Inter-Tel (INTL 23.32) - Peer Perform Initiating Coverage (what does this mean? Can we expect them to trade like LUcent?- now 86 cents???)
BEAR, STEARNS & CO. INC.
EQUITY RESEARCH
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Key Points
*** We are initiating coverage of Inter-Tel with a "Peer Perform " rating.
The
company, with a market capitalization of just under $600 million, is a
leading provider of business communication systems to small/medium sized
enterprises. Products include private branch exchanges (PBXs), voice
mail/processing systems, IP enabled phones, CTI (computer telephony
integration) and networking applications. We are forecasting long term
earnings and revenue growth of around 10%-12%. For 2002, we are expecting
revenues and EPS of $382 million and $1.06, respectively. For 2003, we
expect revenues and EPS of $420 million and $1.28, respectively.
*** Positive Factors - Inter-Tel has been consistently taking market share
against larger vendors with a conservative but effective strategy. Within
Inter-Tel's main addressable market (101-400 lines - circa $1.3 billion
market), the company has gone from approximately 14% market share in 1997
to 20% in 2001. Distribution and sales channels continue to expand as the
company moves into new product and geographic areas. Management has a
strong stake in the business with 25% ownership. The company has a
relatively stable revenue stream and generates free cash flow, unlike most
of other vendors in the communications equipment space.
*** The Risks - Inter-Tel is a small company relative to its major
competitors. If Avaya and Nortel were to get their issues under control,
they may find more resources to allocate into Inter-Tel's focus area. The
macro economy is another factor. If the consumer rolls over and the
economy double dips in the second half / beginning of 2003, then basically
every enterprise equipment player will be hurt. Convergence is also a
risk. Just as there was an upgrade from analog to digital there will be
an upgrade from the current circuit switched architecture to IP. The
question is will some of the data networking companies such as Cisco have
a large advantage as networks truly converge. Lastly, Inter-Tel typically
generates approximately 25% of its revenues from leases. The company
holds some of these leases on the balance but also sells some with
recourse. On and off balance sheet, the portfolio was approximately $252
million at the end of last quarter. We do not believe this is a major
issue as the company is adequately provisioned (typically 4%-6%) of the
portfolio. However, in any slowdown scenario, the company could be
adversely affected.
*** From a valuation perspective, Inter-Tel trades at 1.6x 2002E revenues and
1.4x 2003E revenues. From a P/E perspective, Inter-Tel trades at 22.0x
2002E earnings and 18.2x 2003E earnings. In terms of competitors, the
peer group trades at approximately 18.1x 2003E earnings and 1.4x 2003E
revenues. On a discounted cash flow basis, Inter-Tel is discounting just
under 11% growth. We believe these assumptions are reasonable given the
relative small size of the company and new market opportunities. Other
assumptions include an operating margin of 11%, 5% terminal growth, 10%
WACC and 10-YR CAP.
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GAAP Estimates P/E
Q1 Mar Q2 Jun Q3 Sep Q4 Dec Year Year
2000 $0.18 $0.13 $0.31 $0.36 $0.98 23.8x
2001 $0.19 $0.20 $0.20 $0.26 $0.86 27.1x
2002 $0.24 $0.27 $0.25 $0.30 $1.06 22.0x
2003 $1.28 18.2x
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**PLEASE REFER TO THE LAST PAGE OF THIS REPORT FOR IMPORTANT DISCLOSURE
INFORMATION
We are initiating coverage of Inter-Tel with a "Peer Perform " rating. The
company, with a market capitalization of just under $600 million and 2002E
revenues of $382 million, is a leading provider of business communication
systems to small/medium sized enterprises. Products include private branch
exchanges (PBXs), voice mail/processing systems, IP enabled phones, CTI
(computer telephony integration) and networking applications. Inter-Tel has
been consistently taking market share against larger vendors with a
conservative but effective strategy. Management has a strong stake in the
business, with 25% ownership. The company has a relatively stable revenue
stream and generates free cash flow, unlike most of other vendors in the
communications equipment space. We are forecasting long term earnings and
revenue growth of around 10%-12%. For 2002, we are expecting revenues and EPS
of $382 million and $1.06, respectively. For 2003, we expect revenues and EPS
of $420 million and $1.28, respectively.
Inter-Tel has several ways to grow the business. Historically, the company has
been focused on systems between 50-400 lines. Growth will likely come from
increased penetration in the SME (small medium size enterprises) as well as the
movement into the larger enterprise market with products that address over 400
lines, an area that has not been a focus for the company. Inter-Tel has yet to
truly penetrate the international market on any level (generates over 97% of
revenues from the domestic market). Therefore, the international market
represents another area that the company could focus on in the future. Buying
distribution channels has been another way to grow the top line. The company
has a history of buying distributors for reasonable prices and garnering a
large increase in sales (25%-35%) in the first year. Lastly, growth will also
come from larger upgrade cycles such as that from the current circuit switched
architecture to voice over IP and some larger software upgrades. All of Inter-
Tel's products since 1998 allow for IP capabilities or upgrades.
Inter-Tel has a relatively stable revenue stream due to the replacement market,
add-ons and recurring sales. Currently, the average life of a PBX system is
around 8-12 years. Software upgrades (recurring revenue stream) are usually
purchased every 2 years. Other sales come from maintenance and add-ons.
Overall, Inter-Tel has solid relative visibility because over 45% of revenues
come from this recurring business. The market that Inter-Tel addresses should
be more stable in the near term also. As mentioned by several carriers such as
BellSouth and competitors of Inter-Tel such as Avaya, the small to medium sized
IT market has held up slightly better than the large enterprise market. When
the economy finally turns, the small to medium sized business are also likely
to start spending before the larger enterprises.
In 2002, we expect revenues of $382 million and EPS of $1.06. These
expectations equate to y/y growth of just over 2% on the top line and 24% on
the bottom line. Margin improvement will come from both gross margin
enhancements and operating expense reductions relative to sales. For 3Q02, we
expect revenues and EPS of $95 million and $.25, respectively. Third quarter
tends to be seasonally weak given the summer slowdown. The fourth quarter
tends to be seasonally the strongest as salespeople push to make quotas and IT
executives spend what's left of their budget (typical scenario, but in a
slowdown total budgets may not be completely spent). For 4Q02, we are
forecasting a 6% sequential increase to just over $100 million for Inter-Tel
with EPS of $.30.
From a valuation perspective, Inter-Tel trades at 1.6x 2002E revenues and 1.4x
2003E revenues. From a P/E perspective, Inter-Tel trades at 22.0x 2002E
earnings and 18.2x 2003E earnings. On a discounted cash flow basis, Inter-Tel
is discounting just under 11% long term growth. We believe these assumptions
are reasonable given the relatively small size of the company and new market
opportunities. Other assumptions include an operating margin of 11%, 5%
terminal growth, 10% WACC and 10-YR CAP. Over the past five years, average
revenue growth has been 15% with average EPS growth of 17%.
The End Market And Inter-Tel's Position
Inter-Tel is a leading provider of business communication systems to
small/medium sized enterprises. Products include private branch exchanges
(PBXs), voice mail/processing systems, IP enabled phones, CTI and networking
applications. Inter-Tel has been consistently taking market share against
larger vendors with a conservative but effective strategy.
Inter-Tel has historically been focused on systems between 50-400 lines.
Growth will likely come from increased penetration in the SME (small medium
size enterprises) as well as the movement into the larger enterprise market
with products that address over 400 lines, an area that has not been a focus
for the company.
The market size for PBXs with lines between 100-400 is approximately $1.3
billion. We expect growth of 4%-5% over the next several years for this
segment. We believe the market is fairly mature and will basically grow in-
line with GDP or slightly above given the prospects for a robust upgrade cycle
in the intermediate-term. Inter-Tel can garner more top-line growth from
picking up market share. For instance, if the company were to go to 23%-25%
share from 20% over the next 5 years then an incremental 3%-6% of growth can be
garnered per year. Although dramatic market share shifts do not occur rapidly
in the industry, we believe Inter-Tel is likely to pick up share for 2 reasons.
First, several upgrade cycles are on the horizon. These upgrade cycles may
create an opportunity to oust the incumbent vendor. Usually, incumbent vendors
are difficult to replace because large systems are bought and only software
upgrades are warranted for many years (10-12 years). As VoIP takes off (will
not gain significant traction for several years), more enterprises are likely
to make a larger upgrade of hardware and full systems creating an interesting
opportunity.
The smaller PBX and key telephone systems (<100) represents just under a $3
billion market. We expect growth of around 5% over the next several years for
this segment. The larger line market (>400) represents a slightly larger
market or around $1.4 billion. We expect growth of 3%-4% over the next several
years for this segment. With the new high end software release for the Axxess
product line, Inter-Tel should continue to gain traction in this area. Inter-
Tel currently has a small market share in these segments and could add another |
