Double Blind

I indirectly own shares in Verizon through my ownership of the Telecom Trust (symbol is TTH). I have this in my RRSP and this is a high-yielding trust as it has fractional ownership in high-yielding telecom stocks such as AT&T, Verizon, Bellsouth, etc. I also have no problem owning companies that are associated with the raw delivery of bandwidth to people’s homes, as I do not see this declining in the long term future. The expense ratio is 0.08 divided by the share price, or about 0.23% at present which means that the price of diversification is cheap.

Verizon has decided to distribute its directory publishing business (otherwise known as Superpages) to its shareholders in the form of another corporation, Idearc Inc. You have to wonder where they come up with these names. So for every 20 shares of Verizon that you owned, you would get 1 share of Idearc. Since my fractional ownership of Verizon consisted of roughly 109 shares, I received 5 shares of Idearc and some cash for the fractional portion.

I actually wish that the entire portion was given to me in the form of cash since now I have about $135 of stock in my account that will cost $29 in commissions to dispose of (Interactive Brokers with their dirt-cheap commissions hasn’t gotten into the RRSP game yet). In other words, those five shares of Idearc are total dead weight, although the company intends to give out $1.37/share a year in dividends, which is about a 5% yield at current prices. At least that $135 in dead equity is yielding better than a GIC (a 1-year cashable GIC is 3.8% at present).

Because of the commission ratio, it is financially stupid for me to sell the shares unless if I believe that the stock will drop 22% from current value.

So looking at the financials (careful: this is a large download), a certain number of disturbing things popped out at me like a firefly in a moonless sky:

When Verizon sent the company off on its way that it saddled it with $9.1 billion in debt. This debt costs $690 million a year to service.

The company has large operating margins. For the last 9 months ended September 2006, the firm pulled in $2.4 billion in revenues and operating income was $1.1 billion. This is insanely high profitability.

Their revenues are 95% derived from print product and is sector is in a clear decline. This is very disturbing since this suggests that they will get into a cash flow crunch when it comes to paying dividends and servicing their debt.

Paying a $1.37/share dividend at 146 million shares outstanding means paying out $200 million a year to shareholders. This will be about 40% of their net income after taxes, but more disturbing is that this fraction will very likely increase when their revenues are declining.

Assuming they want to service their debt with their remaining cash flow, they will be able to chip away at it with about $200M in 2007 if you assume their existing revenue declines continue at the same pace. This will reduce their debt from 9.1 billion to 8.9 billion, and save them about $9 million a year after-taxes. A step in the positive direction, but hardly spectacular. If they wanted to convert their debt into equity, the company’s market capitalization is only about four billion, so even if they did a secondary offering for 20% of their equity (which is a very generous fraction), they’ll only be able to take out 10% of their debt.

$1.52 billion of that debt will mature in 7 years, $4.75 billion will mature in 8 years and $2.85 billion will mature in 10 years. The first two are credit facilities while the third is an unsecured note. Presumably in three or four years the company will try to roll over the debt and this strongly depends on how slowly its revenue base erodes.

I am very concerned that the business is going to get eroded away like most traditional newsprint services – when I think about the last time I pulled open the yellow pages to look for something, it must have been at a friend’s place to look for a take-out pizza joint a couple years ago. Other than that I use Google for practically everything. I would think that the yellow pages faces a generational divide – anybody over the age of 35 would use the yellow pages, while anybody under would just use the internet.

That’s the problem with this company – Google is invading its space and there is absolutely nothing they can do about it other than try to compete with them electronically. Print businesses are going out of style due to the internet and Idearc is positioned very poorly.

I do not see a bright future financially for Idearc. While I am tempted to sell my 5 shares and take a 20% hit just on the commission alone, I will pray that I have missed something on my analysis and just hold tight. I will also pray that sometime between now and when they recapitalize their debt (wiping out their shareholders), I find a low-commission way to dump the shares or (heaven forbid) somebody with really deep pockets buys them out.

This entry was posted on Thursday, December 7th, 2006 and is filed under Finance. You can follow any responses to this entry through the RSS 2.0 feed. You can skip to the end and leave a response. Pinging is currently not allowed.