CSN was IIXC's desperation play (this would've been the third quarter of disappointing the street, and they knew they would've gotten slaughtered. Let's see if LaMacchia can trim the fat and get the combined entity ontrack for a sale.
And if anyone cares, PW's Strumingher on QWST/USW from earlier this week:
Qwest Communications International Rating: Neutral (QWST-$35.00)
Qwest: Initiating Coverage with a Neutral Rating
KEY POINTS
· Qwest is an aggressive and opportunistic company that has grown from a concept just a few years ago into a company
poised to become a top-tier carrier and one of the likely survivors in the telecommunications services industry after
completing its merger with U S WEST.
· We believe that the merger with U S WEST will create value for QWST shareholders over the long-term because
Qwest gets needed scale and skill sets at a very good price, and the transaction is structured in a way to give Qwest
management sufficient control over the combined company.
· Qwest has two key assets that are prerequisites for success in the age of the digital economy: lots of backbone
capacity and a management team that has a clear vision about new business opportunities created by innovation in
computing and telecommunications technology.
· Qwest is making the pivot from commodity “transport” to differentiated “applications” sales and has strong partners in
emerging growth areas such as remote hosting of corporate software and data bases.
· Our 12-month target price on QWST shares is $35 based on a multiple of 10x-estimated 2000 EBITDA pro forma for
the merger with USW. The company is on the verge of making a major transformation, and we believe that a “wait and
see” attitude is warranted at this time.
INVESTMENT OPINION
Qwest is an aggressive and opportunistic company that
has grown from a concept just a few years ago into a
company poised to become a top-tier carrier and one of
the likely survivors in the telecommunications services
industry after completing its merger with U S WEST.
Management has a clear vision about new business
opportunities created by innovation in computing and
telecommunications technology and has lots of backbone
capacity to meet demand. The technology behind the
Internet has brought together the telecommunications,
media, and computing industries in a way that has begun
to effect and should continue bring large and lasting
changes to the economy and should be the single
biggest growth area of U.S. GDP for the foreseeable
future, and we believe that Qwest has a good plan of
attack to seize these new business opportunities.
In the midst of this gold rush, Qwest is loading up on
mining supplies before heading into the hills. We believe
that the merger with U S WEST (USW-$60.00)[3] will
create value for QWST shareholders over the long term
because Qwest gets needed scale and skill sets at a very
good price, and the transaction is structured in a way to
give Qwest management sufficient control over the
combined company. Increased scale will give Qwest a
more competitive cost structure with large carriers in the
sector, allowing it to be more aggressive in investing in
new products and services due to its larger base of
revenue and cash flow. In addition, it will bring skill sets
in the local exchange service business that will help
Qwest in its ability to provide end-to-end
telecommunications services. (One good example of
these two benefits is the ability for Qwest to accelerate its
rollout of DSL services across the country). Lastly, it
would also make Qwest a more attractive partner for
larger carriers. We believe that the transaction could gain
regulatory approvals needed to close within one year.
While we believe that the USW transaction would create
value for QWST shareholders over the long-term, we
remain cautious on the stock at this time. This merger will
test Qwest management in ways in which it has not yet
been tested. Parallel processing the integration of U S
WEST and the pursuit of digital economy gold will be a
challenge. Although Qwest has a new Chief Operating
Officer with a strong background in the local exchange
business and who has been through large merger
integrations before, it does not have great management
depth in the local exchange business and will have to
invest time to learn it. Cultural differences and
differences in employee compensation will also be
challenges in merger integration.
Moreover, synergy estimates for the merger are
ambitious, in our opinion, especially given that Qwest will
likely want to accelerate its spending and investment on
new business initiatives given U S WEST's cash flow and
because it will likely need to spend additional money in
the U S WEST region to address service quality issues
and to comply with market-opening requirements
necessary for long distance approval. In addition, Qwest
will need to sell its long distance customer base within
the U S WEST region in order to close the merger within
a year, and we doubt that Qwest will be encouraging
sales representatives to target customers in the U S
WEST region if these customers will ultimately be sold. It
could take U S WEST two years to gain long distance
approval within its region in our view and resume its long
distance sales effort in the U S WEST region.
On a conceptual basis, the Qwest story is now changed,
and the company has probably lost the branding it
enjoyed in the investment community as the big winner in
the telecommunications services space from the
business opportunities created by changes in computing
and telecommunications technology; Qwest is clearly no
longer a “pure play” in this space. We believe that Qwest
will become somewhat less compelling to growth
investors during the transition period from the old story to
the new one. U S WEST is just not a company that one
would find at the top of most growth investors' wish list,
and we believe that the story will be a harder sell to
growth investors, at least initially. Despite our view that
this merger will create value over the long term, we
believe that there will be an adjustment phase in the
market. Then there is the issue of the USW shareholder
base and the turnover there that could occur after the
merger close. Although we remain open-minded because
of management's track record of creating value, we
believe that a “wait and see” approach is warranted at
this time. If Qwest can sustain the momentum it has
established in the digital economy and process in parallel
the integration and transformation of U S WEST like it
thinks it can, we would reconsider our valuation
assumptions. Our 12-month target price on shares of
QWST is $35 based on a 10x multiple on 2000 EBITDA
pro forma for the U S WEST transaction.
TECHNOLOGY CHANGE CREATES OPPORTUNITIES
The primary means through which telecommunications
carriers have differentiated their services to their
corporate customers during the 1990s is to provide them
wide area data networking services. Qwest's revenue
base today is primarily commodity data and voice
transport services, and the company is now targeting
sales of differentiated applications. We believe that the
carrier-customer relationship is now evolving due to
several important changes in technology and a general
shortage of skilled information technology professionals
in the labor market. Innovation in technology such as the
HTML programming language, the introduction of carrier
class routers, and improvements in optics and
transmission technology such as wave division
multiplexing have enabled carriers to offer a more
comprehensive package of data management tools to
corporate customers. Examples of these businesses are
complex web hosting, e-commerce, and remote hosting
of software applications (Application Service Provider or
ASP) market .
Qwest has among the most well defined business plans
and the strongest partner relationships in the emerging
data services business of any carrier we know. Qwest
has three data centers today with plans to have nine by
year-end and 250 IP programmers that came through
last year's acquisition of ICON CMT. Furthermore, Qwest
has formed partnerships with other companies to further
its development of e-commerce and managed software
business opportunities. Microsoft invested $200 million in
Qwest and has offered Qwest access to its extensive
channel of value added resellers to sell these services.
Complex web hosting services, e-commerce, and
security were first offered in Q1 '99, Internet VPNs are
targeted for release soon, and managed software offers
are planned to start in early 2000. In the ASP business,
Qwest has formed a partnership with KPMG in the
managed software area to provide software
implementation, help desk support, and server
management targeted at mid-sized business customers.
The partnership will benefit from a relationship that
Qwest has formed with SAP, Siebold Systems, and
Oracle that will market Qwest's remote hosting
capabilities for their applications. Another Qwest partner,
Hewlett Packard, has agreed to provide Qwest with $500
million of server equipment in return for an annuity
payment that is a function of Qwest's application hosting
sales.
VALUATION
We value Qwest at a multiple of 10x-estimated 2000
EBITDA pro forma for the U S WEST merger or $35 per
share. We believe that this is appropriate given our
forecast that the combined company can grow revenue
at a low double digit top-line growth rate and EBITDA at
a low teens growth rate on a pro forma basis over our
1999-2002 forecast period. This valuation is equal to a
multiple of approximately 30x estimated 2000 “cash EPS”
(excluding goodwill amortization expense) pro forma for
the USW transaction.
RISKS
The main risks to QWST are managing through a rapidly
changing technology and business landscape, pricing in
the wholesale bandwidth business, competition from
companies with large scale, and the integration of US
WEST. |
