Telephone And Data Systems Q1 Earnings Preview (NYSE:TDS)

I am updating my previous analysis on Telephone and Data Systems (NYSE:TDS) in advance of Q1 2024 earnings, which will be released pre-market on Friday, May 3rd.

In my last analysis, I rated TDS a sell for the following reasons:

• Capital investments were not paying off
• Profitability continued to decline, and higher-margin businesses were struggling
• The potential sale price did not support the market cap

Since then, TDS is down more than 14% while the S&P 500 has returned over 12%.

I am expecting a disappointing earnings call based on weak consensus and challenging trends coming out of Q4 2023. If consensus is correct, TDS is trending towards the very low end of guidance. We have yet to see any sign of profitability for TDS as a standalone entity, as the growing fiber business can’t overcome declines in enterprise and stagnant core businesses.

Despite the profitability challenges, market cap is now more favorable in the event of a sale of US Cellular’s (USM) assets, with investors more than likely covered and even some upside potential. With that in mind, I raise my rating from sell to hold.

Q1 Earnings Preview

Telephone and Data Systems is expected to announce EPS of -$0.12 and revenue of $1.26 billion. At consensus, revenue is slightly down sequentially, and EPS is slightly up, excluding the non-cash impairment.

If consensus is correct, then the business is pacing at the lower end of guidance with revenue in the prior year quarter of $1.03 billion, US Cellular predicting a small decline offset by growth at TDS.

TDS has been split on over/underdelivering EPS and guidance, so it could break either way.

My primary focus during earnings will be an update on the “strategic alternatives” for US Cellular or any glimmers of profitability improvement at TDS.

Path To Profitability Still Unclear

Telephone and Data Systems is not well positioned to survive as a standalone entity, and I don’t see any reason the story will improve this quarter.

As of Q4 2023, TDS Telecom generated net income of $38 million excluding the non-cash impairment of Goodwill and the associated tax benefit. Corporate, eliminations, and other lost $62 million. Now, some SG&A and interest expense would go away in a sale, but even reducing by half would barely make the new entity profitable.

That would be fine if TDS’s strategies for growth were working, but expenses outpaced revenue across 2023 and capital expenses grew on top of that.

The challenge continues to be that fiber is a small part of the overall portfolio on top of a stagnant wholesale business, a declining commercial business, and cannibalization on the copper business.

Keep in mind that fiber is not operating in a vacuum. TDS is competing against wireless 5G home internet in many of its markets, and their competitors have a lower hurdle to overcome from investment.

Market Cap Now Within Range Of Sale Price

Given the questionable profitability and negative cash flows from TDS as a standalone entity, DCF analysis is not a valuable tool. Instead, I will look at the potential sale price of US Cellular to set a floor on TDS’s valuation.

Raymond James completed a detailed analysis on the value of US Cellular’s assets. They valued the towers at $2.9 billion, spectrum at $2.5 billion, and mobile subscribers at $2.6 billion. Removing $3 billion of long-term debt, $834 million of capital leases, and a 10% contingency for unknowns like spectrum expiration, it comes to a potential sale price of $3.4 billion. TDS owns 83% of US Cellular, which puts the value of their stake at $2.8 billion. With market cap today down from $2.17 in my previous analysis to $1.8 billion today, there is potential upside to current shareholders.

When we check the valuation differently with EBITDA multiples, we see 8-10x EBITDA multiples for diversified telecom companies tower and spectrum assets that have recently gone through an M&A process. Using the lower-end of the range for a margin of safety, this generates an EBITDA multiple of $6.5 billion less $3.0 billion of debt for a valuation of $3.5 billion. TDS’s share would then be $2.9 billion, within range of the Raymond James analysis.

So while there is still significant risk in the business and how management proceeds post sale, the current market cap and share price are solidly in line with the potential value coming out of the US Cellular deal and investors are likely to be covered with the potential for additional upside.

Verdict

Based on performance entering 2024 and the earnings consensus, I am expecting another disappointing earnings release on May 3rd. However, with the recent decline in share price, investors are more than likely to be covered with the potential for upside coming out of the deal.

There continues to be risk in holding TDS. However, this is now balanced against upside potential from the sale. With that in mind, I raise my rating from sell to hold and will be closely monitoring the earnings call for news that could impact valuation.