Oppy on WCII [part 2]
REVENUE GROWTH
We look for WinStar to post about a 55% CAGR over the next three years with
data revenue growing at a minimum of 100% CAGR, local services at
approximately 50%, and information services at approximately 30% . We expect
international sales to contribute meaningfully to revenues by 2000 and to grow
at a CAGR exceeding 100%. We note that WinStar derives a de minimus portion
of its revenue from reciprocal compensation. Our model assumes no future
reciprocal compensation paytnents or additional acquisitions.
CLEC Services
CLEC service revenues, which include local, long distance, and data services,
have historically been primarily driven by the number of customer lines
installed and in service. These lines may be classified as either local,
comprising approximately 60% of the lines, or long distance or data, each
accounting for approximately 20%. Customers generally are billed a flat
monthly fee and/or a per-minute usage charge. As the CLEC revenue mix shifts
from predominantly voice to data, revenues will increasingly be driven by
customer connections and bits across a connection.
Based on revenues generated through December 1998, CLEC service revenues
reached an annual run rate in excess of $209.0 million compared with
approximately $46.0 million based on revenues generated in December 1997,
This revenue growth was led by strong Tine orders and installations. During
l99S, we saw a dramatic 292% increase in total lines, with installed lines
reaching 319,000. Tn 4098 alone, WinStar installed Sl,000 lines, with
approximately 30% of the lines being on-net. The revenue per line in 4Q98 was
approximately $50, which is about where it had been over the prior few
quarters. Where customers take local and long distance services
revenue/line/month approached $75.
We estimate that WinStar will generate $365 million in CLEC service revenues
in 1999. we look for customer lines to grow to S65,000 at the end of 1999+
Customer line growth should be driven by WinStar's continued national sales
and installation of local, long distance and Internet services to small and
medium size business customers, existing customer base, along with the rapidly
expanding broadband and large account business units and certain acquisitions.
Data services revenues generally are billed as a flat monthly charge for
capacity ordered. Revenue growth depends upon WinStar's addition of new
customers in existing markets, its sale of bundled services, its expansion
into new markets and its introduction of new services, such as broadband data
transmission and video conferencing.
We expect data services to become an increasing percentage of CLEC revenues
with the proliferation of local area networks and wide area networks, Internet
services and video enhanced services. We estimate that data services as a
percentage of total revenue will grow from approximately 25% in 401998 to
about 50% in 2002, at more than 100% CAGR over the next three years. The
ability to access and distribute data and other information quicicly is
critical to business, education and government entities. By utilizing
WinStar's broadband local networks and national data transport backbone,
WinStar should be able to deliver broadband data services to businesses and
other high-capacity users.
WinStar offers its customers a wide range of data telecommunications services
including Internet access services, dedicated and dial-up, as well as web
hosting and collocation services. A large portion of its Internet access
business is as a national services provider, providing Internet access to
other ISPS through its national Internet backbone.
Information Services
We forecast that Information Services revenues will grow approximately 20% in
1999 to $64 million. Information Services focuses on providing media content
to the broadcasting and computer industries.
Specifically, Information Services revenues consist of: (1) sales of content
and related services to traditional customers, such as cable networks and
radio stations; (2) sales to new media distribution channels, such as on~line
services; (3) advertising sales and (4) the bundling of content with WinStar's
telecommunications services. Revenues also are driven by the amount and
quality of WinStar's available program rights during each quarter and some
seasonality of sales, which affect quarter-to-quarter comparability.
We expect information services revenues to increase as WinStar expands its
information service offerings and cross-sales of these services to its CLEC
customers. With what we see as the continuing convergence of access and
content, we do not believe that WinStar will completely spin out this business
in the near term -- as some market observers have predicted - - to concentrate
on its core telecommunications business. Rather, we expect the company to
look for ways to unlock value in the business by perhaps partnering with a
portal company or monetizing part of the business.
WinStar International
WinStar has set aggressive goals for expanding internationally As discussed
further on p. 26, WinStar plans to build local networks and to sell
communications services in six overseas markets by the end of 1999 and 50
overseas markets by the end of 2004. These 50 markets are located primarily in
Western Europe, the Asia/Pacific region and the Americas. Its initial six
target markets are Amsterdam, Buenos Aires, London, Paris, Sydney and Tokyo.
The company expects the major portion of the international revenue stream to
derive from data services. Significantly, almost 100% of installed lines are
expected to be on-net.
WinStar's Sale to Williams of Capacity
The large amount of spectrum WinStar has acquired will allow it not only to
provide broadband services to its customers, but also to provide valuable last
mile connectivity to other service providers for use in extending their own
networks. Thus, in December 1998, WinStar sold Williams a 25-year IRU
(indefeasible right of use) for up to 2% of WinStar's current and future local
Wireless Fiber capacity in the United States. Williams will pay WinStar $400
million for this IRU, with payments due ratably as WinStar constructs up to
270 hub sites. WinStar expects to complete construction of at least 270 hub
sites over the next four years. In addition, Williams will pay WinStar at
least $45.6 million over a ten-year period for network maintenance services
that WinStar will provide over the term of the IRU.
We note that WinStar views the recent agreement between Williams and SBC,
whereby Williams will serve as SEC's preferred provider for all domestic U.S.
transport services as a validation by SBC of WinStar's wireless capabilities.
In markets outside of SEC's region, SEC will rely on WinStar to provide SEC,
through Williams, with last wile connectivity on WinStar's network.
The 4Q98 results of WinStar's sale to Williams reflects a conservative
accounting treatment of the transaction, with both revenue and EEIDTA spread
over the 25-year life of the agreement. Under this approach, WinStar booked
less than $150,000 of revenue to 4Q98. WinStar would prefer to treat the
transaction as the sale of an asset and is in the process of pre-clearing this
treatment with the SEC. If the transaction is accounted for as the sale of an
assets, then WinStar would see about $80-$85 million in additional revenue
upside for 4Q98, and EEITDA upside of $6S-$70 million. The company expects
this issue to be resolved over the next month.
Government Services
The government services market has recently opened up for WinStar, as well as
other ICPs, with a U.S. Court of Federal Claims ruling rejecting the federal
government's decision to limit multimillion-dollar federal telecommunications
contracts to a single awardee.
The U.S. General Services Administration, through its Metropolitan Area
Acquisition (MAA) program, provides the basis for the purchase of local
telecommunications services by federal agencies in more than 40 major markets
across the United States. The first MAA contracts will be for local
telecommunications service in the Chicago, New York City and San Francisco
areas with an estimated value up to $600.0 million. WinStar has bid on all
three contracts. We believe that WinStar is well positioned to compete for a
portion of these and other federal government contracts, such as the
Washington Interagency Telecommunications Service contract, because of the
flexibility and broadband capacity provided by its wireless services.
Nevertheless, to be conservative, we consider any government services revenue
contribution upside to our model.
IMPROVING PROFITABILITY
We believe WinStar's EBITDA margins will grow from a negative margin to
approximately 15% by 2001. Currently, WinStar's costs may be divided into
three principal categories: 1) transport costs, which are almost all third
party costs, e.g, private long haul lines, and account for approximately 45%
of costs of services; 2) payments to RBOCs for leasing of lines, which
accounts for approximately 40% of costs of service; and 3) engineering,
expansion costs and provisioning, which account for about 151 of the costs.
Our optimism that WinStar will be able to improve its margins significantly is
premised on the fact that management is focused on selling on-network access
lines spearheaded by Project Millennium, is transitioning out of certain
low-margin products lines, is about to make significant strides in lowering
its network costs as a percentage of telecom revenue, and is migrating to
common MIS platforms that will reduce costs and increase management
visibility.
Project Millennium
Project Millennium is the centerpiece of management's intense focus on selling
on-network access lines, which can carry gross margins of 60%-70% versus less
than 15% for resold lines. The Project Millennium marketing campaign features
up to a year of free local phone service for new WinStar customers in 1,000
newly-connected commercial buildings in 13 of 30 markets. The company has
made great strides with Project Millennium and significantly all Project
Millennium sales are on-net. In just the first two months of the Millennium
promotion, November and December WinStar moved more than 7% of the market
share in the Millennium buildings from the incumbent exchange carriers to
Winstar, This is quite a significant first step considering the company's
stated long-term building penetration goal is approximately 11%.
We expect waves of Millennium type programs over the course of the next
several months, which should drive Winstar's on-net percentages up further. We
wish to highlight that the company's reported end of year 20% on-net and 40%
on-switch statistics, do not account for Millennium buildings since those
buildings are being provisioned during 1Q99. 1Q99 margins should improve
steadily throughout 1999, even with rapid network expansion and the
continuation of Millennium-type programs. We already know that in the first
two weeks of February, WinStar took orders for LEC resale facilities for just
6% of its lines sold. This is a dramatic reversal of the previous year when
80% of new lines required the resale of LEC facilities.
WinStar's business model seems to be firmly on track, with its mature markets
showing reduced EBITDA losses by year end and with the New York City market,
WinStar's largest and most mature market, being EBITDA positive for the entire
4Q98. The company has said that more than 40% of December 1998 line orders
came from designated Project Millennium buildings. In New York City, 93% of
November line orders came from business in on-net WinStar buildings. Thus,
after its eighth quarter of operations in New York, the company has
successfully placed 55% of its customer lines on-net and generated positive
EBITDA. We, like the company, view the results in New York as evidence that
its business model works and agree that as WinStar achieves a critical mass of
network in other markets, they too will become EBITDA-positive. We believe,
however, that there are certain cost efficiencies in the New York market, such
as the relative density of customers and proximity of buildings that cannot be
matched in cities such as Los Angeles or Dallas and these cities will take
longer to become EBITDA positive.
Not only should margins improve because Millennium sales are on-net, but also
because the Millennium program fosters long-term arrangements that should
provide an opportunity to upsell enhanced services. Under Millennium,
customers are offered one-, two-, or three-year arrangements, with
approximately one-third of the contract term free. The company has reported
that during the first two months of the program 60% of the Millennium
customers signed three-year agreements. We agree with the company that these
customers will be ripe for upselling enhanced services as the world becomes
increasingly bandwidth intensive and clearly, by the long-term nature of the
agreements, the company should experience lower churn and higher margins.
Our optimism that WinStar's margins will expand dramatically in 2001 is
premised on several other factors:
The company is transitioning out of certain low-margin products lines such as
residential long distance and consumer products. As of year-end 1998, WinStar
is completely out of these businesses. Other lower margin businesses are also
being pruned or discontinued;
WinStar is about to make significant strides in lowering its network costs as
a percentage of telecom revenue; we look for this percentage to fall from
approximately 80% in 1998 to approximately 44% long-term. WinStar's recent
deal with Williams Communications should go a long way toward lowering network
costs. Under its agreement with Williams, WinStar purchased a 25-year IRU to
four fiber strands, each on a national route encompassing 14,694 route miles
(58,736 fiber miles), and a seven-year option to purchase two additional
strands over the same route (29,369 fiber miles). WinStar will pay Williams
approximately $640.0 million (in fixed payments of approximately $7.5
million/month) over the next seven years for the IRU, the capacity option,
certain long-haul transport and other network assets. As discussed further on
page 34, the agreement, in effect, will enable WinStar to lock in its capital
costs for long haul capacity - - at roughly its current cost - - while at the
same time enable WinStar to drive multiples of its current volume of traffic
onto Williams' network. WinStar's payments to Williams for its network
services will be capitalized and amortized over 25 years.
3) WinStar is migrating to common MIS platforms that will reduce costs and
increase management visibility.
Exhibit 6 - - Customer Service Organization
WinStar's MIS is being architected to separate its applications from its
customer data and standardizing the data to make it accessible to all internal
and partner applications.
CORPORATE PROFILE
WinStar Communications, headquartered in New York City, went public in 1991.
Since then it has expanded its services into switched voice and Internet/data
services and expanded its geographic coverage to the top 30 U.S. markets with
plans to cover the top 60 by 2000, and 50 international markets over the next
five years.
WinStar has structured its business around five core principles: 1) the demand
for broadband is accelerating; 2) the local network is the bottleneck, 3)
customers seek customized end-to-end broadband solutions; 4) there is a global
need for broadband capacity in the local loop; and 5) an increased focus on
high-margin businesses with outstanding opportunities for growth. As a
result, the company has developed core competencies in the areas we think most
critical to success in the increasingly competitive telecommunications
industry.
Much of WinStar's broadband strategy emanates from the fact that of the more
than 750,000 commercial buildings in the United States, only a very small
percentage of these buildings have broadband connections. These broadband
connections are typically made using fiber. Construction of last mile fiber
connections, however, has slowed substantially in the last few years as
fiber-based carriers are determining that the extension of fiber to many of
the buildings in any given local market is not economically justified because
of the significant cost of deployment. The overwhelming percentage of total
construction costs for last mile fiber is attributable to labor, with only a
small percentage of such total costs attributable to technology. Since labor
costs tend to increase over time, WinStar believes that it will become more
expensive to connect the majority of commercial buildings with last mile
fiber.
Local Broadband Network Strategy
WinStar believes that its wireless access local broadband networks offer a
solution to the increasing need for bandwidth to a larger addressable market
than fiber or copper-based connections. Winstar is able to bring broadband
last mile connections to the substantial majority of buildings in each of its
markets, and focus on those that do not have last mile fiber or which do not
justify the cost of last mile fiber.
An integral part of WinStar's local broadband networks is its "Wireless
Fiber", which uses the 38 GHz, 28 GHz and other portions of the radio spectrum
to carry voice, data and video transmissions. Its Wireless Fiber services can
provide fiber-quality transmission at speeds more than 350 times faster than
ISDN, the fastest service currently in general use on legacy networks. The
company believes that in order to effectively use wireless spectrum for the
commercial provision of broadband communications services, a provider must
have access to a large amount of spectrum in each of the markets where it
operates. WinStar holds licenses that provide it with the largest amount of 38
GHz radio spectrum in the country, as well as a large amount of 28 GHz
spectrum and other various spectrum rights. The company's spectrum holdings
cover markets encompassing more than 200 million people and more than 80% of
the business market in the United States.
We believe that WinStar's broadband strategy is sound. There is no doubt that
the demand for bandwidth is exploding. At the same time, new technologies are
beginning to be deployed that will allow greater access speeds, and increased
competition is driving down access costs. The combination of increased
demand, improved access technology, greater competition and government-guided
reductions in access charges will allow for continued revenue growth and
significant declines in local transport and access costs. As a result, we
believe costs will fall faster than revenue, allowing telecommunication
companies to, at a minimum, maintain margins.
Demand for bandwidth will grow exponentially due to the multiplicative effects
of more PCs, faster access speeds1 the growth of the Internet, and other
computing trends such as the increased bandwidth intensity of messaging.
Exhibit 7 illustrates these trends.
Exhibit 7 -- Computing Trends Drive Demand for Bandwidth
As Exhibit 8 shows, the increased affordability of personal computers is
driving double-digit unit growth worldwide.
Exhibit 8 Worldwide PC Shipments
Source: International Data Corporation |
