From #1 II rated telecom high yield analyst, SSB's Bob Waldman:
WinStar Continues to Beat Expectations, while MCI WorldCom Demonstrates it is the Original
Trading Ideas
WinStar Management Presentation - On June 15, 1999, Salomon Smith Barney's fixed income telecommunications research team hosted a meeting with the management of WinStar Communications (WCII) (Caa1/CCC+) who provided an overview of the company's current financial and operating position as well as its strategy going forward. WinStar highlighted its ability of achieving superior returns on capital by operating alternative local networks through the integration of fiber and wireless technologies.
WCII has embraced a hybrid fiber/wireless network as the means to extend its on-net strategies beyond the confines of local fiber loops while reducing reliance on the incumbent local exchange carriers. As a result, WCII has successfully compiled a portfolio of fixed wireless and wireline assets that enable it to provide a full suite of local, long distance, data and enhanced services on an end-to-end basis across the country.
As computing trends drive bandwidth demand, WCII believes that the market is ripe for competition with the incumbent carriers. Overall, CLECs have connected a small percentage of the commercial buildings in the United States with fiber. Currently, there are 750,000 total commercial buildings in the U.S. of which the CLECs have lit only 10,000 directly. In defining the market opportunity, WCII's management presented the fact that fiber has unlimited capacity compared to point-to-point (45 Mbs on 672 lines) and point-to-multipoint (155 Mbs on 2,430 lines), however, its addressable market of approximately 10,000 buildings is much smaller than point-to-point (over 15,000) and point-to-multipoint's (over 100,000). As for costs, the capital required to connect fiber is approximately $400,000. However, point-to-point costs less than $50,000 while point-to-multipoint costs $25,000. Consequently, WCII needs to sell approximately 165 lines of fiber to break even compared to 20 lines of point-to-point and 10 lines of point-to-multipoint.
WCII has forged two strategic relationships in order to improve its technology and to buildout each new global market and augment existing markets. With Lucent, WinStar has secured $2 billion in vendor commitments with $500 million available immediately.
In this respect, WCII has leveraged the brain power and know how of both organizations. With Williams, WCII receives immediate national long-haul capacity and 60,000 dark fiber miles for $672 million broken into monthly payouts over the next seven years. In return, Williams receives 2% of WCII's local capacity across 60 markets for a total
consideration of over $400million over the next two years. Net the company is getting nationwide long-haul capacity for $272 million. As a result, WCII improved its EBITDA and cash flow and connected its local broadband networks nationwide immediately.
WCII has taken steps to further its presence and penetration in the marketplace by initiating Project Millennium, a high margin business contained 100% on WCII's network. Phase I, sold in 13 of the company's 30 markets, provides free local service for one year with a three-year commitment and acceptance of intraLata toll service. As a result, building penetration has increased to 14%, and 60% of Millennium customers have taken multiple services and committed to 3 year contracts. WinStar launched Phase 2, sold to all networked buildings in all 31 markets, on June 1, 1999, offering free long-distance service for one year with a three-year commitment for local, long distance and intralata toll service. Also, as a part of Phase II, WCII offers free web hosting for 18 months with a three-year commitment for web hosting and dedicated Internet access. In an attempt to increase its penetration in small and medium sized businesses, WCII has developed Office.com with the help of CBS. Office.com provides WCII with an online business brand.
WinStar credits its improvements to its solid operational performance. In the first quarter of 1999, the company installed 65,000 lines, a 5% increase from the previous quarter of 62,000, raising the current total to 384,000 lines. The company added over 600 building access rights during the quarter, bringing the total to more than 4,800 building access rights in U.S. markets. By year-end, WCII believes that it will have access rights to over 8,000 buildings in the U.S. and approximately 200 internationally.
As of March 31, 1999, WCII had 17,600 customers. The company projects that this number will grow to 35,000 domestically and approximately 200 internationally by year-end 1999. To complement its growth, WCII expects the field sales personnel of approximately 500 people at the end of the quarter to grow to over 600 domestically and approximately 50 internationally at the end of 1999. In its most mature market, New York, WCII has been able to increase its on-net percentage to 56%. The company believes that it will be able to increase this percentage to 66% by year-end. As a result, WCII projects that it will be able to obtain gross margins in the 60% to 70% range which would elevate WCII to one of the top performing CLECs in the country.
OPINION: We value the debt of WCII to Low Single B with a positive credit trend. The meeting with WinStar affirmed our belief that WCII has a management team that has assembled an end-to-end facilities-based network with a business plan that is on par with our top recommendations in the high yield telecommunications market. WCII's network platform has the capability to provide a complete suite of communications services to business customers on an end-to-end basis in major markets throughout the United States. We believe the company is only at the early stages of its operational momentum. We also believe that the recent equity infusion by Qwest (QWST) (Ba1/BB+) into Advanced Radio Telecom (ARTT) (Caa2/CCC) as well as the NEXTLINK Communications (NXLK) (B3/B) LMDS Spectrum acquisition act as an endorsement of broadband wireless technology. In this respect, WCII is best suited to addressing the point-to-multipoint market of the future. In this respect, we believe that WCII is undervalued on both a fundamental and relative basis. The company has evolved into a fully integrated communications provider (ICP). Therefore, we have a buy rating on WinStar's bonds at current levels on a fundamental and relative basis.
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• WorldCom is the Original – Ten days ago, we had the opportunity to sit down with WorldCom's (WCOM) (Baa2/BBB+) CFO, Scott Sullivan, and its Treasurer, Sunit Patel. Our major takeaway from the meeting is that the momentum is only beginning to build for the company. During the past few weeks, WCOM has made it clear that it is focusing and investing in the fastest growing parts of the business - Internet,
international, and data. Unlike the new entrants that are deploying assets to emulate WCOM, WCOM is way ahead of the pack. It has substantial network and assets deployed in the major telecommunications markets around the globe. More importantly, the company has customers to drive traffic on its networks. The continuing
consolidation battles within the telecommunications market are focused primarily on customers.
We believe one of the biggest changes occurring within WCOM will be its approach to wireless. Beyond the backhaul traffic and paging business, the acquisition of SkyTel (SKYT) (B3/B-) brings one of the top wireless managers, John Stupka, into the management team of WCOM. Prior to joining SKYT, Stupka had been instrumental in building the wireless business of SBC Communications. In the wireless community, he
is known as a fierce competitor with a real understanding of the business. As WCOM continues the process of evaluating its wireless options, Stupka will be an invaluable asset. Since the announcement of the termination of strategic discussions with Nextel Communications (NXTL) (B2/B-), speculation has continued that at some point in the
future, WCOM will realize that it needs NXTL and the discussions will re-ignite. After talking with the financial managers of the company, we believe this possibility is remote at best. The company has a number of options it continues to evaluate but they do not carry the double anchor of high leverage and large dilution. When WCOM's target
customer base of large multinational corporations begin to demand a wireless solution, then we believe the company will be forced to act, not before.
Beyond wireless, WCOM has moved to the top of everyone's list as the “White Night” acquirer. Our time with Sullivan and Patel gave us the feeling that there is little on the company's shopping list. Between cash flow growth and proceeds from asset sales, the company is stepping up its investments in its growth areas. The company is focused on organic growth driven by increasing penetration in its US and European markets. As deregulation continues and competition accelerates, WCOM wants to be the preferred provider of multi-location corporations on both a local and international basis. Of the companies within the investment grade telecommunications market, we believe
WCOM has the strongest internal momentum. Other carriers are driving credit improvement from acquisitions. The fuel for WCOM's growth is it synergies from acquisitions and growth from investing in key markets and businesses. During 1999 and 2000, we expect that the company's credit profile will strengthen as business accelerates. Looking at Figure 1, it is clear that WCOM compares favorably to its peer group in terms of key credit ratios. The AT&T credit profile is a bit misleading because it does not include the completed Tele-Communications merger and the pending MediaOne acquisition.
Figure 1: WorldCom Credit Profile Relative to Comparables. Latest Twelve Months Ended March 31, 1999
LTM LTM LTM Pretax FFO EBITDA NCF / EBITDA NCF /
Company Ratings Revenue ($) EBITDA ($) Capex ($) Coverage Coverage Coverage Debt / Cap Avg. Debt Margin Capex
AT&T
(1)
A1/AA- 54,005 15,691 8,028 24.6 x 29.3 x 35.6 x 27% NA 29% 127%
GTE Corporation Baa1/A 25,886 10,073 5,465 4.9 x 6.4 x 7.9 x 63% 28% 39% 93%
Sprint Corporation Baa1/A- 17,776 3,016 4,761 0.1 x 4.3 x 4.0 x 48% 17% 17% 44%
MCIWorldCom, Inc. Baa2/BBB+ 31,479 8,222 6,912 3.9 x NA 7.3 x 29% 31% 26% 90%
MCIWorldCom (1999) 37,721 11,694 7,000 5.6 x 6.8 x 8.7 x 31% 38% 31% 111%
MCIWorldCom (2000) 44,753 14,769 7,500 10.7 x 11.4 x 15.3 x 23% 65% 33% 134%
Source: Company Reports and Salomon Smith Barney Estimates. Dollars in Millions. (1) AT&T results are for AT&T Corp. and do not include
results for Tele-Communications nor the pending acquisition of MediaOne.
OPINION: In light of the company's strong performance as well as its accelerating business and credit profile, we are raising our value opinion on the debt of WCOM to Low Single A with an improving credit trend from High Triple B with an improving credit trend. During the past twelve months, WCOM has demonstrated that it is the leader in the evolution of global end-to-end communications. It is WCOM's vision of end-to-end connectivity that is driving much of the consolidation in
telecommunications. During the next 24 months, we expect the company's position to only strengthen as it invests in its key growth engines. With the company's indicated bond prices at 130bp for 30 year paper, 110bp for the 2007's, and 95bp for the 2005's, we are reiterating our buy recommendation on company's bonds based on the business fundamentals and improving credit. |
