Monday, April 30, 2007

Dobson Communications--Hang Up & Sell.

US wireless operator Dobson Communications (DCEL-$9.30), which offers services under the name Cellular One in 70 markets in 17 states, primarily in rural and suburban areas, was started as a family business by E.R. and Ruby Dobson, who founded the Company as Dobson Telephone Company in 1957.

Today, after two reorganizations, the scions of E.R. and Ruby have finally handed the reigns of day-to-day management over to outsiders, but as they still own more than 56 percent of the total voting power of the outstanding common stock, the Company is still an open cash register to them:
  • Everett R. Dobson serves as executive Chairman of the Board of Directors and received a compensation package (salary, cash bonus, options) of $1.48 million in fiscal 2006.
  • Stephen T. Dobson has served as a Director since 1990 and took home $211,865 in director fees/stock options in fiscal 2006.
  • DCCLP, a limited partnership controlled by brothers, Everett and Stephen, owns a 90% interest in a limited liability company that owns a multi-building office complex in Oklahoma City. As of April 24, 2007, DCCLP owned shares of common stock representing more than 56% of the total voting power of Dobson’s outstanding common stock. The Company began occupying a significant portion of this complex as its corporate headquarters effective May 1, 2001. The lease is a 15-year, triple-net lease with an annual rental of $3.3 million.
  • Eric and Stephen are also executive officers of DWL Holding Company, which through subsidiaries provides various telecommunications services to Dobson on a fee basis. Dobson purchased $4.3 million of services from DWL, or its subsidiaries, during the year ended December 31, 2006. DCCLP is a principal shareholder of DWL.
  • Until February 18, 2004, their father, Russell L. Dobson was one of Dobson’s directors, too, where he served on the Compensation Committee! When he retired from the Board the Company paid to him a $150,000 ‘retirement stipend.’ The Company continues to maintain a ‘consulting agreement’ with Russell. Digging into long-buried regulatory filings, we unearthed that “in exchange for Mr. Dobson's services” he receives monthly compensation of $15,000 and insurance benefits commensurate with Dobson’s employee plan (effective through August 31, 2008).

Unfortunately, hanging onto the Dobson name has come with a higher-than expected price for past shareholders.

In February 2002, Logix Communications—a subsidiary business organized in the late 1990s to offer a variety of telecommunications services to medium-sized business customers (and borne as part of a first reorganization of Dobson Communications)— filed for voluntary Chapter 11 bankruptcy protection and reorganization. [Everett Dobson served as chairman and CEO of Logix until 1999.]

Logix emerged from reorganization in April 2003, having since been renamed Intelleq Communications and the aforementioned DWL Holding Co.

In fiscal 2006, Dobson reported its first profit in more than a decade! The Company earned net income of $4.2 million, or 2 cents per share, compared with a loss of $130.7 million, or 90 cents per share, in 2005. [Ed. note. Results in 2006 benefited from a 6 cent gain from a one-time tax benefit.]

Sales rose 8 percent to $1.27 billion from $1.18 billion.

Three key metrics showed improvement in fiscal 2006: (1) Gross customer adds rose to 538,500, up from $507,500 in fiscal 2005; (2) average monthly service revenue per customer rose to $48.48, up from $45.26 in the prior year (principally the result of the continued migration of customers to Dobson’s GSM offerings); and, (3) average monthly post-paid churn fell to 1.9% from 2.5% in 2005.

Management believes that the focus of owning and operating a mix of rural and suburban wireless systems will provide strong growth opportunities because these systems currently have lower penetration rates, higher customer growth rates and less competition for customers than wireless systems located in larger metropolitan areas.

In addition, the Company is looking to drive ARPU (average revenue per customer) growth through GSM migration (and the introduction of enhanced wireless services, giving its customers the ability to access the Internet, to send and receive pictures and video, and to download games and music). Dobson has deployed a GSM network in all of its markets and is currently marketing GSM products. Its average ARPU, for GSM customers has proven to be higher than ARPU from Time Division Multiple Access, or TDMA.

As of December 31, 2006, 89.2% of customers were using Dobson’s GSM network.

As of February 14, 2007, Dobson’s wireless systems covered a total population of 12.7 million in 17 states, with approximately 1.7 million customers (with an aggregate market penetration of 13.2 percent).

Although most of Dobson’s markets have demonstrated positive demographic growth trends and generally have maintained a high population density relative to other rural and suburban markets, customers have—on average—three other wireless service competitors to choose among. In various markets, these companies include, but are not limited to, ACS of Alaska, Alltel, Cingular Wireless, Rural Cellular, Sprint Nextel, T-Mobile, US Cellular and Verizon Wireless.

Given Dobson’s small size, the Company remains highly dependent upon the traffic patterns of its roaming partners for top-line growth. Roaming revenue accounted for approximately 22 percent of operating revenue for the year ended December 31, 2006. Cingular Wireless and T-Mobile accounted for approximately 84 percent and 13 percent, respectively, of Dobson’s roaming traffic for the year ended December 31, 2006.

Year-over-year subscription growth—due to the need for the continued expansion and upgrade of the wireless system—has been costly. The Company remains highly leveraged, with net debt five times EBITDA. Total borrowings were more than 13.6 times stockholder equity! And debt-service was a meager 1.07 times operating income (before interest and taxes).

Pinching future liquidity, too, are total contractual cash obligations (debt securities, operating leases, and purchase goods/services obligations) of $77.7 million, $159.5 million, and $1.8 billion in fiscal 2007, fiscal 2008-2009, and 2010-2011, respectively.

ROA and ROE were 0.4% and 2.3%, respectively in fiscal 2006. [Ed. note. Risk free return on a five-year treasury is about 4.60 percent.]

In our view, selling for an enterprise value of more than 8 times expected EBITDA of $485 million, the share price of Dobson already discounts an expected improvement in finacial improvement—from subscriber gains and slightly higher APRU—in fiscal 2007. Verizon Communications Inc. (VZ-$37.89) and Sprint-Nextel (S-$20.21), by comparison are priced at EV/EBITDA of 4.8 times and 6.2 times, respectively.

Take the money and run! The only shareholders who will continue to make out in 2007 have the last name, Dobson.

Editor David J. Phillips does not hold a financial interest in any of the stocks mentioned in this article. The 10Q Detective has a Full Disclosure policy.

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