Array Digital Infrastructure's Fixed-Income Securities Undervalued Following T-Mobile Deal.

Array Digital Infrastructure's bond prices have dipped after the sale of UScellular to T-Mobile. This is seen as overdone and presents an opportunity for Telephone and Data Systems' preferred holders. The $4.4 billion deal with T-Mobile creates a chance for new investments and opportunities for both companies.

Following the sale of UScellular to T-Mobile (TMUS), Array Digital Infrastructure's (NYSE:AD) fixed-income securities have experienced a substantial dip, presenting new opportunities for holders of Telephone and Data Systems' (NYSE:TDS) preferreds. The $4.4 billion deal will see TDS flush with cash due to its 81% stake in the former fourth-largest full-service wireless carrier in the U.S. [1]

The sale of UScellular, now renamed Array Digital Infrastructure, has resulted in a significant reduction in AD's operational footprint. The company will focus on its tower business, remaining spectrum assets, and non-controlling investment interests. AD owned 4,400 towers as of the end of its fiscal 2025 second quarter and is set to close the sale of some of its spectrum assets to Verizon (VZ) and AT&T (T) for an aggregate of $2.01 billion. [1]

Critically, AD's outstanding bonds have sold off dramatically since the closing of the sale and the subsequent special dividend payment of $23 per share to its common shareholders. The company has divested a core asset, dramatically slimming its operational footprint, while paying out a substantial cash dividend to common shareholders. Bonds are priced for risk, and the sentiment here is that AD is a riskier corporate entity than USM. These have dipped by roughly 22% from their prior high at the start of August. [1]

Seeking Alpha Fixed Income Opportunity With UZE AD's 5.50% Senior Notes due 2070 (NYSE:UZE) pay out an annual coupon of $1.375 per note. UZE is currently trading hands for $17.10 per note, placing its yield on cost at 8.05%. For context, the Series VV preferreds pay out $1.5 per share annual coupon, which places their yield on cost at 7.98%. Hence, UZE offers 7 basis points more of yield but comes with a security that's higher up the capital stack. The contradiction is that a selloff of the bonds should have sparked a selloff of the preferreds, as a further special dividend to common shareholders of TDS is the most logical next step of the closure of the USM sale. [1]

Fitch Ratings As a holder of TDS' preferreds, I can move up the capital stack, lock in a higher yield on cost, and own a security trading at a greater discount to its liquidation value by simply selling out of VV and buying UZE. The bonds have a $25 per note liquidation value; hence, they're currently trading at a 31.6% discount to their liquidation value. The preferreds are trading for a 24.8% discount. Fitch last rated both of these non-investment grades at "BB+." This is just a notch below investment grade, but both securities were placed on rating watch negative ('RWN'). Hence, there could be a pending credit downgrade, with Fitch stating they expect to resolve the RWN once the transaction closes. [1]

The risk for UZE here is a credit quality downgrade, which could drive a further deepening of the current 380 basis points spread to the U.S. 10-year Treasury yield (US10Y). UZE has a recovery rating of "RR4" from Fitch, meaning that in an extreme event of default, investors can expect to recover 31% to 50% of current principal and related interest. The preferreds have a lower "RR6" rating, which means a recovery range of 0% to 10% of the current principal. TDS isn't going to default, but the underlying safer nature of the bonds should mean a lower yield. That's not the case here. [1]

Array Digital Infrastructure's total debt balance will fall from nearly $3 billion to around $700 million following the closure of the USM sale, with management targeting a 3x bank leverage ratio. Cash and cash equivalents, which ended the second quarter at $386 million, is also set for growth of roughly $34 million to $420 million. The underlying tower business is also materially less CapEx-intensive, with the $134 million spent year-to-date nearly all allocated to the now-sold wireless division. Towers generated second-quarter revenue of $62 million, up 7% over its year-ago comp and set for further growth following the signing of a master license agreement ('MLA') with T-Mobile that commits the carrier to 2,015 colocation sites for 15 years and extends the term on 600 existing colocations by 15 years. Operating income from Towers was positive at $21 million, growing by 11% over its year-ago comp, with adjusted EBITDA also positive at $34 million. AD also earned $42 million during the quarter from its equity in earnings of unconsolidated entities, a growth rate of 8% over its year-ago quarter. [1]

The market has reacted with fear to the special dividend, sparking a huge selloff of AD's fixed-income securities. These are now trading at a material discount to their liquidation values, with UZE offering a significant 8.05% yield on cost from a tower portfolio set for growth. I will look to swap out of my TDS preferreds into UZE, with a view to avoiding any future downside from a subsequent special dividend to TDS common shareholders. [1]

References:
[1] https://seekingalpha.com/article/4816954-array-digital-infrastructure-and-telephone-and-data-systems-closure-of-t-mobile-deal-creates-opportunities-with-bonds