“Lock in this Double Digit Income … May Not Last Long”

by Travis Johnson, Stock Gumshoe | March 20, 2009 10:39 am

We close out the week with a look at the “Income Security of the Month” — Carla Pasternak[1] puts one of these out each month as a teaser to get folks to subscribe to her High-Yield Investing[2] newsletter, and we’ve looked at several of them before — it’s been a hodgepodge, the Korea[3] Fund and Capstead Mortgage preferred shares have both made the list, but at least one of them (Capstead) was a good and well-timed idea, so let’s see what she’s got for us today …

The “Income Security of the Month” for March is an exchange traded bond — these are not all that common, but there are at least a few hundred of them that are easily available. Exchange traded bonds are just bonds that are issued in smaller increments (usually $25 instead of the more typical $1,000 for other corporate bonds[4]), and that trade just like stocks on one of the major exchanges. They’re often, but not always, offered by large, well-known companies — Ford, GM and GE have a lot of them outstanding, for example.

This is not one of those suffering “blue chips,” though — no, today we’re looking at some kind of cell phone company. Here are some clues:

“The company behind our “Income Security of the Month” provides wireless telephone services, a sector that has proved to be resilient amid the current economic turmoil. In fact, in the fourth quarter of 2008 — a challenging period for most businesses — this company actually grew its customer base and service revenues. Don’t wait too long to lock in this double-digit income provider — its current discount may not last long.”

OK, so that gets us narrowed down by sector. Any other tips from the ad?

At the time the ad was written, Pasternak told us that the shares were going for “about $14” — which would provide a 13.1% yield and, if the shares return to their principal value, a gain of 75%.

The current dividend is $1.875 a year, paid quarterly.

Carla also tells us that …

“… from here, we are likely to see a rise of +75% in the share price as the shares trade back at the level they had been at for years — approaching their principal value. Investors normally enjoy a solid yield of 7.5% on this security.”

So yes, if they normally enjoy a solid yield of 7.5%, and the payment is $1.875 per year, we must be dealing with a standard exchange traded bond that has a principal amount of $25.

And yes, if we start with a $14 price and it goes back to $25, that’s a potential capital gain of just over 75%.

So we’ve got the math down … why would we want to loan this particular company our money?

“While every other business has cut spending to the bone and lowered expectations for 2009, this company announced that not only would it grow next year, it would continue to invest in its business, allowing it to ’emerge from the economic downturn stronger than ever.'”

“How has this company been able to buck the trend in this lousy economy? Consumers cut back on a lot of things during an economic downturn. They may pass on a costly vacation, a trip to the spa, or even their $5 latte. But you won’t find too many people willing to give up their cell phones. For most people, phone service is essential, like electricity, heat, or water[5].

“And that has been just one of the contributing factors that have caused this security to outperform the S&P 500 by +22.4 percentage points in the last three months alone.”

OK … enough for you? We’ll throw all those clues into the mighty, mighty Thinkolator, and we find out that this is is …

United States Cellular. The regular stock ticker is USM, and the ticker for this exchange traded bond is UZV.

Here are the bond’s details:

7.50% Senior Notes due 6/15/2034
Ticker Symbol: UZV
CUSIP: 911684306
Rating: Baa2 and BBB- (right on the borderline between “investment grade” and “junk,” according to the ratings agencies)
Coupon: $1.875 annually (quarterly payments of just under 47 cents)
Payment dates: 3/15, 6/15, 9/15, 12/15
The ex dividend date for the last payment, which was paid last week, was March 11, so we would assume that the ex div date for June will probably be just a few days before the payment date, too.

The prices of these bonds have recovered a little bit since Carla wrote her ad a few weeks ago (these bonds had a big dip right around March 1 to $14, but recovered quickly), so the price is now right around $17, which makes coupon yield almost exactly 11%. Still not bad. And that means the potential capital gain, if the shares return to their principal value, would be more like 40%.

These bonds are “callable” by the borrower, US Cellular, any time after June 17 of this year at $25 — it seems unlikely that they’d choose to do so, since it would probably be tough for them to borrow at better than 7.5% right now, but you never know — and the environment could certainly change dramatically at any time between now and when these bonds mature (and when they’re required to pay you back the $25) in 25 years.

So … if you cut through all the details the big question is, would you loan United States Cellular money at 11% interest? The calculus that goes into that is essentially: “are they good for it?” and “is that enough interest to compensate for my risked principal?”

Those are questions that will be answered differently by everyone, of course — but here’s the basic sketch of United States Cellular as an operating company:

They are not absurdly indebted, as so many companies are today — they have a market cap of about $3 billion, and $1 billion in debt — of which $300 million is from this particular exchange-traded bond issuance. (These are “senior notes,” so they’re near the front of the creditor line to get repaid if the company gets into big trouble someday).

US Cellular is — and this is the part where it gets a little bit complicated — really a separately-traded subsidiary of Telephone & Data Systems (TDS), which owns 82% of the company. Other than their US Cellular holdings, which make up most of TDS’s market value, TDS provides wireline telecom services — phone lines, DSL, etc. USM is the fourth or fifth-largest wireless phone company in the US, depending on who you ask and how they’re counting, and they’ve suffered to some degree in competing against much larger companies like Verizon Wireless and AT&T, but apparently they have good retention rates and are able to make an operating profit.

Zacks thinks that the shares are priced close to “fair value” and has a $38 target on the shares (they’re at about $34 right now), and they were recently downgraded to “underperform” by the Robert Baird analyst (analyst consensus is a tepid “hold”).

USM had a rough fourth quarter with a big impairment charge, which is part of the reason why these bonds slumped to $14 around the time that earnings were released (you can see the conference call transcript here[6], or the earnings report here[7]), but analysts still expect them to earn $2 a share this year, and a bit more than that in 2010, which gives them a forward PE of about 15.

One wildcard for USM is that they (or TDS, or whoever’s really in charge) are under pressure to do something big, like a merger or sale to a bigger rival, because some activist investors don’t think they can continue to be a small fish fighting in the cellular space against the much larger Verizon, AT&T, Sprint and T-Mobile. Here’s a good article about the push to put themselves up for sale[8] (or something) from investors like Mario Gabelli[9].

And if you’re interested in exchange-traded debt, but don’t particularly want to look at United States Cellular, there are plenty of others to choose from, both directly listed debt and bonds that have been chopped up by investment banks for trading on the exchanges. One of the best place to get information about these is QuantumOnline.com, which I’ve mentioned in this space many times before — you need to register with them, but it’s a free site. Once you’re registered, you can see the lists under the “Income Lists” tab, with standard debt like this UZV listed under Exchange Traded Debt, and others under Trust Preferred Securities or Third Party Trust Preferred Securities (those are the bonds chopped up by the investment banks).

Corporate bonds are getting more attention now than at any time I can remember since the Michael Milken junk bond-era — people seem to be assured by their required coupon payments/dividends[10] and promised return of principal, and entranced by the relatively huge spread between corporate bonds and treasury bonds that means those dividends look abnormally large.

Of course, these are still bonds, and all the standard rules apply, among them: if we get deflation[11], that fixed coupon payment will look great in a few years, if we get significant inflation, it will look paltry … and, that good’ old gold[12] standard rule that seems to have been ignored for the last decade, only lend money to people who can pay it back.

So are you looking for a nice double digit yield from a cellular company, and want the security of a bond coupon that can’t be cut? Let us know if you think USM looks good to you, or if you’ve got other ideas for those who are searching for income.

And as always, if you’ve had any experience with Carla Pasternak’s High-Yield Investing, please click here to share your thoughts on that newsletter[13] — we’ve seen both good and bad reviews so far, but not enough folks have chimed in yet to get a really clear picture. Or if you like some other income-oriented newsletters, we’ve seen reviews of a great many of them, good and bad — you can see the list and their ratings here[14].

And have a great weekend — thanks for reading!

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