Normalized Earnings

I think we can finally start putting it all together and see where we come out. Here are my estimates, in broad strokes, for the next 2.5 years:

The red numbers are hard inputs by me; everything else is either a formula or historical fact.

The final figures differ very slightly from some of the previous figures I’ve thrown out for a few reasons. I’m assuming more store growth (10 stores per year in Canada, 15 per year in each U.S. division) now, but also reducing my Diamond Wireless EBITDA per store assumptions to allow for a ramp-up in traffic at the new BJs locations. There are other small changes here and there, but nothing material.

Most of the other line items either remain static from their current state, or grow with inflation.

Valuation

Based on today’s price, the company’s market capitalization is $250M, and in 2016 the enterprise value would be roughly the same if all the debt was paid down (assuming no change in the share price). That would leave us with an EV/EBITDA, at today’s price, of under 3x, and a P/Cash EPS of under 6x. 

I would argue that Glentel’s strong operating record means it should trade for at least the market multiple, but let’s give it in an illiquidity discount and a “competitive industry” discount, and assume instead that it should trade at 13x FCF. Applying 13x to ~$2.00 of 2016 cash EPS, and adding back cash generated in the interim, implies a $30 stock price, for a total return of 170%.

Using the 8x multiple at which Carphone Warehouse recently sold would also imply a $30 stock price, again using 2016 estimates and giving credit for the cash generated between now and the end of the 2016.

Additional Avenue for Value Creation through M&A Arbitrage

As the table of Glentel acquisitions below shows, independent and contracted cell phone dealer businesses sell for low multiples in private transactions.

The reason is simple: most of these businesses have little or no geographic or carrier diversification. That means if the company’s primary carrier decides to give its phone to another competitor instead, or sell them exclusively in-house, then the business disappears. Allphones is a prime example.

This is a real risk, but it can mitigated by diversification, both geographically and by carrier. If a company can achieve this diversification (Glentel is getting there), then these risks dissolve, and so too should the valuation discount, as evidenced by the Carphone Warehouse deal, which went down at 8x.

This discrepancy in multiples can be arbitraged by companies that are sufficiently diversified to warrant the higher multiple. Glentel is one such company, though to be fair the market currently does not agree. It may in the future though, which would give Glentel the ability to take advantage of this arbitrage opportunity. Seeing Glentel buy companies for 4-5x while its stock sells for 7-8x is not part of my thesis, but I do think this represents a realistic avenue for potential value creation.

Other Risks and Uncertainties

I think by now the risk of losing a major carrier customer has been discussed, directly or indirectly, at fair length. Another concern that some investors have about Glentel—one I haven’t touched on so far—is that Canada is a maturing smartphone market. By “maturing” I mean that smartphone penetration is reaching high levels. This matters because carriers pay the contractors like Glentel more for an activation than for an upgrade/renewal.

Given that the countries with the world’s highest smartphone penetration rates are only at ~73%, I suppose one could say that the U.S. and Canadian markets are relatively mature.

But there is still a fair bit of growth left given that the portion of the population that will never use a smartphone (the very young and the very old) is probably no greater than 10%, leaving 30% of the population as an addressable market. Further, This “maturity” hasn’t stopped Carphone Warehouse from doing very well in an even more mature market.

It is also no accident that Glentel’s recent expansion activities have focused on new parts of the world.

And besides, I do not think this investment is at all dependent on sustained high growth, given the magnitude of profit the company will generate if Canadian cell phone buying patterns simply return to normal.

The final concern I will discuss is the worry that cell phone sales will move online over time, obsolescing physical retailers like Glentel. Such a transition is possible, but it sure hasn’t happened yet:

Despite some efforts by the carriers to move more of their phone sales online, and thereby avoid the costs of rent, salespeople, etc., the percentages have not budged. I believe the carriers themselves are to blame. The carriers want it to be difficult to change phone brands. They want you to struggle to move your contacts, voice mails, pictures, music, and so on, from one phone to another. And in large part they’ve succeeded. Unless you are extremely tech savvy, you need to go into a store to have this stuff done reliably.

I think this will be the case for the foreseeable future. Given how similar the services and prices are among the major carriers, the carriers have no choice but to rely on barriers to switching—in the form of inconvenience, proprietary software, etc.—as a primary means of customer retention. So I don’t see the process of moving data from one phone to another getting simpler any time soon. Just look at how many major carriers sell subsidized phones that run the stock Android OS: none. That’s not a coincidence. The carriers know stock Android OS would store all your data in the Google cloud, making switching phones (and carriers) much easier than it is currently.

Conclusion

I hope it is clear by now that Glentel is trading extremely cheaply and has a clear path to material earnings growth. As for why this market inefficiency exists, there is no shortage of reasons: the company trades in Canada with a float below $100M; the company does not host earnings conference calls; the company does not participate in investor conferences or offer an investor slideshow on its website; the sell-side coverage of the company is very poor; the investment case is complex relative to the small size of the company; etc.

Over time, most of these things will change. As the company gets bigger, investor attention will grow, and the investor outreach effort on the part of the company will improve as well. The latter is a question of resources rather than desire.

These will all be good changes, though none will happen tomorrow. If you invest in Glentel, have patience.

Anyway, that’s it for GLN. I hope you’ve enjoyed it. As always, do your own due diligence, and make your own investment decisions. Enjoy the rest of the summer.