Three Winners from Telco Takeover Fever

07/15/2010 1:00 pm EST

Focus: STOCKS

Roger Conrad

Founder and Chief Editor, Capitalist Times

Roger Conrad, editor of Utility Forecaster and associate editor of Personal Finance, says a new wave of takeovers is hitting traditional telcos, and he names three favorites.

Takeover fever is heating up in the wireline telephone [industry]. Driven by the need to cut costs and up-sell customers to broadband service before they bolt to wireless or cable competitors, providers are turning to scale for salvation. And the result is a growing string of deals.

The biggest providers of traditional service—AT&T (NYSE: T) and Verizon Communications (NYSE: VZ)—make far more money providing wireless services (a space they dominate) than they ever did from their copper-wire networks. And wireless and broadband offerings enable the big boys to grow earnings far faster than traditional local and long-distance services.

Verizon’s sale of [4.8 million rural phone] lines to Frontier Communications (NYSE: FTR) and other divestitures have dramatically enhanced [Frontier’s] growth potential, though integrating the acquired assets and upgrading them for broadband service won’t be cheap.

[But] opportunities to grow cash flow through up selling and cost-cutting abound. And Frontier has the financial strength to see it through. That adds up to considerable safety for the quarterly dividend of 18.75 cents a share—a nearly 10% yield at the stock’s current price.

Frontier Communications’ success buying the Verizon properties makes it a solid buy up to $8 for growth and income. (It closed above $7 Wednesday—Editor.)

Facing [the growing dominance of AT&T and Verizon], other players in the sector have little choice but to consolidate. And with a stable rural base of 6.2 million wireless and 1.1 million wireline customers, rising margins, and steady finances, Telephone & Data Systems (NYSE: TDS) is a prime candidate for acquisition.

The stock doesn’t yield much, but it is cheap; down nearly 60% from its mid-2007 highs, shares trade at just 1.7x book value and 68% of sales. That leaves plenty of room for a [nice] premium.

Meanwhile, a market capitalization of $3.2 billion would be easy to swallow for many industry players or private equity firms. Buy Telephone & Data Systems up to $35. (It closed above $32 Wednesday—Editor.)

Consolidated Communications Holdings’ (Nasdaq: CNSL) market capitalization of just $530 million makes it far easier for a competitor to inhale. A greater attraction, however, is the basic stability of its business, which cut traditional line losses in half during the first quarter and posted strong growth in broadband users.

The company’s properties are located in exurban areas where competition is less fierce and the population is still growing—a major advantage.

But Consolidated has also demonstrated its ability to stand up to fierce competitors—many as three in some markets. One reason: 96% of its access lines are DSL-enabled, with at least three megabytes of speed, allowing the company to offer a full bundle of services.

As with every rural telecom, cash flow is the key. Both the dividend payout ratio and debt level are modest, another attraction for a buyer. Buy Consolidated Communications up to $18. (It closed below $18 Wednesday—Editor.)

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