DBAB Conrad: GST breaks its self-imposed silence and releases its outlook for the
upcoming quarter, forcing us to scale back our revenue and EBITDA
expectations.
n The biggest culprit is the timing for recognition of large facility sales
such as the Williams contract. While these sales are one-time in nature,
we now look for a larger portion of the revenue to extend into 2000.
n Traditional long distance also felt the heat as attrition took its toll and
pricing pressure flared up through a large wholesale customer.
n While these occurrences are a setback for the third quarter, we still look
for double-digit sequential revenue growth in the core communications
business into the fourth quarter and throughout 2000.
n Recent weakness in GST, combined with our expectation for increased
near-term volatility, could provide attractive entry points for what is
quickly becoming a CLEC value story.
Investment Thesis
GST officially gave further guidance on the outlook for 3Q99 following several
weeks of speculation by the Street that numbers would have to be reined in.
In fact, that is just what is occurring as the timing of large-facility-sales
recognition slips into 2000 and long distance feels the all-too-common pain of
price competition and wholesale vulnerability. As a result, we are lowering
our revenue and EBITDA estimates. This step backward comes after several
quarters of solid double-digit growth and one of the most consistent growth
records since the end of 1997. In spite of this adjustment to our numbers, we
still believe the company will post double-digit sequential growth in its core
telecom business (83% of estimated 2000 revenue) in the fourth quarter and
throughout 2000. That said, while this news may create some volatility in
GST's stock price, we believe it may also provide an attractive entry point.
We maintain our STRONG BUY rating and extend our $25 price target (based
on our DCF analysis) through the end of 2000.
Lowering Our Estimates
Specifically, we are reducing our 3Q99 revenue estimate to $93.1 million from
our prior $108.6 million estimate. The largest contributor to this reduction is
the company's facilities sales (construction revenue) business. We had
expected most of the revenue from GST's $62.5 million agreement with The
Williams Companies to hit its P&L in the third quarter ($7.7 million was
booked in 2Q99). It now appears that some of the revenue in this agreement
could be deferred into 4Q99 and 1Q00. In addition, the third quarter will be
affected by the recent divestiture of the company's Guam and GST Home
assets (totaling $1.5 million). GST has also experienced attrition in its stand-alone
long-distance business to the tune of $1 million. Finally, the repricing
of a large customer will impact GST's wholesale private-line business. The
impact from this repricing is expected to reach $2 million ($1 million catch-up).
Going forward, we have taken a much more conservative stance in all of our
projections as the company re-evaluates its strategic direction and its
business focus. We believe the byproduct of this effort will be an increased
emphasis on data-oriented sales and a de-emphasis of traditional (stand-alone)
long distance. In the process, we look for increased SG&A as sales
forces are ramped up and new products and services are unveiled. As such,
with less visibility into the impact of this effort, we have taken the lower road
with respect to our projections. Still, this implies significant growth in the
telecom business on a sequential and year-over-year basis. In the process,
long distance should fall as a percentage of total revenue. Last quarter, long
distance was roughly 45% of communication revenue. By the end of next
year, we believe that figure should drop to only 23%. Besides reducing the
vulnerability in profitability, this should help spur growth, as long distance
annual growth rates are expected to be less than 10%. On the other hand, we
believe that data should easily double in size in the next 12 months and we
expect it to capture roughly 38% of total revenue growth over the next five
years.
We are also reducing our EBITDA estimates for the third and fourth quarters
of 1999, as well as for the full year 2000. Our 3Q99 EBITDA estimate falls to
$10.8 million from our previous estimate of $33.3 million. The largest impact
to our EBITDA estimate was the lower-than-expected facilities sales now
anticipated for the quarter. Furthermore, we had estimated that GST's
facilities sales would contribute roughly 60% EBITDA margins. This now
appears to be too aggressive, which adds to the shortfall. We are now
lowering our EBITDA margin expectations for the facilities sales business to
40%-50%. In addition, EBITDA should be impacted by higher-than-expected
SG&A related expenses as the company continues to add to its sales and
marketing effort. Our 4Q99 EBITDA estimate now stands at $3.4 million,
down from $18.3 million. Our 2000 EBITDA estimate falls to $36.2 million
from our previous estimate of $56.1 million. |
