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Dial Up Profits With a Plain Old Phone Company
Michael Brush
September 22, 2005
Given that advances in technology are driving the price of phone service
gradually towards zero, it’s surprising to see insiders buying shares at a
basic phone company.
But that’s exactly what’s going on at Minneapolis, MN-based Eschelon Telecom
(ESCH)
– a phone company that serves about nineteen markets in the west and
northwestern regions of the U.S.
What does an insider who recently put a quarter million dollars into
Eschelon stock see in this company, which just started trading as an initial
public offering (IPO)? Three things, I believe.
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First, Eschelon skips over residential customers to focus on smaller
businesses. These customers want more than just plain phone service --
demanding an array of more sophisticated voice and high speed services
instead. So Eschelon’s line of business isn’t going to disappear.
Next, Eschelon operates in the realm of one of the former baby bells, or
Qwest (Q). Like most of the big regional carriers, Qwest likes to go after
the big fish on the business phone services side. That leaves room for a
competitor like Eschelon to come in with lower pricing to pick up
second-tier customers.
But what separates Eschelon from other smaller phone companies that fish in
the same waters? “We have a dramatically higher level of customer service,”
says chief executive Richard Smith. “We keep our customers informed. We fix
their problems promptly.”
Any CEO worth his options will make this kind of claim, of course. But
Eschelon has a record that backs it up. Unlike most of the new generation of
phone companies from the 1990s that stumbled when the tech and telecom
bubble broke a few years back, Eschelon has turned in nothing but steady
growth over the past nine years. During the past four years, the company
produced 38% compound annual revenue growth.
It must be doing something right.
Analysts don’t predict that kind of growth going forward. Instead, they’re
looking for annual revenue growth of around 10% over the next several years.
But they also think cash flow will grow a lot faster than that – at about
20% to 25% per year. The difference will come from cost savings out of a
recent acquisition and others to come, and improved margins as Eschelon
spreads more revenue out over a relatively fixed cost base.
Valuation
The third attraction is that Eschelon looks cheap. It trades for about 4.6
times estimated 2006 cash flow, compared to a level of about six times cash
flow for competitors. Yet Eschelon has debt levels below the industry
average, besides the solid growth prospects. Strong performance ahead should
close the valuation gap in time, says Romeo Reyes, an analyst with
Jefferies, which helped underwrite the IPO.
Risks
Aside from the normal risks that come from operating in a highly competitive
sector, Eschelon has a “lockup release” in January 2006. This means
shareholders restricted from selling their stock following the recent IPO
will be free to do so in four months. Nine million shares could potentially
come on the market at that time. Since Eschelon is a fairly low-volume
stock, that could create an overhang – or worse.
The bottom line: A lot of lockup releases only suppress stocks
temporarily. Besides, there’s no guarantee the lockup release will push the
stock below today’s levels and we suggest holding stocks for the long term,
in any case. So I’d buy right here – prepared for some potential turbulence
ahead followed by greater rewards down the road.
Disclaimer
At the time of publication, Michael Brush did not own or control shares in
any of the companies listed in this column. Mr. Brush is an independent
columnist for this web site.
For more on Insiders Corner disclosure, see the disclosure section in About
Insiders Corner:
http://www.investorideas.com/insiderscorner/. InvestorIdeas.com
Disclaimer:
www.InvestorIdeas.com/About/Disclaimer.asp. InvestorIdeas is not
affiliated or compensated by the companies mentioned in this article.
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