Monday, January 05, 2009

Recommendation to buy USM bonds- UZV, UZG, GJH

USM analyis-
Recommendation to buy USM bonds- UZV, UZG, GJH
I previously recommended buying UZV preferred (see earlier post for cursory credit analysis). As a refresher, UZV is a preferred-stock whose underlying asset is 30-year senior unsecured notes of US Cellular (USM 7.5% notes). Based on current price of $15 (60% of par), the yield on this senior note is approximately 12.5%, whereas peer-company bond yields for Verizon, Telefonica, Vodafone, DT (Tmobile), and AT&T average nearly 6.5% (+350bps over 30yr treasury rate of 3%).

US Cellular is a good credit risk, with minimal leverage relative to the underlying value of the business. For example, Verizon recently purchased Alltel (in cash) for $28Bln, which equates to a valuation multiple of $2,500 for each of Alltel's 11Mln subscribers. Although Verizon dramatically overpaid for Alltel, let's assume that US Cellular is worth at least half of this multiple ($1,250/subscriber). Based upon 6.3Mln subscribers x $1,250/subscriber=$7.9Bln implied enterprise value. Since US Cellular has only $1bln in debt and a core business intrinsically worth at least $7.9Bln, its debt is well-protected and safe (by a factor of 7.9x). In addition, the company also owns a 5.5% interest in a major Verizon wireless asset (SMSA LP) that generates an additional $80Mln income per year. I assume this is worth an additional $800 Mln ($80Mln/10% discount rate).

In total, US Cellular's enterprise value is worth $8.7Bln ($7.9Bln for core business + $800Mln for partnerships owned). After subtracting out net debt of $820Mln ($1Bln gross debt- $180Mln cash), the remaining intrinsic value of the equity is $7.9Bln. This equates to $90/share in intrinsic value per share ($7.9Bln/87Mln shares outstanding). Currently, USM stock is at $45/share, which implies a 50% discount to the intrinsic value of the company.

Recommendation- USM bonds appear to have at least 50% upside and are generating significant current income, regardless of whether management maximizes the value of the company. As such, I recommend buying UZV. Full disclosure- I have owned UZV since $11.50 and have been a buyer as high as $14.50. I would only buy the stock if it fell into the $30s (200% upside), as the bonds (traded on NYSE under UZV, UZG, GJH are more attractive and safer at current levels)

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