U.S. Cellular faces price competition, other challenges

By Wenjing Yang

United States Cellular Corp. is expected to maintain modest growth by focusing on less competitive rural markets amid Wall Street’s downbeat forecast on subscriber growth, while facing price pressure and scale disadvantage in competing with national carriers in 2017.

Analysts anticipate the Chicago-based wireless service provider will post revenue of $4.02 billion in 2017, slightly higher than their 2016 estimate. Net income is estimated to be $72.9 million, or 92 cents per diluted share, compared with the estimated $39.3 million, or 34 cents per diluted share, in 2016.

Despite a better estimate for the coming year, analysts foresee competitive pressures bearing on U.S. Cellular, the fifth largest wireless service provider in the United States.

U.S. Cellular has lagged its rivals in network technology and phone availability. The company, with a market capitalization of $3.83 billion, is much smaller in scale compared to AT&T Inc. and Verizon Inc., strong competitors in its territories, which enjoy a market capitalization of $255.43 billion and $202.47 billion, respectively.

Analysts believe the scale disadvantage will make it less competitive in the capital-intensive telecom industry, as national carriers are heavily investing in technology, advertising and promotions.

“We believe U.S. Cellular is simply less able to endure the ups and downs in the promotional environment than national carriers,” wrote Alex Zhao, analyst at Morningstar Inc., in a research note, questioning the long-term viability of the company.

The price/earnings ratio of U.S. Cellular stock is much higher than its competitors' in the 12-month period ended Feb. 23. (Wenjing Yang/MEDILL Source: The Wall Street Journal)
The price/earnings ratio of U.S. Cellular stock is much higher than its competitors’ in the 12-month period ended Feb. 23. (Wenjing Yang/MEDILL Source: The Wall Street Journal)

Out of eight analysts covering U.S. Cellular, four rate the stock a buy, three call it a hold, one says sell.

Analysts’ average 12-month target price on U.S. Cellular’s shares complied by Bloomberg is $44, which is actually 1.9 percent lower than their latest close. The stock hit a 52-week high at $45.87 and a low at $33.97. Shares gained 12.5 percent in the past 52 weeks.

Morgan Stanley analyst Simon Flannery upgraded the stock on Dec. 12 to equal weight and hiked his target price by 25 percent to $44 from $35, driving the shares up 4.6 percent, their biggest jump since Aug. 5.

Flannery wrote in his notes that the company could benefit from “strategic optionality” in the wireless sector, noting that the valuation of wireless companies is expected to rise following the Federal Communications Commission’s spectrum auction in March.

“The wireless industry is very competitive. Other carriers are cutting prices and offering promotions,” said Barry Sine, analyst at Drexel Hamilton LLC, in a phone interview.

Sine said U.S. Cellular typically prices its services about 10 percent cheaper than AT&T and Verizon and sometimes it cannot make any money in order to keep itself competitive. As a regional carrier, the key to maintain growth is to continue focusing on less competitive rural markets, he added.

U.S. Cellular came into business in smaller towns and rural areas that big carriers often overlooked early on as they sought to cover major markets nationwide. Subsequently U.S. Cellular expanded geographic coverage so that, according to Morningstar, U.S. Cellular now competes with other companies across 90 percent of the 40 largest markets it serves.

The company is eyeing offering fixed wireless broadband for rural customers and planning to conduct testing in the first half of 2017, U.S. Cellular CEO Kenneth Meyers announced at an investor conference Jan. 4.

U.S. Cellular upgraded its prepaid offerings with more plans and more high-speed data early this year. Its $45 Simple Connect Prepaid plan now comes with 3GB of high-speed data, the $60 plan now comes with 6GB of high-speed data, and there is a new 12GB high-speed data plan for $75. Its Ready Connect Prepaid plan, a limited-time promotional offering, has also added value. Service is available with no contract, credit check, overage charges or activation fees.

Analysts estimate earnings per share of 34 cents in 2016. The full-year earnings per share in 2015 was $2.84. (Wenjing Yang/Medill Source: Bloomberg)
Analysts estimate earnings per share of 34 cents in 2016. The full-year earnings per share in 2015 was $2.84. (Wenjing Yang/Medill Source: Bloomberg)

U.S. Cellular said it added 61,000 subscribers in the third quarter helped by a better-than-expected growth in prepaid users. Yet on the flip side, the company encountered the first net postpaid losses in more than two years, shedding 6,000 postpaid users among a loss of 27,000 phone users.

Analysts have growing concerns about the subscriber metrics and its shifting focus from postpaid to prepaid.

Average Revenue Per User, or ARPU, a measurement of a wireless service’s revenue each user generates, is generally lower and requires less commitment for prepaid customers than postpaid ones, said Philip Cusick, analyst at J.P. Morgan, in a research note. “We are skeptical of the long-term durability of the business turning to prepaid for growth as this sub base tends to flow to whoever has the best current offer,” he wrote. He lowered price target for U.S. Cellular to $38 from $42.

The third quarter prepaid ARPU declined for the fifth consecutive quarter, falling 4 percent from a year ago, while postpaid ARPU declined 12 percent.

U.S. Cellular posted a net income of $17 million, or 20 cents per diluted share, in the third quarter ended Sept. 30, missing the consensus estimate of $20.5 million, or 24 cents per diluted, although revenue slightly beat the estimate.

“The continued decline in these revenue metrics, coupled with weak customer growth numbers, are a clear indication of the challenging competitive environment U.S. Cellular faces,” wrote Zhao.

U.S. Cellular has enjoyed high postpaid-user retention throughout the years. Churn rate, the percentage of subscribers who discontinue their subscriptions, remained at a low level of 1.3 percent for postpaid in the last four quarters.

However, Cusick said U.S. Cellular sees little opportunity to acquire new customers, as Verizon’s and AT&T’s churn rates are at or near record lows. He lowered postpaid net add estimates for 2016 to 125,000 from 191,000 after the third-quarter earnings report.

Nevertheless, amid their downbeat forecasts, analysts expect the wireless carrier to improve margins as it shifts to equipment installation plans for postpaid users, which they believe will gradually reduce phone subsidy expense, the cost of offering customers a discount to buy a new smartphone in order to attract subscribers on two-year contracts.

U.S. Cellular shares gained 12.5 percent in the past 52 weeks, closing at $44.84 on Thursday. (Wenjing Yang/MEDILL Source:The Wall Street Journal)
U.S. Cellular shares gained 12.5 percent in the past 52 weeks, closing at $44.84 on Thursday. (Wenjing Yang/MEDILL Source:The Wall Street Journal)

U.S. Cellular’s profitability hinges on how well its management is executed.

The company has been struggling to generate cash. In the third quarter, the company posted a negative number from financing activities and a smaller amount of cash from operating activities than a year ago. The trend, if sustained, will in turn affect its investment activity and trap the regional carrier into a weaker positioning, analysts say.

Zhao believes U.S. Cellular has several attractive assets, such as two spectrum licenses. He expects the company to sell off nonstrategic and uncompetitive assets to improve its overall position, possibly a precursor to going out of business.

“If executed properly, we believe this process would ultimately end with the complete liquidation of the firm,” Zhao wrote.

Analysts also call attention to the ownership structure of U.S. Cellular and its relationship with the parent company.

U.S. Cellular was founded by Leroy T. Carlson, the founder, president and CEO of Telephone & Data Systems Inc., and operates as its subsidiary. Telephone & Data Systems, which operates and invests in wireless markets throughout the United States, owns 84 percent of U.S. Cellular and controls the majority of the voting rights. Leroy Carlson remains chairman of U.S. Cellular and family members sit on the boards of both companies.

In a 2016 article, Flannery said T-Mobile might consider buying U.S. Cellular instead of merging with Sprint, although the Carlson family doesn’t seem interested in selling the wireless business.

Signals about the possible purchase are expected to appear in the following year, Sine said.

U.S. Cellular will announce its fourth quarter and full-year results on Feb. 24. Analysts polled by Bloomberg estimate fourth-quarter revenue to be $1.03 billion, with a net loss of $13.1 million, or 34.7 cents per diluted share.

Photo at top: A U.S. Cellular retail store at 225 High St., Ellsworth, Maine. (Photo by Taylor Bigler/The Ellsworth American)