TAKING STOCK

Dear Mr. Berko:

I was visiting an old friend several months ago in Idletown, Pa., and was told that his phone company was called Commonwealth Telephone Enterprises Inc. He says the service is excellent, offering Internet access and all the other amenities expected from a large phone company. Please tell me if it would be a good company to add to my portfolio. Because it sells at $41 a share, I would like to buy $1,600 worth, or about 40 shares.

G.K.  Harrisburg, Pa.

Dear G.K.:

Commonwealth Telephone Enterprises Inc. (CTCO-$41) serves some 450,000 people in a 5,000-square-mile area of eastern Pennsylvania. Thanks to the mountainous topography in its region, CTCO is virtually immune to the wireless competition that is eroding revenues and profits of its much larger brethren.

CTCO has minimal debt (just $75 million) and has a paid-for, state-of-the-art digital switching that uses an advanced fiber-optic network with host/remote architecture. As a rural local exchange carrier, approximately 60 percent of its revenues are, by federal law, exempt from competition. These exempt revenues derive from long-distance charges to CTCO networks, monthly fees for basic local use and enhanced revenue services (call waiting, call forwarding, etc.).

CTCO also operates as a competitive local exchange (27 percent of revenues) that borders its RLEC operations. CTCO provides local, toll, broadband, data and high-speed Internet services to 1.5 million users. This customer base consists primarily of colleges, hospitals and business users. The remaining 13 percent of CTCO’s revenues are from digital subscriber line service to 49,000 subscribers.

CTCO’s revenues have grown nicely since 1997, from $197 million to $319 million this year. Earnings though have been bouncing around like a football: up nicely in 1997 to 97 cents, way down in 1998 to 35 cents, up nicely in 1999 to 95 cents, crashing to a $2.46 loss in 2000, up again in 2001 to $1.83 and again last year to $2.41. Confusing, that! However, if management doesn’t trip, slip, sprawl or spill, revenues should easily grow by 5 percent a year.

The company continues to offer a wide array of new services to its steady customer base, primarily colleges, small businesses, hospitals, municipalities and other government organizations in its very secure service area. If management keeps its eye on the ball, its nose to the grindstone and its shoulder to the wheel, earnings should advance modestly over the foreseeable future.

Compared to other telephone companies, CTCO has a strong balance sheet, its net profit margins are middling, its return on assets are a mite less than mediocre, gross margins are this side of ho-hum and its five-year growth rate is underwhelming.

I like CTCO, I really do. The stock is way down from the $60s, where it traded a few years ago during the high-tech heyday. At $41, CTCO trades at 16 times expected 2003 earnings of $2.51 a share, and I think that’s a tad too high to reach. The price may also be a bit rich considering the fact that management is niggardly with shareholder money.

CTCO has a strong cash flow of close to $6 a share – almost $130 million, or 40 percent of revenues – and this little baby has never paid a dividend. Commonwealth is an unexceptionally managed company, operating in a dandy service area, with practically no competition and all the advanced technology it could want already in place. So if management minds its p’s and q’s, CTCO will inch forward each quarter and in three years it should be a foot ahead. Frankly, I see absolutely no compelling reason to own the stock.

Please address your financial questions to Malcolm Berko, P.O. Box 1416, Boca Raton, FL 33429 or visit his Web site at www.berkoradio.com.  (c) Copley News Service  Visit Copley News Service at www.copleynews.com.