noteworthy: AG Edward's Dave Heger's upgrade report on WinStar:
(other reports are hard vs e and too much trouble to OCR)
Equity Research - Telecommunications
August 10, 1999
Analyst: David Heger
Associate Analyst: Greg Teets
2ND QUARTER IN LINE WITH EXPECTATIONS; RATING UPGRADED TO BUY FROM ACCUMULATE
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WinStar Communications (WCII/45 15/16)
BUY/SPECULATIVE
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WinStar reported second quarter results that were in line with our expectations and indicated that the company continues to develop its business as anticipated. Revenue of $96.5 million was in line with our $95.9 million estimate, while the EBITDA loss of ($83.1) million was better than our most recent ($85.0) million estimate. Gross margin improved to 24% of revenue from 22% of revenue in the previous quarter. SG&A expenses were a hefty 110% of revenue, but in line with expectations due to the significant head count and resources needed to implement the company's comprehensive long term plans. WCII has delivered another quarter in which it met its financial targets and is developing its business as anticipated. In the next two quarters, we will be watching for the company to deliver notable improvements in gross margins as its network development efforts and growing on-network customer base yield a more favorable cost structure. With the recent weakness in the WCII share price, combined with today's evidence that WCII is developing its business on track, we are upgrading our rating to buy from accumulate.
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Market Cap: $2.19 bil. Price Objective: $64
52-week price range: 10 1/4 - 64 7/16 Estd. 1998-2001 EPS cagr: N/A
Dividend: nil Yield: N/A
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Telecom services revenue was in line with expectations. Core telecom services revenue, which represents proceeds from local dial tone, long distance and data services, was $76.9 million vs. an estimated $76.8 million. Other telecom revenue, which is primarily from former Midcom long distance customers, was above our estimate, as the company reported $7.0 million vs. an estimated $5.7 million. This revenue will continue to decline through the year due to the planned attrition of these customers, however the attrition is not occurring as quickly as we expected. Information services revenue continued its trend of tracking below our estimate, as revenue of $12.6 million was below our $13.5 million estimate. We do not expect that information services revenue will start delivering any notable growth until the Office.com web portal rolls out in the upcoming months.
WinStar continues to improve its data penetration and sell multiple services to customers. Of the 69,000 lines installed during the quarter, about 40% were for data services, which was up from 20% in the second quarter of 1998 and 27% in the previous quarter. This statistic indicates the increasingly important roll that data services will play in the company's future revenue growth. Similarly, 62% of new customers purchased multiple services from WinStar, up from 46% in the second quarter of 1998 and 60% in the previous quarter. The company is also seeing average monthly revenue per customer increase, indicating that customers are buying more services from WinStar.
On-network efforts continue to yield gross margin improvements. The two percentage point improvement in gross margin, from 22% to 24%, was driven by the increased provisioning of lines on-network and on-switch. The company's efforts to serve more lines on-network are paying off, as WCII installed 48% of its lines completely on-network, vs. about 40% in the previous quarter. Approximately 40% of the lines were data lines, which are typically served by one of WinStar's data switches, but are still typically provisioned on leased transmission facilities. About 5% of the lines installed were on-switch voice lines and the remaining lines were local resale lines or long distance only lines. We are encouraged by the continuing decline in low margin resale and long distance only lines. Cumulative lines in service that were served on network increased to 27% from 24% in the previous quarter.
Gross margin improvements were constrained due to increased hub installations. At the end of the quarter, WCII had activated 97 hub sites, with an additional 43 sites under construction and 29 sites to begin construction shortly. The sites in service increased from 69 sites at the end of the previous quarter. The total active or under development sites increased to 169 from 136 at the end of the previous quarter. Since WCII activated 28 sites during the quarter, vs. 17 sites activated in the previous quarter, it experienced higher operating costs for leasing local fiber facilities to the hub sites, yet these new sites were yielding little revenue. As the company starts to generate revenue from these hubs, the revenue will start to defray the high fixed cost of the leased facilities, yielding margin improvements. As a result, we expect the increased number of hub sites and continued on-network sales efforts to generate a gross margin of 30% or better in the third quarter.
SG&A expenses were below expectations. WinStar's reported SG&A expenses were $106.2 million, which was below our $107.5 million estimate. These expenses were 110% of revenue vs. an estimated 112%. We expect SG&A expenses to remain relatively flat through the rest of the year as the company has spent heavily in the first half of the year to add personnel for its accelerated entry into domestic markets and new entry into overseas markets. Also, it has been investing in improvements to its back office systems that should greatly increase line provisioning capabilities in the future.
The net loss per share solidly beat our estimate and the consensus view. We estimated a net loss per share of ($3.68) vs. a reported loss of ($3.53) and a consensus estimate of ($3.72). The difference between our estimate and the actual was primarily driven by the stronger than expected EBITDA result and interest expenses that were almost $4 million below our estimate. We attribute the discrepancy vs. our estimate to difficulty in estimating how much WinStar will draw against its financing from Lucent in any given quarter and the resulting interest expense.
New York and the other mature markets continue to prove the WinStar model. New York city, which is WinStar's initial market, is often viewed as a proving ground for WinStar's business model. New York has delivered positive EBITDA for the third consecutive quarter, and EBITDA increased fourfold vs. the previous quarter. In the company's mature markets, which include New York, Los Angeles, Chicago, Boston and Dallas, 62% of the lines installed during the quarter were on-network, which is approaching the goal of installing at least two thirds of all lines on-network. The percentage of cumulative installed lines in these markets that were on-network increased to 42% at the end of the second quarter vs. 39% at the end of the previous quarter. The mature markets also delivered over 20% sequential revenue growth and improving gross margins and SG&A as a percent of revenue.
What really separates WCII from other CLECs is success at gaining access to buildings. WCII continues to be on track with its goal of of obtaining roof rights in 8,000 buildings by the end of 1999. The company received roof rights in over 700 buildings during the quarter, resulting in a total of 5,500 buildings where it can offer its broadband wireless services. The building access count should accelerate through the remainder of the year, as it holds the option to place equipment in a number of additional buildings, but does not report these buildings until it is within 12 months of actually installing equipment.
WinStar continues to be a long-term story, but we are encouraged by quarterly results that were in line with expectations. We feel that the company reached an EBITDA trough during the quarter and will start to deliver notable EBITDA improvements in the third and fourth quarters. We continue to think that WinStar faces a bright future leveraging its broadband wireless technology to attract business customers. We also support the company's strong on-network focus that will drive improving gross margins. Once again, the company delivered results that were on track with its promises, although the bottom-line impact of its strategy will not be realized for several years. With recent weakness in the WCII share price offering more upside to our $64 price objective and a quarter that was right on track with expectations, we are raising our rating to buy/speculative from accumulate/speculative. |
