Talk Is Still Cheap

Once upon a time, telecom service bundler Talk America (Nasdaq: TALK) was the favorite son of the Motley Fool Hidden Gems newsletter. But sad to say, that favorite son went prodigal on us. Its business generated a lot of cash, sure, but we eventually decided that there was just no telling how long that was going to last -- through no fault of its own, the kid was just out of control ("O-O-C" -- in the parlance of the day). Regulatory risks abounded. Legal risks mounted. With a tear in our Foolish eye, we ultimately decided to let Talk America go off to find its way in the world alone.

Thus it was that the very first Hidden Gems "buy" recommendation became its very first "sell" recommendation as well. We still keep in touch, though, from time to time. In fact, Talk America wrote us just the other day (albeit in a press release). It was good to hear from the kid, even if his news was a bit mixed. Things aren't going great, but they're not altogether bad, either.

The worst news was that Talk America's business is shrinking. A few months back, Talk America was able to boast of reeling in cash from 683,000 billed bundled lines. But by the time the official fourth-quarter 2004 numbers are in, it expects that number to shrink by 2%-3%, declining to just 665,000 or so. And Wall Street expects that trend to continue, with the effect that, over the next five years, Talk America's profits will decline by about 9% per year.

For Q4, Talk America's holding the line with guidance of about $125 million in revenues, and earnings of roughly $11 million, or about $0.41 per share (although asset write-downs could hurt that number). Even with significant write-downs, the company would have a forward P/E ratio of about six, a fraction of the valuations sported by much larger competitors Verizon (NYSE: VZ), SBC (NYSE: SBC), BellSouth (NYSE: BLS), and AT&T (NYSE: T), and orders of magnitude cheaper than currently unprofitable Qwest (NYSE: Q) or MCI (Nasdaq: MCIP).

On an enterprise value-to-free cash flow basis, Talk America is even cheaper. Its trailing numbers show an EV/FCF ratio of just 2.75. So all other things being equal, and assuming profits decline no faster than the Street expects, within the next three or four years the company could generate enough cash to pay back an investor the entire purchase price paid for Talk America shares -- making ownership of the business itself a freebie.

Rather read than talk? Give these Foolish articles a look:

• Talk America Bundles Up
• All Talk, No Action
• Talk About Network Unbundling
• Talk America Rings Up the FCC

Fool contributor Rich Smith has no position in any company mentioned in this article.