James H. Henry (212) 272-2741 03/09/98
Subject: Company Update
Industry: Telecommunications
BEAR, STEARNS & CO. INC.
EQUITY RESEARCH
Intermedia Communications, Inc.** (ICIX-$78-BUY)
Raising Our Price Target On Intermedia To $115 Per Share
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***Strategic Acquisitions & Organic Growth Have Dramatically
Expanded ICIX's Prospects.
***Data & Internet Deal With US West Could Only Be The Beginning
Of Strategic Deals.
***New Price Target Of $115 Per Share Implies Upside Of 50% Over
The Next 12 Months.
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PRO FORMA MARKET CAPITALIZATION $2,012.4 (MM)
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INVESTMENT VIEWPOINT
Raising Our Price Target On ICIX To $115 Per Share. We are
raising our price target on Intermedia Communications Inc. to
$115 per share from our previous target of $80 per share. Our
revised price target is predicated on a number of key factors
that have served to dramatically expand the company's market
addressable market opportunity, significantly strengthen its
competitive position in the marketplace, improve its cost
structure, and diminish the level of execution and financing risk
that is inherent in the story. We clearly believe that
Intermedia is the highest quality name in the CLEC group and is
without a doubt the company that we expect to be the primary
beneficiary of the $3.0 billion in Teleport equity float that
will need to be reallocated as we get closer to the closure of
the Teleport-AT&T transaction. We believe that Intermedia should
be considered as a core holding by a broad base of
telecommunications investors. As a well-managed, large-cap,
highly liquid company that will generate approximately $751
million in revenue and $94 million in EBITDA in 1998E, there are
few investors that Intermedia should not appeal to. The
following paragraphs briefly outline the reasons for our revised
target price:
1. Strong Financial & Operational Performance. Pro forma for
the acquisition of Shared Technologies Fairchild, LDS
Communications, and National Telecom, Intermedia exited 1997 with
a revenue run rate of $676.5 million, 3,395 employees, 92,209
business customers, 207,064 access lines, 3,499 buildings
connected to its network and a formidable sales machine of 617
people spread across 102 sales offices. Assuming the closure of
the transactions during the first half of 1998, we estimate that
Intermedia will post approximately $751 million in revenue and
$94 million in EBITDA, putting it only behind Teleport (when
combined with ACC Corp.) as the largest and most profitable
company in the CLEC group. From this base, we expect Intermedia
to deliver an internally generated revenue growth rate of 30%
over the next 5 years, with EBITDA growing at compound annual
rate well in excess of 100% during that same period. In an
environment where investors are increasingly focused on financial
performance in addition to strategic asset value, Intermedia is
at the forefront of the industry. Table 1 outlines our 5-year
revenue and EBITDA projections for the company.
Table 1. Revenue & EBITDA Projections For Intermedia ($ in millions)
Revenue 1997A 1998E 1999E 2000E 2001E 2002E
Dedicated 19.0 24.9 28.6 32.9 37.9 43.5
Switched 136.1 558.7 745.4 1,029.5 1,317.6 1,624.0
Data/Internet 92.8 167.2 252.1 371.5 523.2 669.2
Total 247.9 750.7 1,026.0 1,433.9 1,879.1 2,336.1
EBITDA (49.8) 94.2 182.0 311.1 484.2 638.2
Margin (20.1)% 12.5% 17.7% 21.7% 25.8% 27.3%
Source: Bear, Stearns & Co. Inc.
2. Enhanced Ability To Address A Larger Market. As a result of
its organic expansion and strategic acquisitions, Intermedia is
now able to directly address the $35 billion market for business
local, long distance, data, and Internet services within a
targeted geography that we expect to grow to $55 billion by the
year 2005. While our initial projections had the company posting
only $2.5 billion in revenue in the year 2005, we now expect
Intermedia to generate approximately $4.0 billion in revenue in
the year 2005, implying business market penetration of 7.3%.
This uptick in our projections is the result of two factors:
First, a combination of organic growth along with strategic and
tactical acquisitions conducted by the company during 1997 grew
the company's revenue base more than four-fold from a run rate of
$160 million in 4Q96 to a pro forma run rate of $675 million in
4Q96. In addition, the acquisitions endowed Intermedia with
sales people and product capabilities that accelerate its time to
market and strengthen its position in the market. Second, the
company's 1997 results in its switched services business were
very strong and illustrated that it can ramp up access line sales
very quickly. The company went from a standing start to a run
rate of $100 million in only 4 quarters in its dialtone business,
and is seeing accelerating levels of growth today. Our
visibility into the future of this business which will be
Intermedia's primary growth driver looks very good.
3. Evolution From CLEC To ICP Offers Distinct Advantages.
Explicit in the strategic and tactical steps that Intermedia took
during 1997 was its attempt to fully evolve from a pureplay
Competitive Local Exchange Carrier (CLEC) into a full-service
Integrated Communications Provider (ICP). As an ICP, Intermedia
now boasts a best-in-class product portfolio that includes local,
long distance, enhanced data, Internet, and systems integration
services. We believe that the breadth and depth of this product
portfolio offers distinct advantages as it relates to revenue,
profitability, and customer retention. As an ICP, Intermedia
will be able to pump 4 separate revenue streams (referenced
above) over a single pipe into a customer's premises, offering
maximum leverage of its underlying network infrastructure. It
will also have a single sales agent selling four products,
providing maximum leverage of its sales machine. Moreover,
Intermedia should see lower churn in its customer base than other
carriers, given that it has been empirically proven that a
customer will stay with a carrier longer for each incremental
service that it sells. With a great product portfolio, a sales
machine 617 people strong (larger than any other in the CLEC
group except TCG), and excellent provisioning capabilities
through its systems integration group, we believe that Intermedia
will be a powerful force in the marketplace.
3. Significant New Partnering Opportunities Exist. While we
clearly believe that Intermedia can remain a very successful
independent entity for the foreseeable future, we also recognize
that it has many opportunities to partner with larger players.
Excellent evidence of this potential is the deal that Intermedia
recently signed with US West Communications pursuant to which
Intermedia will provide US West's !nterprise business customers
with data and Internet services. While the magnitude of any RBOC
deal and the pace at which it will proceed are difficult to
estimate, it is very clear that this deal has served to elevate
Intermedia's profile among the larger players in the telecom
industry. Conversations with management have indicated that
Intermedia has had direct enquiry from a number of domestic and
international heavyweights with respect to relationships in the
data and Internet business. With the recent petitions that
Ameritech, Bell Atlantic, and US West have made to the FCC for
permission to construct next-generation data networks and carry
traffic on an interLATA basis within their own regions, we
believe that the RBOCs have tipped their hands as to what one of
their primary initiatives will be going forward. As such, it
would be hard to miss the fact that Intermedia already possesses
a state-of-the-art next generation network today and is ideally
suited to helping the RBOCs get a head start in the data and
Internet business. Whether you look at Intermedia's prospects as
a standalone entity or its potential attractiveness to a larger
player, the company's future clearly looks bright.
4. Intermedia Offers Investors A Compelling Valuation. Our new
year-end 1998 price target of $115 per share is based on a
combination of our discounted cash flow (DCF) valuation and our
gross PP&E valuation. Our DCF analysis yields a target price of
$120 per share based on terminal year 2005 revenue of $4.0
billion, EBITDA of $1.1 billion, an EBITDA multiple of 10.0x, a
discount rate of 14.0%, and a public market discount of 20%. We
reduced our discount rate from 15% to 14% to reflect the
company's lower cost of capital as well as the diminished risk
associated with the execution of its business plan as evidenced
by its results during the past 4 quarters. From a gross PP&E
perspective, we believe that Intermedia will trade at 5.0x is
projected year-end 1998 gross PP&E of $905 million, for an
enterprise value of $4.5 billion. After backing out $2.1 billion
in pro forma debt and adding back $400 million of pro forma cash,
we arrive at an equity value of $110 per share. From a relative
valuation perspective, pro forma for its acquisitions, Intermedia
is trading at 4.9x 1998E revenue and 5.5x gross PP&E versus a
CLEC group average of 10.8x and 6.3x, respectively.
Companies Mentioned:
Ameritech (AIT-$44 15/16)
Bell Atlantic (BEL-$95 5/16)
Shared Technologies Fairchild (STCH-$14 7/8)
US West (USW-$53 1/2)
Stocks priced February 25, 1998.
*Bear, Stearns & Co. Inc. is a market maker in the security of
this company and may have a long or short position in the
security.
*Within the past three years, Bear, Stearns & Co. Inc. or one of
its affiliates was the manager (co-manager) of a public offering
of securities of this company and/or has performed other banking
services for which it has received a fee.
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*
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agreement or any information about any transaction, customer account or
account
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