Citizens Communications: Cash Calling

Raise your hand if you like cash.

OK, you can put both your hands down -- I get the picture. I think it's pretty safe to say we all love cash, especially us Fools. We love to see companies that consistently turn out cash, both in free cash flow and in dividends. Dividends are the best kind of cash, as they flow right back into shareholders' pockets.

So for those of you raising your hand(s) -- and especially those jumping out of your seats -- you might want to take a look at a sleepy little telecom company, which happens to be a Motley Fool Income Investor pick, called Citizens Communications (NYSE: CZN). Sound management and efficient operations have helped the company succeed in a tough market and generate enough cash to reward its investors with market-beating returns in the process.

Cash and carry
One secret that's little-known to the average investor is that you can make great returns off companies that are no longer growing the top line. Achieving market-beating returns from businesses operating in stagnant or decaying markets takes sound cost controls, prudent capital investments, and savvy acquisitions -- just plain old good business management. While Citizens' 2006 revenue was flat compared to 2005, the company has proven successful at milking cash from wireline and DSL services that it deploys predominately in underserved rural markets.

Serving rural markets keeps Citizens out of the crosshairs of much larger, deep-pocketed competitors such as Verizon Communications (NYSE: VZ) and AT&T (NYSE: T), which largely ignore rural markets in favor of denser urban areas. While capital costs to serve rural markets can be steep, Citizens still produces hearty amounts of free cash flow -- management estimates between $425 million and $450 million in 2007.

Back from the brink
Wall Street considers Citizens Communications a turnaround play. After years of lackluster performance as a diversified utility company, Citizens shuffled management and eventually sold off all of its utility assets. The current chairman and CEO, Maggie Wilderotter, came to Citizens from Microsoft in late 2004, as the company reorganized to focus solely on telecommunications services, taking its place as one of the larger incumbent local exchange carriers in the United States.

In the last few years on Wilderotter's watch, the new company has shown that it can move the business in a positive direction:

What's limited Citizens' ability to achieve substantive revenue growth is the number of customers dropping traditional landline phone service, as seen in the 5% decline of billed access lines. But Citizens' push to sign up customers for high-speed Internet services has largely offset this decay with a 5.2% increase in the average monthly revenue from each line.

The cost containment measures Wilderotter has implemented are also helping increase overall returns from the company. To drop operating expenses, the company has been reducing head count and taming benefits costs. The company is confident enough in its strategy that it recently announced a $250 million share buyback plan, which equates to roughly 5% of outstanding shares.

So what's the downside?
Citizens finished 2006 with a sizeable debt load of $4.5 billion, which has grown from approximately $4 billion in 2005. Some of the debt will be restructured with a $750 million private placement connected to the recent acquisition of Commonwealth Telephone Enterprises for $1.29 billion. Investors in Citizens need to be comfortable with the risks associated with an acquisition that will (hopefully) equate to better returns down the road.

While competitive pressures in Citizens' markets are relatively tame at this point, they could increase in the future as larger telecom concerns continue their expansion. Companies like Clearwire (Nasdaq: CLWR) and Sprint Nextel (NYSE: S) aim to penetrate farther into rural areas with next-generation, long-range WiMax wireless services. Cable providers such as Comcast (Nasdaq: CMCSA) are also increasing efforts to grab residential phone service by bundling their video and broadband services into what that company refers to as its Triple Play package. To top it off, wireless companies are also actively coaxing people away from their landline service and encouraging them to make a mobile phone their only phone.

Citizens has been proactive in staving off this competition, though. The company formed a partnership with Echostar (Nasdaq: DISH) to offer television programming via the Dish Network in 2005. It is also getting into the business of providing city-wide wireless broadband service via Wi-Fi technology in select markets.

A good call
Even considering the risks facing the company, Citizens presents a potentially compelling investment opportunity, particularly if the share price drops much below the recent price of $15.50. Citizens management does not factor the recent acquisition of Commonwealth Telephone into its cash flow projections, so any added cash flow from that business in 2007 will be a bonus. Using the company's conservative guidance of $425 million to $450 million in free cash flow for 2007 and assuming sub-5% earnings growth going forward, my discounted cash flow model values the company at around $16 to $17 per share.

Beyond organic growth, Citizens' 6.5% yield gets investors more than halfway to beating historical market returns. While shares of the company are up 43% over the past five years, the generous dividend has helped boost Citizens' total return to a rather impressive 95% in that time frame. While Citizens is not the safest income-generating investment, a reasonable price for its efficient business management and considerable cash flow make it a worthy consideration for any portfolio.

For related Foolishness:

• 3 Stocks That Stack Your Odds
• 2 Stocks I'm in Love With
• Citizens' Rockin' Margins: Fool By Numbers

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Fool contributor Dave Mock thinks he could play bagpipes if he only knew which end to blow in. He owns no shares of companies mentioned here. Dave is the author of The Qualcomm Equation. The Fool's disclosure policy bobs and weaves like nothing you've seen before.