from Merrill's Kastan / Reingold
Investment Highlights:
· Initiating coverage of IXnet with intermediate
term Accumulate and long term Buy opinions.
IXnet is a leading provider of voice and data
communications services to the global
financial services community.
· 12-18 month price objective is $29 based on
our 10 year DCF model, a 15% discount rate,
a 10.5 multiple on terminal year EBITDA, and
a 10% public market discount to reflect 87%
ownership by IPC Communications.
Fundamental Highlights:
· Strong 10-year top line growth of 42%.
CAGR forecast fueled by the growth of data
and content-related services.
· Increased profit margins to be driven by the
combination of lower network costs and a
richer revenue mix. EBITDA breakeven
expected by 1H02 with EBITDA margins
expected to hit 33% by '08.
· Strong management team with extensive
experience in the financial services and
financial trading systems sectors.
· Acquisitions should help to accelerate top line
growth as well as boost profit margins.
Initiating Coverage Of IXnet With Intermediate Term
Accumulate And Long Term Buy Opinions.
Following the successful completion of its initial public
offering of 6.5M shares at $15 on August 12, we are
initiating coverage of IXnet, Inc. (EXNT) with
intermediate term Accumulate and long term Buy
opinions. Our 12-18 month price objective is $29 or 39%
upside from current levels based on our 10 year discounted
cash flow (DCF) model.
Company Description: IXnet is one of the leading
providers of voice and data communications services to the
global financial services community. IXnet has deployed a
global seamless private voice and data network (i.e., an
extranet) which, as of July 31, interconnects 521 customers
in 34 countries. This extranet provides global connectivity
between financial service firms and their business partners
as well as multiple locations within the same organization.
IXnet's predecessor company was originally incorporated
as International Exchange Networks (IEN) in March of
1993. Following the commencement of operations in June
of 1995, 80% of the company's stock was acquired by IPC
Communications, the world's largest supplier of integrated
telecommunications equipment and services specifically
tailored to the trading operations for the global financial
services marketplace. In 1998, Citicorp Venture Capital
recapitalized IPC and incorporated the company as a
subsidiary of Cable Systems Holding Company, a cable
manufacturer. As part of this transaction, IPC gained
control of the remaining 20% of IEN's equity. In
December of 1998, IEN acquired Saturn Global Network
Services Holdings Limited, a provider of managed,
premium voice and data services to financial services firms
in Europe as well as the Asia/Pacific markets. Lastly, in
May of 1999, IPC formed IXnet via the combination of
IEN and the contribution of Mxnet, a provider of market
data distribution services to content providers. Following
the recently completed initial public offering of IXnet, IPC
will hold 44.1M shares of IXnet or 87% of the outstanding
shares.
The Network: IXnet's customers, financial services firms,
require that their traffic be transmitted over a network that
is both secure and reliable. Because the internet is
relatively unreliable and cannot satisfy these requirements,
IXnet serves its customers by offering both dedicated and
switched voice and data services over its extranet to meet
its customers' needs. The backbone network is comprised
of leased or owned long haul capacity (up to DS-3) and
last mile circuits (typically T-1s or 1.5Mbs and above)
leased from incumbent suppliers which are interconnected
via 73 globally distributed network points of presence or
“POPs” in 39 key financial centers. At each customer
location, leased last-mile circuits are interconnected to
customer premise equipment (i.e., trading turrets, LANs,
WANs, etc.) via a customer access node or CAN.
Deployment of these CANs – typically a Newbridge
multiplexer, a Cisco router and DLICs or digital line
interface cards -- allows IXnet to remotely provision
service as well as fully monitor end-to-end network
performance on a 24x7 basis.
IXnet Services: IXnet offers several different options for
specialized voice and data services over its extranet as well
as access to third party content (i.e., news, research and
other trading applications transmitted over the IXnet
network) under the Liquidity brand name. 1) Customers
can purchase voice products that range from dedicated
lines to switched long haul services with flat rate pricing.
Clients can order dedicated services such as hoot & holler
networks and digital private lines that connect firms both
within metropolitan areas and across the globe. 2) For data
products, IXnet offers services such as high-speed
dedicated links and frame relay transport. 3) Finally,
IXnet offers Liquidity, a turnkey managed data network
service based on IP technology. Using Liquidity,
customers can receive multiple content feeds from various
vendors through one network connection.
Sales Force: IXnet primarily relies on its direct sales
force, currently at 36 members, but it also receives
revenues from content providers that purchase IXnet
services to transmit their own services. IXnet plans to
grow its direct sales force to 40 members by YE'99 and to
over 50 by YE'00. This global sales force, largely
concentrated in North America but with a significant
presence in financial centers in both Europe and Asia,
develops tailored solutions specific to a client's needs.
The direct sales force targets clients strategically located in
sites that are either already on-net or ones that are large
enough to merit network investment. Content providers
supplement IXnet's direct sales force by offering content
applications over IXnet's extranet to potential clients in the
financial services industry.
Strong 10 year Top Line Growth Of 42%. CAGR To Be
Driven Both By Increased Penetration Of A Large
Addressable Market And The Rollout Of New Services:
From a 1998 revenue base of $35.9M, we project IXnet's
total revenues will grow 103% to $72.8M in 1999, 48% to
$107.8M in 2000 and to $1.2B by 2008 for a 10 year
CAGR (compounded annual growth rate) of 42%. We
estimate that IXnet's current addressable market is $25B
globally, a market that we project will grow an average of
15% per year due to growth in both the velocity of
financial market transactions and increases in network
traffic within the investment community. Additionally, as
financial services companies continue the move towards
the outsourcing of network operations, demand for IXnet's
services should continue to grow. By 2008, we project
that the addressable market will be $88B and that IXnet
will have 1.4% share vs. the 0.3% that we project it will
have at the end of FY'99. (See Chart 1)
In addition to the anticipated growth of data traffic, we
project the number of potential content providers that can
offer services over IXnet's extranet will continue to grow.
Because IXnet provides a content neutral delivery medium
(i.e., it acts as a distribution conduit for content but does
not compete with the providers themselves), we believe
these providers will have an increased desire to partner
with the company. By utilizing IXnet's global extranet for
the financial services community, content providers can
focus on core competencies (i.e. content generation vs.
devoting scarce resources to both network deployment and
network capacity expansion), a strategy that lowers costs
to content suppliers and therefore end users. Another
advantage of IXnet's outsourced content distribution
service is that customers can retain their own formatting
vs. a system such as Bloomberg on which a provider's
content must conform to a specific format.
Multiple Drivers Of Margin Expansion: From a FY'98
EBITDA loss of $13.3M, we anticipate that EBITDA
losses will widen to $20.3M for FY'99 and to $29.5M in
FY'00, a sequential widening of $7.0M and $9.2M,
respectively. During FY'02, we expect that IXnet will go
EBITDA positive and achieve an EBITDA margin of 7%
for the year. By FY'05, we predict that IXnet will go free
cash flow positive and reach an EBITDA margin of 23%.
By '08, we expect EBITDA of $403.4M or 33% of total
revenue.
Increased profitability should be driven by 3 key factors as
follows: 1) Network Migration: previously having used
fractional T-1s for its backbone network, IXnet has
recently begun to convert over to higher capacity DS-3
circuits (equivalent to 28 T-1 lines). Although this has
negatively impacted gross margins in the near term, IXnet
has already begun to recognize lower unit costs of
providing voice, data and content services. We estimate
that FY'99 network costs (backbone and local facilities
costs only) -will be approximately 75% of revenue and
will decrease to 66% and 52% by FY'00 and FY'03,
respectively. 2) Favorable Revenue Mix: We also
estimate that IXnet's revenue components will shift over
time. For FY'99, we anticipate that voice services will
comprise about 57% of total revenues and that the higher
margin content (or Liquidity) and data businesses will only
be 42% of the total. However, as IXnet gains momentum
with its content-neutral Liquidity business, we predict that
content and data will become a much more important
source of revenues and that it will reach 65% of revenues
by FY'08. (See Chart 2) As data revenues become a more
significant portion of IXnet's revenues, we expect that data
margins will increase. We estimate that network costs as a
percentage of revenues for data services will decrease from
72% in '00 to 42% by '08. Conversely, we expect voice
service costs to only slightly decline in the same time
period from 61% in '00 to 55% by '08. 3) Increased
Network Utilization: as the number of customers who take
a higher number of multiple services over time grows,
IXnet's bandwidth cost as a percentage of revenue should
decrease, giving it even more potential margin expansion.
Strong Management Team: The management team at
IXnet (collectively) has an impressive breadth of
experience in both the financial services and in the trading
systems equipment sectors. In particular, David Walsh,
the CEO, has held several technology-related positions at
different financial services firms, including the various
New York Commodities Exchanges. Walsh also founded
Voyager Networks, a New York City-based Internet
company that was acquired by GlobalCenter and
subsequently sold to Frontier in 1998. Gerald Starr,
President of IXnet, founded Bridge Electronics, a provider
of digital open line speaker systems, in 1987 and served as
its President until the organization was sold to IPC in
1995. Charles Auster, the COO, is a founding member of
IXnet and was an executive at Ameritrade until 1993.
Finally, Anthony Servidio, also a founder, was a Sales
Vice President at WorldCom, and he has been a Senior
Vice President since 1995 at Ixnet. Altogether, the IXnet
management team has over 240 years of relevant
experience in the financial services industry.
Potential To Leverage The IPC Relationship: As the
world's leading supplier of voice trading systems to the
financial services community with over 100,000 turrets
(i.e., trading positions) in place or an approximate 60%
market share, IPC provides IXnet with a number of
important strategic benefits: 1) The ability to jointly
market services alongside the IPC sales force directly into
the IPC customer base; 2) the relationship with IPC gives
IXnet's network services instant credibility in a market
segment that has traditionally had relatively long sales
cycles and has been leery of new network services
companies; and, 3) the IPC relationship provides IXnet
with significant technical expertise vis-à-vis designing
network interface equipment for IPC turret systems, and
just as important, access to the IPC technical service staff
for equipment installation and maintenance.
Growth Via Acquisition: IXnet intends to use a portion of
the IPO proceeds to continue its acquisition and
consolidation strategy. Communications services in the
financial services industry remains a highly fragmented
sector, and we project that IXnet could obtain significant
revenue and cost synergies by combining its operations
with network providers. These potential acquisitions
would accomplish several goals: 1) deeper geographic
penetration of IXnet's addressable market; 2) add new
network relationships with content providers; 3) rapidly
expand the number of customers on IXnet's global
extranet, thereby making the private network more
valuable to existing customers as well as to help to attract
new customers such as potential on-net trading partners;
and, 4) help increase network utilization, which in turn
would increase margins.
Attractive Valuation: Our 12-18 month price objective is
$29 or 39% upside from current prices. Our price
objective is derived from our 10 year DCF model. Key
assumptions underlying our DCF-based valuation analysis
include a 15% discount rate, a10.5x terminal EBITDA
multiple, 33% terminal EBITDA margin and a 10% public
market discount to reflect the majority (87%) ownership
by its parent, IPC Communications.
Risks To Our Recommendation Include: 1) IXnet's
relationship with IPC: IXnet has agreed to remain a
consolidated subsidiary of IPC for tax purposes until
November '01, and it therefore cannot issue stock such
that it reduces IPC's ownership of IXnet below 80% until
that time. Therefore, IXnet may be unable to raise
necessary equity capital to continue the expansion of its
infrastructure and it will be unable to be sold to another
entity within this time period. Furthermore, 5 out of the 9
board members of IXnet are also either directors and/or
senior executives of IPC, a factor that could cause a
conflict of interest between the two companies. 2) IXnet
is not self-financing, and we predict that it will need to
raise additional funds by 2H00. 3) IXnet's revenues are
derived entirely from the financial services sector, and any
consolidation and/or downturn in this industry could
negatively impact IXnet's financial performance from
occurrences such as a reduced number of trading positions
or a reduction in velocity of trading activity. |
