Paine Webber's Hodulik: GSTX: Pre-releases 3Q Below Expectations
September 21, 1999
KEY POINTS
* After the close, GST pre-announced results that will fall below our
expectations for the third quarter. Management expects recurring telecom
revenue (including dial-up Internet access) of $50-52 million, essentially
equal to the $51.2 million produced in the second quarter. We had expected
roughly 10% internal growth, or an incremental $5 million in revenues.
* The slowdown is the result of a number of factors ranging from
recent divestitures, discounting of private line services, increased
pressure in long distance pricing and one-time adjustments.
* Additional shortfalls are expected in the non-recurring segments of
the business due to construction delays experienced in the build out of the
company's long haul networks. These revenues are not at risk but will be
recognized in later periods when construction has been completed.
* As a result of this shortfall and unexpected increases in cost of
goods sold, EBITDA losses (not including the contribution from Williams) are
expected to be in the $9-12 million range versus losses of $4.7 million in
the second quarter. We had originally expected the company to hit breakeven
during the quarter.
* Our 2000 revenue estimate is being reduced from $377 million to $345
million, or 8%, while 2000 EBITDA expectations fall to $32 million from $47
million. These changes and additional modifications to our operating model
have caused us to reduced our 12-month price target on GST shares to $16
from $18.
* Given its recent 40% pull-back we believe much of this news is
already discounted in GST shares. The stock currently trades at 4.3x our
reduced expectations for 2000 revenues and 1.8x PP&E, below the Tier 1 CLEC
group averages of 7.5x and 4.5x, respectively. Despite the above issues, we
continue to believe its western footprint and relative valuation make it a
compelling stock for long-term investors.
* We maintain a Buy rating on GST stock with a new 12-month price
target of $16 per share based on our discounted cash flow analysis.
After the close, GST pre-released third quarter revenue estimates that fell
below our expectations. The company now expects to report total recurring
telecom revenues of $50-52 million versus our expectations for $56.3
million. Combined with approximately $30 million in revenue from the
Williams conduit sale and an additional capacity sale of $9-12 million,
total revenues are expected to come in at $90-95 million for the quarter. .
The $5 million shortfall in recurring revenue is due to a number of factors
which we have broken out below:
* $1.8 million due to divestitures of properties in Guam and GST Home,
the company's shared tenant business,
* $900,000 from discounts given to the company's largest long haul
private line customer (responsible for roughly 25% of private line revenues)
due to cost reductions that had to be passed due to contract language,
* $1 million "one-time" adjustment to the previous quarter to
reconcile the books for unrecognized volume discounts to the same customer,
and
* $1.0-1.5 million shortfall in stand-alone long distance as pricing
pressure continues to effect the industry as a whole.
Additionally, line growth is not expected to meet our expectations for the
quarter. We had been estimating the company would add 35,000 new lines but
now see net adds of roughly 30,000. The line mix should remain relatively
constant to the second quarter with a 70/30 split between commercial/ISP
lines.
Line growth should improve in the fourth quarter as the positive impact of
the company's new provisioning systems kick in and a major contract,
consisting of 12,000-15,000 new lines (that was originally expected to by
provisioned in the fourth quarter), is installed. Additional sales
headcount, added to support the launch of service in San Jose, San Diego,
Dallas and Sacramento, should drive improved revenue growth in early 2000.
Effects on profitability
We had expected GST to post positive EBITDA, net of the Williams contract
this quarter. Discussions with management, however, now indicate that the
deficit of $10-12 million is likely. Aside from the revenue shortfall,
additional expenses related to the capacity sales were incurred. These
include:
* $4 million in additional cost of goods related to the testing of
conduit for Williams.
* $2 million for bonuses and commissions associated with the sale to
Williams, and
* $2 million in costs associated with its launch of service in new
cities.
The release of this information signals the end of a quiet period the
company was in for the past few weeks. Although specifics were not
announced, we believe this quiet period was related to fund raising the
company was looking to do as its stock price rose above $17 per share.
After this announcement, it would appear that a deal to raise capital is no
longer on the table. However, given the $30 million the company secured in
the settlement of the Global Light lawsuit and the additional $50-75 million
the company should receive from previously announced capacity sales, we
believe the company remains funded through mid-2000.
Looking ahead
We are reducing our estimates for total revenues in 2000 from $377 million
to $345 million, or 8.5%, due to the weakness in the third quarter. EBITDA
estimates for 2000 fall from $47 million to $32 million. As a result of
these changes and additional modifications to the outer years of our
projection period and their effects on our discounted cash flow model, we
our reducing our 12-month price target to $16 per share from $18.
Given the 40% pullback in GST shares, we believe the majority of the bad
news is already reflected in the stock price. At roughly $11 per share, the
company trades at 1.8x PP&E and 4.3x our reduced estimate for 2000 revenues.
The relatively low PP&E multiple, combined with the company's attractive
asset base, make GST a leading candidate for consolidation by companies
requiring a western footprint in the U.S. or a gateway to Asia. We are
therefore maintaining our Buy rating on the stock with new price target of
$16 per share.
Risks
Risks include regulatory change, ability to execute, the existence of
substantial financial leverage, dependence on the capital markets,
increasing competition and technological change.
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