Glentel Post-Mortem Analysis: Good Things Happen To Companies Trading For 7 Times Free Cash Flow

| About: Glentel Inc. (GLNIF)
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On 11/28/14, BCE announced its intent to acquire Glentel for $26.50 per share, a 108% premium.

The proposed deal highlights the value of Glentel's distribution capabilities.

We believe the price fairly values Glentel; however, we think the current deal spread is attractive for merger arbs.

On 11/28/14, Christmas came early for Glentel investors (OTC:GLNIF) ("Glentel", "GLN", or the "Company") as BCE, Inc. (NYSE:BCE) announced its intent to acquire Glentel for C$26.50 per share or a staggering 140% return when compared to its price of C$11 per share when posted earlier this month. Although we did not expect a sale to a strategic buyer to be in cards in the near term, it is not a surprise given Glentel's consistent free cash flow generation and wireless distribution capabilities as Canada's largest wireless retailer.

The proposed transaction represents a take-out multiple of 10.8x LTM EBITDA and 16x LTM FCF per share, a fair value for the asset (in excess of our going-concern valuation of ~$20) considering the levers BCE will be able to pull to increase earnings in addition to gaining control of the largest independent wireless distribution network in Canada. BCE is funding the $654MM transaction with ~$330MM in cash and the remainder in newly-issued BCE equity, implying little risk on the financing front for the acquisition.

We believe Glentel is a prime example of a "sleepy" company for which Mr. Market not only overlooked going-concern catalysts such as an increase in renewals/earnings derived from the Canadian Wireless Code of Conduct changes, but also the Company's private market value to a strategic such as a carrier or a peer such as Carphone Wireless.

Thoughts on BCE, Inc.

BCE, Inc., also known as Bell, is the largest telecom company in Canada with ~7.9MM wireless subscribers, 2.3MM broadband subscribers and 2.4MM video subs. The Canadian wireless market can be described as an oligopoly, divided between the "Big Three" consisting of Rogers (RCI), BCE and Telus (NYSE:TU). The wireless market is attractive in Canada from a growth perspective as the market is only ~80% penetrated, with post-paid subs consisting a material portion (over 85%). Additionally the Canadian market touts high barriers to entry as it is materially more expensive to build out a network in Canada due to density (smaller population spread across a large country) and cost of spectrum. Yet with these favorable characteristics, carriers have started to think long and hard in regards to controlling churn and the importance distribution as the market reaches saturation. For instance, Rogers and Telus started Wow! Mobile late last year while other smaller wireless dealers have been rolled up. BCE has also been very active on the acquisition front recently, acquiring the ~55% of Bell Alliant which it did not own as well as Astral Media. Continuing its acquisitive trend, BCE's acquisition of Glentel makes perfect sense given GLN is the largest mobile retailer in Canada with over 500 points of distribution. Hence as the competition intensifies in Canada (as well as the government hinting at a new entrant), distribution is king and BCE has potentially solidified its positioning going forward. An interesting tidbit is the Company's highly profitable Verizon store base in the USA and Allphones segment. It would not be surprising to see these segments sold off or, in Allphones' instance, used as a diversification tool by BCE to expand into Asia to some degree.

Currently priced at ~$47 per share, BCE appears fairly valued as it trades for 8.3x LTM EBITDA, 18x earnings and at a 4.7% dividend yield. Note that this does not include any incremental EBITDA contribution/synergies from the Glentel acquisition which could be significant. For instance, BCE may be able realize significant back office synergies as well as increased capital and reach to expand upon GLN's Philippines/Asian business. For investors who may be facing short-term gains on Glentel, it may be prudent to accept BCE shares in lieu of cash to possibly defer taxes (I'm not a tax professional, please consult a tax advisor before any decision). Through purchasing a position in Glentel at under $13 per share, one is effectively re-creating BCE at ~4.1x EBITDA.

Key Takeaways

The positive outcome in Glentel is not surprising in hindsight. Over the past year, the sentiment towards Glentel was highly negative as the Company was viewed as an undifferentiated retailer that would likely share the same fate as RadioShack (NYSE:RSH) or Phones4U. The market overlooked two key facts that made GLN a superior investment and business model. (1) Glentel is not your ordinary retailer. Why is that? Simply due to distribution. The carriers heavily rely on Glentel for customers, inclusive of both renewals and new activations. Hence Glentel's business is more akin to a value-add distributor versus a pure-play retailer such as RSH (which has no scale or value to the carriers in the US). (2) The market clearly downplayed the Skidmore brothers' incentives and track record as capital allocators. Recall they sold another wireless retailer system to Rogers in the past. Recently, both Tom Skidmore and a director were aggressively buying shares earlier in the month, a clear bullish indicator that often goes unnoticed.

This created the perfect setup, allowing investors to purchase shares at under 10x depressed free cash flow, while being paid to wait in the form of a generous dividend (we prefer share buybacks, however). Simply said, Glentel is a good company operating in a tough industry, yet it was well-managed, had scale (i.e. was massively important to the carriers) and was offered at an absurdly low price. Although investments do not repeat, they often rhyme. We will be cognizant of these tidbits going forward in our hunt for value.

As a refresher, our original long thesis is as follows:

Strong Financial Profile

  • GLN operates under a modestly negative working capital model in which additional inventory is essentially funded by the carriers.
  • Since 2011, EBITDA to FCF conversion has ranged between 50%-60%.
  • Maintenance CapEx needs are minimal, at less than $10MM per annum.
  • The Company has invested heavily over the past year in its Target Canada and BJ's Wholesale kiosk businesses (ramping up to run rate EBITDA).

Aligned Management Team

  • The Skidmore brothers collectively own over ~30% of shares outstanding.
  • Management has proved themselves to be adept at growing wireless retailers and savvy acquirers, often paying low EBITDA multiples on single-digit margins for businesses with growth potential when run properly.
  • The Skidmore's previously built and sold a Rogers Wireless (NYSE:RCI) independent retailer (Cantel), which makes up much of Roger's current store backbone.

Glentel's Store Network is Valuable for Carriers

  • Glentel accounts for over 10% of Bell and Rogers activations in Canada, supporting the notion of the importance of Glentel's distribution network.
  • Through Diamond Wireless and Wireless Zone, Glentel owns an est. 7% - 8% of the total Verizon (NYSE:VZ) store base (USA only).
  • Glentel added BJ's Wholesale kiosks (NYSE:USA) last year. BJ's 155 kiosks should contribute between $3MM-$4MM, as sales force and employees were in play.
  • GLN owns 2 out of the 6 premium Verizon retailers. Having BJ's on the east coast allows for Glentel to continue to roll-up smaller dealers or Verizon-owned stores.
  • Having a massive store base and preferred relationship with carriers has allowed the Glentel's units to acquire smaller operators at low multiples, in some cases even at discounts to net asset value. Interestingly, Verizon has gifted stores to Glentel, such as 20 stores in 2011. The rationale is that Glentel can run these stores more efficiently, hence increasing activations for the retailer.

Attractively Priced at a Low Multiple of Free Cash Flow

Opportunities to Grow EBITDA

  • In regards to organic growth, Glentel is poised to benefit from any positive performance from its Target Canada footprint (worst case inventory can be shifted to other stores). Recall that this segment is generating minimal if any EBITDA.
  • Glentel continues to execute and grow its retail managed stores. Current concepts include Samsung/Apple stores which have been strong performers, various in-store kiosks (Costco's Canada/BJ's) and a recent win of Vodafone outlets in Australia.
  • Excluding Australia as of the current date, Glentel's management team has created tremendous value through bolt-on acquisitions. Our diligence suggests that opportunities to roll-up Verizon dealers exists and would be highly accretive to cash flow if consummated at historic prices paid.
  • As previously mentioned, the Canadian Wireless Code of Conduct negatively impacted EBITDA, starting mid-2013. The rule changed wireless contracts from 3 years to 2 years, which in turn led to carriers increasing pricing and was met by steep declines in upgrades and new activations. As new pricing is slowly accepted (and people want new phones), 4Q14 and FY15 will be an inflection year as 3-year contracts from FY12 and 2-year contracts from FY13 come up for renewal. Note this trend has already started to appear in 3Q.

Smart Capital Allocation

  • The Company currently pays a 52-cent annual dividend (~$11.5MM per annum) which is a 4.7% yield at current prices (~30% payout of FCF).
  • Glentel has increased its dividend 300% since 2007.
  • GLN instituted a share repurchase program on 1/29/13 with authorization to buy 500k shares or 2.5% of total shares outstanding. The Company has repurchased 59,175 shares spending $1.0MM). Trading at such a low multiple, we believe share repurchases would be highly accretive to shareholder value.

In conclusion, we are supportive of the proposed transaction and believe it is a great outcome for Glentel shareholders. Furthermore, for BCE we believe it Glentel is an attractive asset due to its distribution and hidden earnings potential. We wouldn't be surprised if down the road if BCE doubles EBITDA at Glentel. Additionally, we think the current ~3% deal spread and dividend payment is also attractive for merger arbs due to the solid financing in place in addition to what we perceive as low deal risk on the regulatory front.

Disclosure: The author is long GLNIF.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Please consult your financial, legal, and/or tax advisors before making any investment decisions. While the Author has tried to present facts it believes are accurate, the Author makes no representation as to the accuracy or completeness of any information contained in this note. The reader agrees not to invest based on this note, and to perform his or her own due diligence and research before taking a long or short position in GLN/GLNIF. Reader agrees to hold author harmless and hereby waives any causes of action against author related to the note above.

Additional disclosure: Also Long TSX:GLN

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