent in all cost me about 3 years worth of MetroPCS services and I will never return. Had it not been for the option to go with MetroPCS, communication during that horrible event would have been devastating to say the least. Unless you have been in a "low-income" position and been without a phone, please don't assume what they are more capable of going without. Regardless of your financial position, a hardship hurts all the same and requires networking to get through it.

2008 Sep 29 05:06 PM

[NOgasATL:]

MPCS has the right product at the right time. With it's latest move to roam 'nationwide' with it's competitor Leap/Cricket it is poised to have a big 3rd & 4th Qtr 08. Launching those huge expansion markets as you said will be huge in 1st qtr 09. The current financial situation, job loss danger, 'cubicle' people like me see this as a way to 'braise' yourself to have mobile communications 'for cheap' in an unfriendly economy. I am long MetroPCS (PCS) also. note: I wish they sold some gas in ATL!!

2008 Sep 30 11:17 AM

[Urbane Gori...:]

I don't see the Iphone as an issue... I looked at MetroPC for my daughter in Santa Cruz as it is considerably cheaper than Verizon and has a better package.. She could get Internet, and Text for $65 a month as opposed to the $100+ we pay now without the internet.... People using MPCS are looking for features and cheap ... Now, the downside is the poor coverage and complaints about MetroPCS selling used phones as new.

jegan

2008 Sep 30 02:30 PM

[Anonymous01:]

MetroPCS is gonna come out on top, especially if people's finances continue to worsen. I had MetroPCS in Miami, but had to drop it with an unexpected move to NYC. I can't describe how much I miss the serivce. All the major carriers nickle-and-dime endlessly all while skimping on features. And their customer service is wretched, to boot. Wanna know how MetroPCS customer service stacks up? I couldn't tell you, because for all the time I was with MetroPCS, I had to call them a grand total of ONE TIME, and that was to ask THEM if I could please pay another $5 for an unlimited feature the national firms would've charged $1.25 per usage for. When you get to talk and text all you want, what do you need the customer service reps for?

MetroPCS is gonna do very well over the next couple years, especially here amongst deal-loving New Yorkers. So well, I hope, that they knock the arrogant, nickle-and-diming, over-priced, useless, headache-inducing national carriers out of the market.

2008 Sep 30 05:40 PM

[Zoltan:]

Switching cost? Okay a 200.00 cancellation fee that I recoup in 5 months - At 70.00 a month avg with AT&T I spend 350... with MetroPCS I get unlimited for $35 if I add my bells and whistles - $175 in 5 months and I pay AT&T the 200 on my terms... no contract and equal coverage - I think many will figure out that a free phone is not free when you are actually financing a phone. MetroPCS is the way.

2008 Oct 01 09:33 AM

[topdocdog:]

In my home town we didn't have a METROPCS Store but we did have good signal, so I drove 80 miles to buy a phone. The first thing I noticed was that their customer service was almost non existent. Most of the employees could not speak English. I hand one 611 call answered in Spanish. I happen to speak Spanish so I asked her why she was answering the phone in Spanish, she told me it was a Mexican company?! I told her that as long as she was doing business in the US she should attempt to answer in English, she promptly hung up on me.

I helped a friend open a Pak and Mail store in a local shopping center and we had ample room to have a METROPCS storefront. We called the Corporate number in San Francisco a total number of 28 times with absolutely no response over a period of 30 days. Now 9 months later a new METROPCS Store opened in my town. I went in to see who was running it, guess what, all Hispanic. I have dropped my METROPCS in favor of ATT, at least they have customer service, and don't discriminate against gringos.

2008 Oct 15 07:24 AM

[chrisinboca:]

On Sep 29 11:21 AM TexasMeat wrote:

> I agree with most of your points, especially the undervaluation of
> "MetroFlash". With discount, secondary handset markets (eBay) there
> will be solid demand for this tool.
>
> IMO the company is less insulated from the economy than the article
> states. There is a reason that the company's beta is significantly
> higher than Verizon, Sprint, or other wireless companies. If the
> economy worsens, those without contracts are more likely to drop
> service than those with contracts. As for an AT&T customer breaking
> their contract to move to MetroPCS? Prolly won't happen. The switching
> cost is too high. They will have to pay to break the contract, pay
> to purchase a new handset, pay a new activation fee, and give up
> some of their coverage area. All just to save a few bucks a month
> by switching carriers. It won't happen. They will just move to a
> cheaper service plan. As for the lower-income MetroPCS customer,
> they can cancel their contract easily and are more likely to go without
> a phone during hardship.
>
> Just my $.02
I think this is where you are making a serious miscalculation. with the downturn in the economy, people are going to HAVE to give up the standard contract cell services, because they are based per minute, and are obligated. I know from my own personal experience when I had sprint, the fair and flexible plan, I was paying for 600 minutes per month on two phones. It was costing me about two hundred dollars after all the hidden charges. I now have two nice phones, not the be all and end all, but a razr, and a keyboarded samsung, and I pay a little over a hundred dollars a month with unlimited text, internet, and talk, long distance included. people are going to start looking for value for their dollar, and if you are trying to conduct a job search, possibly with interviews over the phone, the last thing you need to be concerned about is how much money the interview just cost you. Short calls may be a problem. in essence, I couldn't afford to pay my stacked up sprint bill, and had to let go of my service. I didn't have to pay to break my contract, and it's not on my credit. of course, I was a customer for 9 years, but... they got too expensive

Mar 29 08:22 PM

[User 436832:]

I have tried Metro Piece of Crap Service (metropcs) and it is mostly mexicans in all stores here in dallas fort worth, the service is non-existent, very hard to get someone on the phone using 611. If you do get someone on the phone it is hard to understand or they are are extremely rude. I had them for last 2 years, In that time they have lost payments, cut off my phone prematurely half way through the billing cycle. One month they told me I had 61.07 in collections and I told them how is this possible your a prepaid service I have paid the month in advance, And received my month of service. It was ridiculous. Ended up being another huge error on their part. Metropcs is an absolute joke, I have now gone back to AT&T prepaid for now, and looking at the many other more reputable companies offering unlimited plans. Sure they have an attractive price but most people that have tried them for a while have changed back to a big carrier. In terms of investing look how many customers they lose a month, once every one tries them out they will fail in the long run.

Jun 25 07:48 PM