Fahnestock's John Bauer/ James Lee:
WinStar Communications, Inc.
(OTC-WCII-46)
Bingo! WinStar hits our numbers to the decimal point.
Investment Opinion: We are reiterating our BUY rating on WinStar. Our year-end target price of $67
reflects a 30% public market discount to our 1999 net asset value of $95 per share and offers 45%+ upside
potential from the current price levels. Key points:
· Winstar reported 2Q results that were in line with our expectations. As a result, we are making no
changes to our near-term or longer term forecast. Access line additions in 2Q99 totaled 69,000 exceeded
our estimate of 68,163. Core telecom revenues totaled $76.856 million versus our estimate of $79.017
million and total revenues of $96.505 million were in line with our $96.134 million estimate. Gross
margins continued to expand (from 23% in 1Q99 to 24% in 2Q99) again as expected. EBITDA losses
bottomed during the quarter at $83.1 million (we were looking for an $83.5 million loss). Net – net, the
quarter was solid with no surprises.
· WCII shares have declined nearly 30% over the past four weeks reflecting rising interest rates and to
a lesser degree, confusion over a number of regulatory issues that are, in our opinion, benign. Since
early spring, the CLEC group has been whipsawed as interest rates (measured by the 10-year bond yield)
have seesawed between the 5.5% and 6% levels. Small changes in interest rate like these generally have no
impact on CLECs ability to raise capital and no impact on our valuation. Nonetheless, the knee-jerk
reaction to rates (which affects all cash flow stories) is unlikely to change. As a result, we would expect
WCII shares to remain under pressure until we get some closure on this issue. Fundamentals are expected
to improve dramatically in the third and fourth quarters so if rate concerns can be put to bed, the stock
should have a good second half.
· In yesterday's 2Q conference call, management repeatedly noted its confidence in a strong second
half. This is encouraging since the company needs a very strong 2H99 to make our numbers. Specifically,
sequential access line installations (up 3,000 in 1Q99 and 4,000 in 2Q99) are expected to grow by
approximately 10,000 in 3Q99 and 4Q99. Gross margins advanced from 23% to 24% during the second
quarter but are expected to hit the 35% to 40% level by 4Q99. Finally, EBITDA losses should shrink by
$28 million (to a loss of $55.5 million) in 4Q99. Given the solid guidance given for the first half of 1999,
we think the company can achieve these financial goals.
Valuation
The mathematics behind our net $95 per share year-end 1999 net asset value estimate for WinStar runs
as follows. The net present value of WinStar's free c ash flows (EBITDA minus capital spending) discounted at
14% for ten years approximates $609 million. The net present value of WinStar's liquidation value ten years
hence (based on a multiple of 10x cash flow and discounted at 14%) approximates $5.9 billion. The sum of
these two estimates ($6.5 billion) reflects WinStar's gross asset value. After subtracting roughly $1.5 billion
of net debt, the Company's net asset value approximates $5 billion or $95 per share. These figures are
detailed in the box in the lower left hand of our 10-year DCF model accompanying this report. The box in the
lower right hand side of our 10-year DCF highlights the sensitivity of our target price to different discount
rates and terminal multiples. Although a strong case can be made that our 14% discount rate is too steep and
our 10x terminal multiple is too light, these metrics continue to successfully identify undervalued CLEC stocks
and as such we think they represent reasonable (and useful) valuation metrics.
WinStar's public market discount
Charts on page 3 offer a historical perspective of WinStar's public market discount vis-à-vis our
historical and current published net asset value estimates.
· Top Chart: This chart highlights WinStar's price action from February 1998 to the present. A line
representing our historical net asset value estimates for the company has been superimposed on this chart.
Over this period our net asset value estimates have increased by a modest 10%, reflecting management's
focus on house cleaning (as opposed to growth). With the company now operating on an even keel, we
expect our year 2000 net asset value estimate to be significantly higher than our 1999 estimate.
· Bottom Chart: The bottom chart tracks WinStar's public market discount i.e., the spread between the
company's stock price and our net asset value estimate at any point in time.
· History: In February 1998, we established coverage of WinStar with a year-end 1998 net asset value of
$87 per share. At the time WinStar's public market discount approximated 55%. Over the following six
weeks, the stock was trading between 50% to 70% discount to its NAV. During the August – October
“financing scare” (which called into question the industry's ability to finance its build-out plans) WinStar's
shares plunged 72% resulting in a public market discount of nearly 85% when the stock bottomed at $13
per share. Since that time, WinStar's public market discount has continued to shrink, reflecting Winstar's
improved fundamental outlook. The stock is currently trading at a 52% public market discount which has
historically proven to be inexpensive.
(tables in hard copy omitted here)
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