Shareholders of MetroPCS Communications, Inc. (PCS) were greeted with a sharp increase in the share price in the latter half of November. The stock rallied largely as investors endorsed the company’s low cost business model.  PCS offers customers the ability to have unlimited cell phone minutes for a low price (usually $35 to $45 per month).  In addition, customers do not have to sign a long-term contract or have their credit checked.

In an environment that has been difficult for consumers, this model appears to be gaining traction.  Currently the major carriers charge an average of more than $100 per month for similar unlimited calling plans.  But one big difference is the network coverage.  Sprint (S), AT&T (T), Verizon (VZ) and T-Mobile all have networks that span the entire US (and many areas abroad).  While PCS has signed a mutual agreement with Leap Wireless International (LEAP) to offer roaming services for each company’s customers, the coverage is still limited.

PCS is working to expand that network by concentrating on large metropolitan cities where it can get the most efficient growth out of capital expenditures.  In 2008, the company was able to launch service in its first Northeast city – Philadelphia.  Management expects to roll out New York City and Boston sometime during 2009.  While the company will likely spend $700 to 900 million in capital expenditures, management expects to add 1.4 to 1.7 million new customers.  2009 should also mark a transition for the company as they begin to operate at cash-flow positive levels.

Looking at the company’s balance sheet, they ended the third quarter with cash of roughly $1.02 billion.  This appears relatively healthy, but keep in mind that the company will spend the majority of this as it pursues expansion plans.  At the same time, PCS is carrying a hefty debt load of roughly $3 billion.  This financial leverage increases risk for shareholders.  If cash-flow does not come in as expected, the company could be forced to raise capital (adding to debt or diluting shareholders), or to cut back on expansion plans.  Although the balance sheet shows total shareholders equity of $2.02 billion, assets include FCC licenses which are valued at $2.4 billion.  It is difficult to determine whether these licenses would carry the same value if they were sold on the open market.

Ironically, success by MetroPCS could become its greatest liability. As the business model begins to show success and gain market share, the larger wireless companies will certainly step up the competition.  Currently the higher cost national firms are able to maintain pricing power because customers are willing to pay.  But if the business begins to shift towards low priced offerings, you can expect to see Spring, AT&T, Verizon and T-Mobile all cut their rates.  Since a national network is superior to coverage in a certain number of cities, the big firms will still have a competitive advantage.

MetroPCS is currently trading at 31 times 2008 expected earnings and more than 20 times 2009 expectations.  While bulls argue that the growth justifies the high price, I would submit that this growth is in jeopardy due not only to a difficult economy, but also due to the potential for strong competition.  So at this point, the recent run-up in price seems to give those willing to short the stock an attractive entry.  If you are currently holding the stock, I would think carefully about lightening your exposure at this point.  Despite the strong start to the market the first day of trading, risk is still significant and could negatively effect this stock.

FD: Author does not have a position in PCS
PCS Notes
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