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We will update our prior analysis on Telephone and Data Systems (NYSE:TDS) ahead of its Q2 2024 earnings, which are released pre-market on Friday, August 2nd.
In our previous analysis, we rated TDS a Hold because the stock price and market cap are likely below the value shareholders would receive from the sale of U.S. Cellular’s assets. The coverage and potential upside offset the downside risk arising from TDS’s uncertain path to profitability as a standalone company.
Since then, TDS has gained 32%, while the S&P 500 has gained 7%.
I don’t expect any major surprises in Q2 earnings as management moves forward with the sale of US Cellular and stabilizes the rest of the business. The big question for me is what will happen to the business if the deal goes through. Evaluating both scenarios results in a significant range, from $17.30 on the low end to $37+ on the high end.
I lean toward the higher end of this range, considering the possibility that the deal will go through in some form (with concessions) versus being blocked outright. T-Mobile knows how to play this game, having previously dealt with Sprint, a more difficult merger from a competitive standpoint. With both upside potential and downside risk in mind, I am raising my rating to Buy from Hold, with a price target of $25-35, assuming the deal goes through with concessions.
Second Quarter Results Preview
TDS is expected to report EPS of -$0.13 and revenue of $1.24 billion, both of which would represent declines sequentially and year-over-year.
If the consensus is correct, TDS will still be on pace to hit the lower end of management guidance, even taking into account strong first quarter results.
Management has underperformed EPS more often than overperformed, but the first quarter was an exception, and I don’t expect any big surprises, especially as the company navigates the sale of US Cellular and looks to keep operations on track.
When earnings are released, I will be looking primarily at management’s commentary on the progress of the U.S. Cellular deal, as well as signs of improvement or underperformance in the core business, which is key to the downside scenarios I discuss below.
T-Mobile and US Cellular deal not guaranteed
On May 28, T-Mobile announced it would acquire 30% of U.S. Cellular’s wireless operations and spectrum for $4.4 billion. The deal is expected to close in mid-2025, pending regulatory approvals.
Regulatory approval was not guaranteed, but it became more likely on July 23 when a group of six senators led by Elizabeth Warren (D-MA) called on regulators to carefully scrutinize the deal. Their specific concerns included:
Further market consolidation could have far-reaching effects, reducing consumer choice and resulting in greater concentration of radio spectrum ownership, leading to higher prices and other harms for consumers across the country.
M&A deals have struggled recently, with examples such as Spirit and JetBlue and Simon & Schuster and Penguin Random House among the most notable. In fact, more M&A lawsuits have been filed in 2022 and 2023 than ever before.
While considering the possibility of a merger challenge, it is also important to consider a few points. First, T-Mobile is familiar with the merger process. A merger challenge does not mean that the merger will be blocked outright. It just means that the carriers may make concessions similar to those that T-Mobile made when it acquired Sprint.
U.S. Cellular would also benefit from having less overlap with the big three and a network that is primarily in rural areas. Rural access is a priority for the federal government, which must balance competitive concerns.
Profit from US Cellular sales
Even with the concessions, the potential gains for TDS shareholders are significant if the deal goes through.
U.S. Cellular’s current market cap is $4.49 billion. Raymond James estimates that after the sale, U.S. Cellular will be worth:
That amount, minus about $1.5 billion in debt, gives the company a value of $3.1 billion on top of about $2.4 billion in cash (potential for a 40-50% appreciation).
TDS owns 83% of US Cellular, valuing it at about $4.5 billion, an increase of more than 80% from its current market cap of $2.4 billion. If it were to sell, the target price would be more than $37.
Wall Street has a target price of $34, which is well within that range.
Quantitative ratings also reflect upside scenarios based on valuation multiples and momentum.
If concessions affect the overall sale price or the basis value of the remaining assets, the target price may be reduced.
Disadvantages if a transaction is blocked
In the scenario where the sale was completely blocked, we modeled the value using a DCF analysis. We made the following assumptions:
Lower bound of management guidance for 2024 based on historical performance. Costs grow with inflation and revenues grow with the industry. WACC-based discount rate for TDS is 8.3%.
This analysis gives us a target price of $17.30, which implies an 18% downside from current prices.
The target price could be raised by stronger performance in the core fiber business and more aggressive cost management, especially in corporate overhead.
verdict
All things considered, the most likely scenario for this deal is that the merger goes through with concessions. T-Mobile has experience navigating M&A challenges, and the Sprint deal was much more anti-competitive than US Cellular, which has a large rural footprint. A deal with acceptable concessions would push this price to $25-35 per share, or even higher. The downside risk is that the deal is blocked outright, lowering the target price to $17.30. Again, I think this risk is mitigated by the scope of the deal and T-Mobile’s experience. And in the best case scenario, the stock would rise 80-90%.
With the above in mind, my rating is being upgraded from “Hold” to “Buy.”
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