Leap's Problems Create Opportunity for MetroPCS Investors

Includes: T, TMUS
by: Matthew Acker

On Friday, November 11, Leap Wireless International (LEAP) announced that it would have to restate financials for fiscal years 2004, 2005, 2006, and the first two quarters of 2007. Apparently, according to LEAP press releases, LEAP mistakenly booked revenues for some customers that had discontinued service. LEAP has estimated that approximately $20 million in revenue and operating income was overstated. A concern of the overstatement is that LEAP may be in default of senior secured loan covenants, and is reportedly seeking waivers and modifications of loan agreements with its lenders. Adding to LEAP's problems is they are adding fewer than expected new customers in their market areas. LEAP's shares ended the day down over 36%, and off its high of the year by over 54%.

The effect of this bad news for LEAP bled over to fellow fixed rate plans provider MetroPCS Communications (PCS), as PCS fell over 22% on the LEAP news. Interestingly, earlier this year PCS made an offer to buy LEAP, that was ruled "unacceptable" by LEAP's board of directors. PCS withdrew their offer to buy LEAP earlier this month. In consideration of LEAP's problems, it looks as if PCS was very wise in not reacting to LEAP's rejection of the PCS offer by attempting to sweeten the bid, and ultimately pulling the bid off the table.

With PCS's shares taking such a huge hit, and now priced well under its IPO price of $23 in April of this year, it would appear that the LEAP news is creating a significantly undervalued price for PCS (currently at $16.10). Let's take a look at PCS, and where it stands in its drive to be a national leader of fixed price wireless service plans.

PCS faces competition in their fixed price plans business model from the larger national players; however, PCS has the most advanced, least cost network of any of the wireless service providers (MetroPCS is among the first wireless operators to deploy or use an all-digital network based on third-generation infrastructure and handsets). Further, they have good cashflow, a very low debt level for a wireless provider, and they are expanding their markets into key areas that will provide exceptional year over year customer, revenue, and earnings growth (PCS added the LA region to its service area in Q3 '07; it is also adding NY/Boston/Phil regions in late 2008, early 2009).

The new market areas have intense competition, and this will mean higher customer aquistion costs for PCS. And as the larger players offer fixed rate plans in existing PCS markets the effect of this is showing up as higher customer churn rate for PCS. (Up from 5.0% to 5.2% in the latest quarter). However, the net additions of PCS customers is going well, albeit not hitting the high end of estimates; however, these customers, because of PCS's low service costs, add directly to the bottom line for PCS in a very short period of time. Further, with PCS's primary competitor, LEAP is now hamstrung by its restatements and lender issues, which will distract and slow LEAP's efforts to grow and compete, PCS stands to gain customers at a higher rate, and likely stem the tide of growing customer churn.

With the market throwing PCS overboard along with LEAP, it appears that the market may have over-reacted. Moreover, the market has been a little surly of late, as the credit crunch has led to valuations of real-estate backed securities being written off in huge amounts by major financial centers, which is affecting all stocks, even those that are well capitalized and growing nicely, like PCS. It is prudent to tread with care in this punishing market environment, but when PCS has projected annual growth of 35%, is a low cost leader, and the market penetration of their business plan has incredible upside room to support that growth, it would appear that PCS is grossly undervalued at its current price.

Also favorable to PCS is they very well may become a "target" for acquisition as a quick, effective, and accretive means of a larger player to immediately be strong in the fixed price plan service model (the key here would be how well the PCS network can be technologically melded with an acquirer's network). It would be hard to imagine Verizon (NYSE:VZ) and ATT (NYSE:T) not eying PCS with keen interest. Earlier this year there was a mini-binge of large wireless carriers aquiring customers though acquisitions. These deals roughly valued the customers added at $2000 to $4000 per customer. With PCS having approximately 3.8 million customers and rising, the range of the market value of these PCS customers is $7,6 billion to $15,6 billion dollars; which equates to a customer acquisition share price for PCS of $22.00 to $44.00 per share.

Bottom line, to this reporter, the LEAP crash appears to have created a very nice value opportunity for those that see the sum total of PCS's customers, advanced all-digital network, and healthy growth rate. And, since PCS reports its Q3 earnings on Wednesday, November 14, PCS will most certainly be on many investors' and traders' radars screens this coming week; the earnings may provide much needed clarity into PCS that can remove the LEAP overhang, and move PCS back into more favorable light.

Disclosure: Author has a long position in PCS

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