Wednesday, June 17, 2009



The business of rural phones can be very cash generous or cash gobbling. Here are two that pay you and two that won’t.

If you were to look at your monthly checks that you cut to companies providing communications it might end up being a bit of a shocker of a total.

All of us have expanded our demands to be able to speak with, text to, email with, gain access to the internet as well as receiving evermore entertainment and other content.

And we want all of it – all of the time.

In our offices, homes, on the road, on planes, trains and every other place. And if we can’t get and keep connected – well, we won’t be happy campers.

And we’re willing to pay for it.

Over the past 15 years – communications and related content delivery companies have seen a continuing surge in services demanded and paid for by everyone. Think about it – back in the early ‘90s – you had basic landlines and perhaps a cellphone the size of a small brick and perhaps cable television.

But now, more likely you have landlines, multiple cell phones, smartphones, data connections for your laptop as well as data connections for your homes, cable, satellite and many other subscription services that quickly add up to hundreds of dollars a month for households.

And for businesses – the bills very quickly run into the thousands and many thousands each month and every month. And since the early ‘90s through the last current calendar year – the growth in spending has soared by nearly 200 percent on a national average as tracked by the US Bureau of Economic Analysis (BEA)

This is an interesting industry to be in. For there’s cash, lots of it – and that cash keeps coming in month after month and year after year – making for a very nice and steady stream of revenues that you can bank on to build and maintain a very lucrative business.

But there is a catch. You have to keep investing in capital expenditures to maintain the services that you have – while also investing to build and expand to meet new and expanding demand for services. And in many markets – there’s plenty of competitors that are just itching to poach some of your very nice cash cow customers.

Running a business in the communications world therefore comes down to maximizing revenues while controlling costs and keeping and building customer bases.

There are markets that have plenty of steady customers – but with less direct competition. Rural areas around the nation offer different market conditions than urban centers. Fewer providers means less competition and not only potentially better pricing power – but also stickier customers. More certainty that the cash will keep coming in not just over months – but years.

And there is an added benefit – Uncle Sam Incorporated is eager to see rural markets better served.

Back in the Franklin Roosevelt Administration – the US Department of Agriculture and its Rural Development Division began a major public investment to provide a host of utility services to households and businesses that were underserved by private companies more focused on urban areas.

By providing underwriting and cash subsidies – rural communications providers sprung up around the nation – often being local operations. This continues through today and has expanded considerably in recent years.

In 2005, the government expanded its mission to subsidize not just landline and wireless – but also higher-speed or broadband data transmission capability throughout the rural markets of the US.

And in the recent additional expenditures including chucks of the Stimulus Package Legislation – billions upon billions of Uncle Sam cash is continuing to flow to companies providing and expanding communications in rural areas.

So, the bottom line is that this is a market that has lots of steady customers and lots of Federal cash and credit to keep it going and expanding.

The result has been a move to consolidate many of the local companies serving rural markets. Over the past several years – companies have gone public and have acquired local service providers. In addition, in markets where the major Baby Bells have been operating – rural focused companies have been buying out local rural services as the Baby Bells have been increasing focused on what they see as there core markets in urban areas.

I got involved in this market years ago as I recognized that there were plenty of these companies that were operating good businesses with lots of cash and were paying out large cuts to investors.

But like with any industry or market – even good ones like rural services – it comes down to finding the right companies rather than just the right segment.

The key to investing in the right company comes down to finding management teams in markets whereby they can maximize cashflow while controlling costs. And not just doing acquisition deals just for the deals’ sake.

In addition, landline customers are contracting around the nation from urban to rural markets. With alternative communications products and services – every telecom company has to minimize losses of landline revenues with growth in other alternatives to keep the cash coming in.

This comes in two ways. First, add additional services – from wireless to higher cost data and entertainment and media services. Second, buy up other markets at a faster pace than what is being lost to declining demand for landlines.

The first is harder. For it involves improving services and sales as well as additional capital expenditures. The second can be easy in the shorter term – but it comes with lots of costs – including overpaying for customer bases and the costs of integrating the acquired customers into the existing businesses.

There are two companies that continue to prove out on both approaches and two that should be avoided.

On the buy side – there’s Otelco (NSDQ: OTT) and Iowa Telecommunications (NYSE: IWA). On the sell side – there’s Fairpoint Communications (NYSE: FRP) and Frontier Communications (NYSE: FTR).

Otelco is based in Alabama and has operations in rural markets in that state as well as in central Missouri, select areas of Maine and Massachusetts and West Virginia. The company is a cost container – one of the better ones and continues to grow overall revenues by an average annual rate of over 20 percent. Margins are fat with gross running in the 63 percent. And more importantly – it keeps lots of cash on hand and controls debt with a debt to assets running at only 76 percent.

For investors, the company’s shares are structured as an Income Deposit Security (IDS) in which each share is made up of one common share of stock and one intermediate corporate bond.

The dividend is made up of cash from operations paid to the common stock and the interest coupon paid to the bond. That gives us a lot more certainty and security of the dividend – while also continuing to focus management on serving shareholders.

Paying a rock-steady dividend of 42 cents – the yield is running in the 13 percent range and should continue to be bought under 16.

Iowa Telecommunications operates as its name implies - throughout the state of Iowa. It has a decline rate in local landline services running at an average annual rate of 3 percent – yet, like Otelco, it continues to ramp up additional data and bundled services for both households and increasingly to business customers resulting in overall revenue gains in these complementary and off-setting services amounting to average gains of 20 to 40 plus percent.

And also like Otelco, it’s a cost controller with heavy gross margins in the 60 plus range and less debt with debt to assets running only in the low 60 percent range.

This well-focused rural operator pays steady every quarter and has kept paying 40.5 cents giving you a yield from its regular common stock of just shy of 13 percent. It’s a buy under 16.

First on the sell side is Fairpoint. It’s been on the sell side from me for the last few years stemming from a grave departure by management away from shareholders.

This company continues to me more focused on acquisitions rather than local business growth. The results have been that the company has entered into a series of deals that have come at too high a cost and have resulted in a debt strain that potentially puts the company at risk for bankruptcy.

Two deals in particular are responsible for the continued slide. Both have been bought from Verizon – one in Maine and the other in Vermont. In both cases – the company failed to do enough diligence to determine what they really were buying – including antiquated switching systems and not all of the business customer base.

Adding to the troubles were local union leaders that saw the deals as threatening their power. With Verizon – the unions could always threaten other major markets to get want they wanted. But with Fairpoint – this leverage would be reduced.

The campaign against the deals led to the local Public Utility Commissions resulting in Fairpoint making major concessions including cutting back on dividend distributions.

Now as the deals have been done – revenues are lacking and capital needs are outstripping the potential of the company to fund them. Dividends are now suspended and debt rating agencies are now finally weighing in with downgrades and negative outlooks. This should be sold or avoided.

The other sell side rural operator Frontier Communications has been following a similar and increasing aggressive deal making campaign over the past few years. And while not as initially challenged as Fairpoint has become – its debt load particularly with maturities in the next couple of years will be challenging to rollover.

And with local landline business attrition – other services are not expanding as rapidly as Iowa and Otelco have been able to generate. This puts its dividend further in jeopardy and is why I am recommending selling and avoiding Frontier.

Neil George is editor of Stocks That Pay You and By George.

The above is only opinion and does not represent and/or offer to buy or sell any security and/or any financial advice. The opinions contained may not be suitable for all investors who should consult their own financial adviser before making any investment or other decisions. I may own some of these same securities noted in accounts under my control or for my benefit.

Errors/Omissions: I always welcome being called on facts, figures and commentary from readers and look forward to your feedback. I can be reached by email at or or at 01-314-616-3325.