Lehman has a BUY on RSLC, target $55
Headline: RSL Communications: Expect A Strong Q2 In Europe, Reiterate Buy
Author: Dan Fletcher, CFA 1(212)526-3375/Blake Bath 1(202)452-4732
Rating: 1
Company: RSLC
Country: COM CUS
Industry: TELECM
Ticker : RSLC Rank(Old): 1-Buy Rank(New): 1-Buy
Price : $18 5/8 52wk Range: $45-15 Price Target (Old): $55
Today's Date : 07/9/99 Price Target (New): $55
Fiscal Year : DEC
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EPS 1998 1999 2000 2001
QTR. Actual Old New Old New Old New
1st: -0.85A -1.08A -1.08A - -E - -E - -E - -E
2nd: -0.97A -1.32E -1.32E - -E - -E - -E - -E
3rd: -1.27A -1.23E -1.23E - -E - -E - -E - -E
4th: -1.33A -1.16E -1.16E - -E - -E - -E - -E
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Year:$ -4.42A $ -4.79E $ -4.79E $ -3.68E $ -3.68E $ - -E $ - -E
Street Est.: $ -4.73E $ -4.83 $ -3.77E $ -3.96 $ - -E $ - -E
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Price (As of 7/8): $18 5/8 Revenue (1999): $1.60 Bil.
Return On Equity (99): N/A Proj. 5yr EPS Grth: N/M
Shares Outstanding: 53.2 Mil. Dividend Yield: Nil.
Mkt Capitalization: $990.9 Mil. P/E 1999; 2000 : N/M; N/M
Current Book Value: N/A Convertible: None
Debt-to-Capital: N/M Disclosure(s): C, A
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* The continued decline in RSL's shares has, in our view, created an
excellent buying opportunity. Q2 results, which should be reported July 26th,
should bring visibility to strong continued trends in Europe, RSL's growth
engine.
* We expect RSL to report that Europe (half of revenues, >75% of our
valuation), grew 16-18% Q199-Q299, and that at least 10 of the 14 European
countries were EBITDA break-even in June. We expect consolidated revenue of
$172M (up 10% vs. Q1) and EBITDA of -$3.6M (+$4.3M vs. Q1)
* Furthermore, we expect the company to report that sequential growth from
Germany (25% of RSL Europe) accelerated in Q2 to the 8-10% level (despite
only a modest contribution from debitel). This should allay fears that the
competitive pricing environment in Germany holds risk to RSL Europe.
* We believe the outlook for the US business remains flat, and while this is
not new (and the US is < 15% of our sum of the parts), the US could swing our
$16M '99 EBITDA estimate down by $5M. We also expect RSL to restructure the
US away from low margin prepaid/wholesale, moving towards bundled data/voice.
* RSL is a Europe story and Europe's Q2 should be solid. RSL trades at a
third of our sum of the parts valuation which is driven by Europe (more than
three quarters of our valuation) and supported by a DCF on Europe and
European comps (see Note dated 5/21/99).
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RSL shares have continued to slide, based in our view, on two things: Number
one, we believe insider sales (as discussed in our Note on 5/21) have created
the fear that there is something materially negative coming, and we believe
this fear is overblown. Second, we believe that the competitive environment
in Europe, and particularly pricing in Germany (a quarter of RSL Europe) has
created fear that growth expectations for the European business would be
coming down.
We believe that information flow out of the company over the next two months
will disprove those fears, and set the stage for very strong performance from
current levels.
Q2 Should Bring Visibility To Strong Trends Continuing in Europe
On July 26th, RSL should report second quarter results. Our consolidated
expectations are presented below, and we expect the company to be in line
with these numbers, although we believe the key points will be the
performance from Europe. We expect RSL to report that European revenues were
up 16-18% sequentially and that 10+ of the 14 country operations in Europe
are EBITDA positive. Additionally, we expect RSL to report that sequential
revenue growth in Germany accelerated to the 10% level Q199-Q299 which we
view as key as pricing has been more competitive than anticipated (beginning
largely mid Q199) and we believe Germany has been a point of investor concern
regarding competitive entrants in Europe. In terms of gross margins, we
expect Europe to be in line with our expectations and Q199 of approximately
35% (30% excluding Telegate). We believe debitel (a German reseller with
which RSL has a contract to carry traffic, see Note 2/3/99) will be below our
expectation of $15M, based on the tough pricing environment for carriers with
few facilities, although we believe execution of the direct salesforce in
Germany will offset.
Additionally, we believe the UK, which is approximately 20% of RSL Europe, is
performing above expectations, and above RSL's budget. We continue to expect
European revenues to grow at least 15% sequentially on average in 2H99.
RSL's UK operation is now the fourth largest provider of international
service to business customers behind British Telecom (BTY, $172-1/16,2-
Outperform), Cable & Wireless (CWP, $40,2-Outperform), and MCI WorldCom
(WCOM, $90,1-Buy).
Q299 Expectations For RSL
Q199a-Q299e Q298a-Q299e
($M) Sequential Y-Y
Q299e Q199a Change Q298a Change
Revenue 372.4 340.3 9.3% 166.6 123.5%
Gross Margin % 27.6% 26.4% +120 bps 16.7% 1090 bps
EBITDA -3.6 -8.0 +4.4M -16.4 +12.4M
US Continues Flat
Revenues from the US were likely flat vs. Q1 as growth from Westinghouse
(focused on offering voice & data to medium sized companies) was likely
offset by the competitive environment in US wholesale (11% of total revenues)
and prepaid (13% of total revenues). While the flatness of the US is not new
information, we believe ongoing flatness in 2H99 could swing our consolidated
EBITDA down by $5M. While we believe this potential could be a source of
consternation for investors, we continue to view RSL as a Europe story, as a
sum of the parts story, and the US is less than 15% of our sum of the parts
valuation, which implies more than a double in the stock.
We believe RSL's management is focused on repositioning the US, and we
believe the announcement of a restructuring and repositioning of the US is
likely in the next two months (with a potential one-time charge). This would
likely entail scaling back or exiting the prepaid and wholesale businesses
with increased focus on medium sized businesses offering voice and data
services, similar to what the Westinghouse unit is doing now (i.e. private
lines, frame relay, ATM, LAN/WAN, we believe Westinghouse currently has a
data revenue run rate of $40M, or 3% of total revenues). We would view a
restructuring along these lines as a strong strategic move, it would likely
be accretive to US gross and EBITDA margins, and likely bode well for the
long term EBITDA potential of the US.
RSL Is A Europe Story, And Europe Is On Track
Our investment thesis and positive view continues to be based on the
company's European business given its growth and margin outlook, and the
strategic allure of its revenue and customer base ($720M in run rate revenue,
500k customers), distribution infrastructure (approx. 750k directs, agents
and distributors), and network presence (operational interconnects in all
Western European countries, $430M in '99e year end gross plant) in the
consolidating telecom industry environment. Approximately 75% of our sum of
the parts valuation for RSL, which is $50-60(see note dated 5/21/99), is
based on Europe, while less than 15% is derived from the US.
RSL trades at just 1.2X Q299 annualized revenues, which is a) a third of our
sum of the parts and DCF valuation, b) at the bottom end of its historical
trading range, and c) and a sizable discount to the valuations of other
emerging telecom sectors (also potential acquirers). Q2 results should
provide greater visibility/confidence into growth track of the company's main
asset, Europe, and set the stage for material stock price performance from
current levels. |
