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Covad Communications: DSL Expansion to Spur Further Gains
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Eliot Walsh (9/3/99)
Two weeks after it reported stellar second-quarter results, broadband Internet access provider Covad Communications (NASDAQ: COVD - Quotes, News, Boards) has wowed the Street again, announcing Thursday night that it will expand its Digital Subscriber Line (DSL) service to reach up to 40% of the homes in the U.S. by the end of 2000.
The company said it would push into 49 new markets throughout the country to give it market share in 100 metropolitan areas.
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Although the stock was up $3.81 to $47.63 in afternoon on Friday, it still trades at a discount to its peer group, according to Deutsche Banc Alex. Brown analysts Michael Bowen and Kevin Moore.
Friday morning the two analysts upgraded their rating on Covad to a ?strong buy? from a ?buy,? with a new fourth quarter year 2000 price target of $90.
Covad provides and enables broadband access over copper xDSL telephone lines to corporations and ISPs, which then pass the service on to individuals.
The company?s marketing strategy targets corporations with more than 100 broadband users, and ISPs that offer both business and residential service. By employing this neutral or ?Switzerland? business model, Covad largely pre-empts the costs of marketing and customer service and acquisition they would face were they to offer their technology directly to consumers.
Currently, MCIWorldCom?s (NASDAQ: WCOM - Quotes, News, Boards) UUNet, Mindspring (NASDAQ: MSPG - Quotes, News, Boards), Earthlink (NASDAQ: ELNK - Quotes, News, Boards) and other ISPs all resell Covad?s services.
According to the Deutsche Banc Alex. Brown analysts, the high-speed local data transport sector, which includes office LAN lines, is a ?$65 billion opportunity.? They further estimate the North American market for xDSL lines to grow at a compounded annual growth rate of more that 160% through 2002 to over 3 million lines, with the potential for 6.4 million lines by 2003.
?The thing to focus on is not only what they?re building,? says Pacific Crest Securities? Brent Bracelin, ?but more importantly their new branding strategy, which was not included in the press release today. Covad is investing $45 million dollars in marketing to build a brand, and to differentiate themselves as a higher-quality broadband service.? He likens the concept to Intel?s ?Intel Inside? campaign, in which PC makers who use Intel processors plug the chipmaker in commercials.
Ken Hoexter, an analyst with Goldman Sachs agrees: ?We view this as a very positive move, going after the end user. We see it as a very positive signal that they?re sending out about their build out.?
Bowen and Moore?s valuation model, based on multiples of 16 times to 17 times estimated 2003 revenue, by their own admission does not factor in another significant growth driver for Covad: a strategic partnership with AT&T (NYSE: T - Quotes, News, Boards), which will use Covad?s services to roll out its own DSL initiative.
?The Company has not yet reaped benefits from these relationships, as they should begin to contribute positive revenues in 2000,? the analysts wrote in an August 17 research report.
?However, the Company reported that it has completed the training of AT&T sales representatives and that AT&T?s DSL rollout, using Covad, should commence nest month, with measurable service volume expected in 3Q99,? the report said. The analysts believe the AT&T deals have the potential to generate demand for tens of thousands of Covad lines.
Bottom Line:
Covad has proven itself to be a critical, successful behind-the-scenes player. The company is on the verge of transitioning itself to be the dominant national DSL-backbone provider in anticipation of an explosion in the demand for broadband Internet service. ?There are 70 million Internet users in the US,? says Bracelin, ?and they?re clamoring for more speed.? Covad is in a unique position to benefits from this trend, and the stock still has lots of room to grow.
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