AG Edwards Dave Heger - FLAT SERVICES REVENUE EXPECTATION SPOOKS THE MARKET
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GST Telecommunications, Inc. (GSTX/7 5/8)
BUY/SPECULATIVE
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GSTX shares were under heavy selling pressure today following a press release yesterday regarding the revenue and EBITDA outlook for the third quarter. In particular, investors reacted negatively to flat telecom services revenue expected in the quarter. We have since spoken with management to gain further clarification on these projections. We feel that some of the flat revenue guidance can be explained. Taking into account these items, revenue growth is closer to the company's 10% sequential growth expectations. Although we understand investor concerns, we feel that the stock's slide is an overreaction.
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Market Cap: $570.2 mil. Price Objective: $20
52-week price range: 17 9/16 - 3 5/8 Estd. 1998-2001 EPS cagr: N/A
Dividend: nil Yield: N/A
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Several factors contribute to the flat revenue guidance. First, the sale of GST Home and the company's Guam operations remove about $1.5 - 2.0 million in quarterly revenue. Second, GSTX provides private line service on a wholesale basis to a particular customer. As traffic has grown, GSTX has received price breaks from its supplier, which it contractually must pass on to the customer. As a result, GSTX has to back out $1 million in revenue for the previous quarter and reduce revenue in the current quarter by $900,000. GSTX's costs associated with this revenue has dropped in tandem, hence there is no change in gross margin. Furthermore, GSTX had about $1.5 million in churn of customers only buying long distance service, since the company has chosen not to drop prices as quickly as major long distance carriers. Long distance revenue that is not associated with a local line generates low margins; hence we are not overly concerned about declines in this revenue. We have anticipated that long distance revenue would not grow significantly this year as churn of long distance only customers is offset by growth of local customers buying long distance. Overall, these factors account for drops in revenue that are not associated with the company's core business.
Local line growth will be in line with guidance, but may be below some analyst expectations. The company appears to be on track to install 30,000 local lines in the quarter, which is in line with management guidance, but analysts were anticipating some upside to this due to a strong backlog of lines after the second quarter. We feel the market overreacted to the revenue projections when digging into the details. Although local line growth did not represent any surprise upside, we will watch closely for upside in the fourth quarter as new back office systems should facilitate higher line installations and revenue growth should be back on track with the company's 10% sequential quarterly goal. We feel that the current price on GST shares offers a favorable buying opportunity.
A.G. Edwards makes a market in the shares of GSTX
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