Two Views- Kaufman and Merrill
KAUFMAN
Exodus Communications (EXDS $0.17, Intraday) is in receivership (Chapter 11).
We believe that fear of the Exodus situation is driving irrational selling in
GX shares.
-Global Crossing has not counted the sale of 108 million EXDS shares in its
funding assumptions. We still believe that Global Crossing is fully funded to
positive free cash flow in 2003.
-The company is guarantor of $70 million in annual leases for data centers of
Globalcenter sold to Exodus in 2000. The $70 million per year exposure over an
average lease life of 10 years is a worst-case scenario. They represent
nothing more than original leases of Globalcenter.
-Global Crossing is a guarantor of the leases but Exodus is the primary
guarantor and, of course, on the hook if they restructure or sell the company.
-The company has met with Cushman Wakefield and looked at all sites. They have
been advised that they could reduce exposure to $25 million/year through
subleasing/negotiations, etc. That assessment was made before the WTC tragedy.
Some of those centers were in lower Manhattan, which now have new value
attached to them (lower).
-Net/net: 5-18 years leases with average of 10-year lives = $25 million x 10
years = $250 million cumulative exposure over 10 years. This is a small sum,
albeit a cash outflow, for Global Crossing that does not break its back,
assuming it becomes an issue.
-Exodus is still operating and plans to comeback either on its own or through
sale to the likes of Cable & Wireless (CWP $12.10, Intraday), which would make
all this moot.
-With regard to revenue exposure to Global Crossing, $200 million was prepaid
by Exodus for bandwidth through 2002. Revenue impact to 2001 and 2002 are
immaterial to the extent that Exodus uses less bandwidth due to attrition of
its business.
-By 2003, Exodus either comes back to life or could be sold to a large telco,
which could magnify the opportunity for Global Crossing to sell bandwidth. We
think we will know the outcome for Exodus by 2003. Even if Exodus is torn
apart, its customers will go somewhere and will need capacity and Global
Crossing will get its fair share of that business. If someone buys Exodus,
that company cannot terminate the network contract between Exodus and Global
Crossing (which gives Global Crossing over half Exodus's bandwidth business)
for two years following the change of control.
-No matter how you slice it, in our view Global Crossing is a real winner.
Rumors of others, like Tycom (TCM $7.44, Intraday), undercutting Global
Crossing in the subsea market, and speculation that Exodus's failure will
destroy the company have no merit. According to our channel checks, Tycom is
focusing mostly on subsea and not working on backhaul, which limits that
company's market. Exodus, for a variety of issues mentioned above, does not
make or break Global Crossing's income statement or balance sheet and still
could be a sizable opportunity if/when it reorganizes or auctions itself to the
highest bidder. Other companies that lack worldwide city-to-city networks
cannot service the largest companies telcos and institutions in the world.
Global Crossing has the full package of terrestrial-subsea-terrestrial
infrastructure that positions it to dominate the enterprise and capacity
markets. Other companies that lack end-to-end connectivity cannot offer IRUs
to largest customers and are pushed to meet numbers by serving small customers
which, it so happens, want short-term leases. Global Crossing is seeing
strength in its IRU business still because of this network-based competitive
advantage.
-As an aside, we would like to point out Global Crossing has a card many may
not be considering - the potential sale of its Global Marine business, which it
bought for 800 million (US$1.5-1.6 billion). It generates $700 million in
revenues and $165 million in EBITDA and could fetch as much as US$1 billion
even in this market, which could overfund the company and pave the way for
Global Crossing to consolidate the fragmented telco marketplace.
-Global Crossing is inexpensive at an EV of $11.3 billion, 1.7x 2001E cash
revenues and 5.9x 2001E cash EBITDA. We reiterate our BUY rating and $16 price
target.
MERRILL
RESEARCH COMMENT: 30227029
SEP 27, 2001
Telecommunication
Neutral Ratings on All Leveraged Bandwidth Co's
*******************************************************************************
Merrill Lynch, as a full-service firm, has or may have business relationships,
including investment banking relationships, with the companies in this report.
*******************************************************************************
Reason for Report: Lowering Ratings
RC-TOPIC:Global Crossing (GX; $2.03; D-3-1-9 To D-3-3-9)
Reported EPS (Dec): 2000A d$2.69; 2001E d$3.47; 2002E d$4.02
RC-TOPIC:Asia Global Crossing (AX; $2.60; D-1-1-9 To D-3-3-9)
Reported EPS (Dec): 2000A d$0.27; 2001E d$0.65; 2002E d$0.54
o We are lowering our ratings on Global Crossing (long term Buy to long term
Neutral) and Asia Global Crossing (intermediate and long term Buy to
intermediate and long term Neutral). As a result we now have intermediate and
long term Neutral ratings on all of the bandwidth companies in our coverage
universe with significant net debt.
o Economic weakness, over extended balance sheets and nearly closed capital
markets have hurt the outlook for all of these companies and crucially, the
financial health of their customers. Our current models show GX as "fully
funded", but this is contingent upon several crucial assumptions, including: 1)
capacity price erosion moderating significantly (i.e., from around 30% p.a. to
around 20% p.a.) to sustain revenue growth as volume growth slows (industry bit
growth is down from 100%/year to maybe 60%/year according to mgt) 2) continued
share gains from incumbents especially in the commercial segment of the market
3) the mix of volume growth, pricing and market share gains referenced above
driving parent cash revenue growth at 18%/year from 2001-03, and 4) customer
confidence in GX and AX's financial viability (which as we have seen with other
emerging telecom companies can become negatively self-fulfilling at sub-$3.00
share prices).
o Upon re-evaluation of each of these risks, we conclude that operational
funding sources could erode more quickly in a post 11th September environment,
leaving shares of GX and AX, and indeed shares of all leveraged carriers highly
exposed. Witness Monday's profit warning by Time Warner Telecom ... a hitherto
"strong" emerging carrier whose shares have fallen 56% since markets reopened
last week.
The US recession and the Sept 11(**th) attacks have raised equity risk
premiums, driving widespread "housecleaning" by more cautious investors in
favor of larger, more mature telecom businesses, at the expense of most all
emerging names. Hence, we are adopting an even more cautious stance on all
emerging carriers with significant net debt. These including Global Crossing,
Asia Global Crossing and their peers in the bandwidth space. Meanwhile our
colleague Ken Hoexter has near term Neutral or Reduce recommendations on all
the competitive local carriers under his coverage with the exception of
Allegiance (ALGX; $3.92; D-1-1-9), Network Plus (NPLS; $1.51; D-2-2-9) and GT
Group Telecom (YGTGB; $1.71; D-2-1-9).
o
RC-TOPIC:Ratings Lowered
We are lowering our ratings on Global Crossing (long term Buy to long term
Neutral) and Asia Global Crossing (intermediate and long term Buy to
intermediate and long term Neutral).
Global Crossing
Global Crossing has assembled a unique portfolio of global network assets, in
our view, but the company faces several crucial challenges which prompt our
change of long term view. These include:
o Global economic weakness (technology and internet related spending are
especially hard hit),
o Deteriorating customer quality (witness Exodus' bankruptcy - but also the
stresses on incumbent carriers in Europe to cut capex),
o Sub-$3.00 share price (raises customer concerns over financial viability ..
which can quickly become self-fulfilling),
o Limited access to additional public market capital (applies to all
emerging telcos),
o Investor "flight to quality" (with quality defined as large revenue bases,
strong balance sheets and positive free cash flow).
Each of these factors has worsened for Global Crossing since the WTC attacks on
Sept 11(**th). Moreover, the time horizon for these risk has also lengthened,
in our view. As such, near term risks have stretched into the long term ...
prompting us to reduce our long term rating on Global Crossing to Neutral.
Funding Outlook
At 2Q 2001, Global Crossing had cash of $1.9B, restricted cash of $167MM and
available credit facility of $1.7B. Available liquidity thus totaled $3.8B.
Debt consisted of short term debt of $61MM, long term debt of $6B and
convertible preference shares of $3.2B. Set against interest obligations of
around $500MM p.a. and preference share dividends of around $240MM p.a., Global
Crossing would appear to be in little danger of missing interest payments for
over a year. However, we still remain concerned that 1) cash "trapped" at Asia
Global Crossing is unavailable for servicing parent obligations, and 2) a
sudden drop off in demand for bandwidth could quickly erode operating cash
inflows.
RC-TABLE0164001500
Table 1: Global Crossing Liquidity- June 2001
US$MM Consolidated Ex-Asia
Cash 1923 1256
Restricted Cash 167 31
Available Credit Facility 1700 1654
Total Liquidity 3790 2941
ST Debt 61 2
LT Debt 6048 4947
Total Debt 6109 4949
Net Debt 4019 3662
Convertible Preference Shares 3159 3159
Net Debt + Prefs 7178 6821
Source: Global Crossing 10-Q, Asia Global Crossing 10-Q
RC-T-END:
Asia Global Crossing
Asia Global Crossing is also assembling a unique asset portfolio in Asia, where
pent up demand and long term demand are quite strong. However, AX's high
exposure to emerging markets raises overall business risk in this time of
global unrest. Several Asian markets are in deepening recessions and China
remains officially closed to foreign telcos. We believe revenue visibility has
worsened (from an already murky state due to complex accounting) and imputed
risk premiums have risen. Moroever, Asia Global Crossing is inevitably linked
to the same challenges as the parent company described above, i.e., if Global
Crossing was unable to draw upon credit facilities in a time of need, Asia
Global Crossing likely would not be far behind, in our view. Note that, Asia
Global Crossing has a $400MM stand-by facility (as yet untouched) with the
parent company. Having concluded that the long term outlook for Global
Crossing has materially deteriorated, we cannot logically and consistently take
a rosier view for the subsidiary - despite what we acknowledge is in some
respects a superior operating and competitive environment in its region.
Hence, we are reducing our intermediate and long term rating on Asia Global
Crossing to Neutral following the change to the parent.
Funding Outlook
As with the parent, our model shows Asia Global Crossing as "fully funded".
However, as we noted above $400MM portion of its cushion is provided directly
by the parent company in the form of a subordinated credit facility. We also
suspect that if the parent were to encounter material financial pressure, Asia
Global Crossing shares would fall in sympathy, particularly as minority
investor concerns rise that Global Crossing will attempt to extract any cash
"trapped" at the subsidiary. That said, the key positive for Asia Global
Crossing is its higher pricing umbrella and less competitive core market ... suc
that Asia Global Crossing could reach free cash flow breakeven as early as late
2002E. Even then, Asia Global Crossing shares will have a hard time escaping
investor concerns about the parent's deteriorated outlook, in our view.
RC-TABLE0161001500
Table 2: Asia Global Crossing Liquidity
US$MM June 2001
Cash 667
Restricted Cash 136
Available Bank Facility 46
Available Parent Facility 400
Total Liquidity 1249
ST Debt 59
LT Debt 1101
Total Debt 1160
Net Debt 357
Source: Asia Global Crossing 10-Q
RC-T-END:
Neutral on the Entire Group
We are now Neutral in both intermediate and long term for all of the leveraged
bandwidth companies. (Our colleague Ken Hoexter has Neutral or lowered
recommendations on all the CLECs bar Allegiance, GT Group Telecom and Network
Plus.) Each of the risk factors discussed above also apply to the other
leveraged next generation LD network operators, and we now have Neutral ratings
on the entire group. Besides GX and AX, this group includes Level3 (LVLT,
$3.52, D-3-3-9), Williams Communications (WCG, $1.23, D-3-3-9). The only
bandwidth related companies which we rate more favorably are Qwest (Q, $17.25,
C-1-1-7), which has incumbent scale and an investment grade credit rating, and
TyCom (TCM, $7.47, D-2-1-9), which has net cash and a financially strong parent
company. Our rating on Broadwing is Neutral in the intermediate term, and Buy
in the long term, reflecting the company's strong ILEC cash flows and shorter
time to free cash flow breakeven (likely within the next 12 months).
Whilst financial concerns now dominate we still believe there is logic to the
Global Crossing business model. Should the company be able to recapitalize
itself, for example via a private equity injection possible related to a debt
buy back, we would look to reassess our rating. |
