Fahnestock - WinStar Communications, Inc.
"WinStar Does It Without Wires"
John L. Bauer III
James Lee
Investment Opinion: We are initiating coverage of WinStar with a BUY rating. Our year-end target price of $53 reflects a 55% public market discount and offers 60%+ upside from the current levels.
· The Difference is Wireless: WinStar's is building broadband wireless networks in 60 U.S. markets. These markets support 75% of the business access lines in the country. The company's wireless networks (which operate at 38 GHz) match the performance and reliability of fiber optic networks. Of greater importance, they can be built at a fraction of the time and cost typically associated with comparably sized fiber networks.
· Low Cost Provider With Speed to Market Advantage. Wireless networks can be deployed faster than fiber networks because it takes less time to install antennas than to “break ground” and lay fiber. Wireless
networks are less expensive than fiber networks for equally obvious reasons – the cost of bolting an antenna onto a roof is cheaper than digging up miles of concrete. Walla! The wireless advantage.
· Strategic Partnerships Insure Expansion Plans. In October 1998, WinStar selected Lucent Technologies to design, finance (up to $2 billion) and construct its domestic and international local networks. In December, the company chose Williams Communications to construct its long-haul networks. These agreements are accelerating expansion, providing financing, lowering operating costs, and reducing execution risks.
· Attractive Valuation. WinStar is currently trading at a 58% discount to our estimated year-end 1999 asset value of $74 per share. As the year progresses, we expect this public market discount to shrink (as it has in the past) to approximately 30% thus driving the stock to $53. The 60%+ upside implied by this target price supports our BUY rating.
Investment Thesis
In most respects, WinStar is similar to other Integrated Communication Providers (ICPs). The Company offers customers the usual ICP fare of local and long distance service in addition to enhanced services, data and Internet access. It offers “one-stop” shopping at competitive prices with a standard 99.999% network performance guarantee. In one respect the company is radically different from the majority of its peer group. WinStar's networks are wireless. As a result, network infrastructure can be built at a fraction of the cost and time typically associated with comparably sized fiber networks. As a low cost provider with a speed-to-market advantage, the Company is extremely well positioned to take its share (perhaps more than its share) of a telecommunications market that we estimate currently tops $150 billion.
Low Cost Provider. Construction outlays can represent up to 90% of the cost of building a fiber ring. As a result declining technology costs will have little impact on the overall expense of these networks. WinStar's network infrastructure on the other hand, consists largely of 12” dish antennas that it installs on the roofs of commercial buildings. Once installed, voice and data traffic from customers in the building can be transmitted to the nearest Winstar “hub” where it can be handed to a fiber network.
Speed-To-Market Advantage. Wireless networks can be deployed more rapidly than fiber networks for obvious reasons - the permit and construction time required to lay fiber in the ground far exceeds the time required to secure roof rights and install antennas. As a result, WinStar can be the first operator in many of its market footprints. The Company's ability to provision service quicker than its subterranean counterparts also enhances its competitive position.
Reliable “Work-Horse” Technology. During the early 1990's, misnomers regarding the performance and reliability of wireless networks were rampant; “they don't work in heavy snow,” “birds can disrupt transmissions” etc. Today, 38 GHz networks are universally acknowledged to perform on par with fiber networks in terms of bit transmission error rates and reliability (99.999%).
Strategic partnerships insure expansion plans. In October 1998, WinStar announced a five-year deal with Lucent Technologies for the design, construction, and financing (up to $2 billion of vendor financing) of its domestic and international local networks. In December 1998, the Company announced a seven-year agreement with Williams Communications to construct its long haul network. By subcontracting out its network construction, management can now train its focus on domestic marketing and international expansion.
Huge Untapped Market. Less than 3% of the 750,000 commercial buildings in the U.S. have broadband access (i.e., fiber to the building). A portion of these buildings will never generate sufficient revenues to justify connectivity via fiber link. As a result, WinStar (and other wireless ICPs) will have this market to themselves.
Given WinStar's competitive advantages vis-a-vis subterranean ICPs, we believe its market share in certain markets could approach 20% - a possibility not accounted for in our forecast.
Valuation. By year 2000 WinStar plans to be operational in 60 markets which support approximately 45 million addressable business access-lines (about 75% of the nations' total). We assume these lines will grow 6% annually to 75 million by 2009. Our forecast calls for WinStar to capture about 8% (6.0 million) of these lines (each of which generates $60 per month in revenues) by 2009. Finally, we assume cash flow margins will peak at 39% also in 2009. Our projected 10-year free cash flows (EBITDA minus CapX) and terminal value (10x 2009 cash flow), discounted to a net present value using a 14% rate, total $4.4 billion. Adjusting for long-term debt and other assets, our 1999 year-end NAV is $3.1 billion, or $74 per share. Our year-end 1999
target price of $53 reflects a “historically normal” public market discount of 30%. The 60%+ upside implied by this target price supports our BUY rating on the stock.
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March 29th Buy Reiteration
Investment Opinion: We are reiterating our BUY rating on WinStar. Year-to-date, WCII shares are down 14%. The Company's big-cap peer group (stocks with $1 billion of market cap or more) is up roughly 47%.
WinStar is the only big-cap ICP sitting out this rally. As concerns over margin pressures abate, we believe the stock will regain its momentum and rejoin its peer group (from both a price performance and valuation standpoint). Our year-end target price of $53 reflects a 30% public market discount to our 1999 net asset value of $76 per share and offers 55%+ upside potential from the current price levels. Key points:
· Big-cap ICPs have advanced 47% year-to-date. The table accompanying this report highlights the uneven year-to-date performance of the ICPs. The chart on the left in this table quantifies the year-to-date
performance of big-cap ICPs. (market capitalization of $1 billion+). The chart on the right quantifies year-to-date performance of the small cap ICPs (market capitalization of less than $1 billion). With the exception of WinStar, big-cap names have vastly outperformed small cap names so far in 1999.
· Small-cap ICPs are down 9% year-to-date. This figure excludes the performance of e.Spire Communications (OTC-ESPI) –a stock who's price action may have been positively impacted by recent rumors of a possible takeover or restructuring. Admittedly a few of the small-cap under-performers are “reshaping their business plans”- but not everyone. At this juncture we don't know if the big-cap bias within the group is a recent phenomena or a long-standing one. We are presently deconstructing our ICP index (into big cap and small-cap names) to find out.
· Winstar is the only ICP in the big-cap sector that's not participating in the rally. In October 1998, WinStar chose Lucent Technologies to build (and finance) its local wireless networks. In December, a deal with Williams locked in the company's long distance capacity and costs. With sufficient financing to build 60 domestic networks and highly competent partners (who will build these networks), the near term outlook for the company is bright. Lucent's $2 billion vendor financing has allowed WinStar to add 10 domestic and six international markets to its expansion plans in 1999. The domestic roll out alone will increase the company's addressable market by 56% (from 30 million access lines to 47 million access lines) over the next two years. Obviously, WCII shares are not taking their cues from these observations.
· Margin questions seem to be at the heart of WinStar under-performance. WinStar's price performance mirrored its big-cap counterparts until early this year (around the time management began
guiding 4Q98 gross margin estimates down. Finally, on March 4, the Company reported 4Q98 results that showed gross margins had contracted to 11% from 25% in the prior quarter. Management maintains that
the drop in margins reflects a one-time ramp up of expenses associated with its “millennium” marketing campaign. Presumably the surge of demand created by this program has kept (and will continue to keep)
engineers and other provisioning personnel working overtime for the next few quarters. As revenues advance (and operating costs plateau) gross margins should expand to about 35% by the fourth quarter of
this year (a trajectory management endorses). We believe WCII shares will rebound in lock-step with its margins – a scenario that should put the stock within our target price of $53 by year-end.
· Valuation: By year 2000 WinStar plans to be operational in 60 markets which support approximately 45 million access lines (about 75% of the nations' total). We assume these lines will grow 6% annually to 75 million by 2009. Our forecast calls for WinStar to capture 8% (6 million) of these lines by 2009. Monthly revenues per line of $60 remain flat throughout our forecasting period. Finally, we assume cash flow margins will peak at 39% in 2009, The resulting free cash flows and terminal value (10x 2009 cash flow) discounted to a net present value using a 14% rate, total $4.42 billion. Net of debt, this value is $3.09 billion or $76 per share. Our year-end 1999 target price of $53 reflects a public market discount of 30%. The 55%+ upside implied by this target price support s our BUY rating on the stock.
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(again, an email request will get a copy of the pdf with charts/graphics) |
