Wireless messaging provider USA Mobility (SPOK 0.77%) has been left for dead as evident by the low valuation and lack of analyst coverage. The recent stock rebound is proof investors are beginning to realize the persistent reports of its death are greatly exaggerated.
Investors that rely on broad industry generalizations may miss out on a company trading at 4.2 times trailing 12 months EBITDA -- earnings before interest, taxes, depreciation, and amortization, a 16% free cash flow yield, and $392 million in net operating losses that can be used to reduce future taxes.
Many investors consider pagers relics from the 90s and a casualty of the introduction of the cell phone. Although the number of messaging subscribers continues to decline due to the growing use of smartphones, there are three important mitigating factors.
First, revenue is declining at a slowing rate. For example, management said on the most recent conference call that the annual rate of revenue erosion reached a record low. This improvement is driven by new mission critical products designed for customers who care more about cost and reliability than the latest gadget. For example, its HIPAA-compliant and unified communications solution provides increased productivity, reduced costs, and improved quality of care.
A core health care customer base and 99.5% maintenance renewal rate provide a recurring revenue stream along with increased overall business stability. For example, all 18 hospitals listed in the U.S. News & World Report honor roll of best hospitals use its products.
Second, the company responded to the secular change in demand by significantly reducing its cost structure through ongoing workforce reductions and network rationalization by consolidating subscribers onto fewer, higher capacity networks with increased transmission speeds. Moreover, the company is better able to survive this challenging period with $72 million in cash (22% of market cap) and no debt.
The export business continues to grow as the high domestic market share provides a platform to expand into fast-growing international markets. For example, in May its subsidiary Amcom was awarded the President's "E" Award for exports, which is the highest recognition a company can receive for contributing to U.S. exports.
What could go wrong?
The most obvious threat is a faster than expected decline in the core business.
The competitive threat from the major wireless carriers such as AT&T (T 0.18%) and Verizon (VZ 0.15%) is less than anecdotal evidence would suggest for two reasons. First, USA Mobility currently enjoys an entrenched market leadership position with strong customer relationships, a long operating history, and superior products. Second, there is little risk of the carriers directly challenging USA Mobility as the size of the market wouldn't "move the needle" for them. Moreover, USA Mobility poses little risk to the carriers as it focuses on niche markets with little overlap.
Furthermore, AT&T and Verizon both trade at higher valuations yet face similar growth constraints. For example, both AT&T and Verizon are increasing their exposure to wireless as the landline business continues to shrink. AT&T is considering acquiring European wireless assets as the domestic market is saturated while Verizon recently acquired the portion of Verizon Wireless it did not already own as this was its fastest growing segment.
The key metrics to watch that would merit a reevaluation are an acceleration in sequential revenue declines, a decline in overall renewal rates, net paging unit losses in the core health care segment, and a shrinking backlog.
Bottom line
While the transition from paging to unified communications provider will not be easy or quick, the fact remains that it is happening and progressing better than expected. Investors are paid to wait during this transition period with a 3.3% yield and a shareholder-friendly management.
The market is currently focused more on what can go wrong than what can go right. However this should reverse as the company continues to generate high free cash flow, reward shareholders, and maintain a strong market position. Investors should remember that in general, the lower the expectations, the lower the risk.
