more from PW's prolific Hodulik: NEXTLINK: Ramps Data Strategy Through CNCX Acq.
January 11, 2000
KEY POINTS
* NEXTLINK announced definitive plans to purchase Concentric Networks (CNCX-$39.63)[2] in an all-stock deal for roughly $2.9
billion. Concentric shareholders will own roughly 16-20% of the combined entity.
* Cost savings related to the combination of functional areas and the ability of the combined company to leverage the NEXTLINK
network with the additional traffic from Concentric are estimated to be $40 million in 2001 and approximately $400 million in the
period from 2001-2004.
* The company pre-released net access line additions of 78,881, dramatically ahead of our expectations for 71,000 for the
fourth quarter. This demonstrates the strength in the company's underlying business, which should help it defend against any
potential slowdown as the company digests this acquisition.
* NEXTLINK also announced the resignation of Mark Gunning from the CFO position due to health problems. Mark joined the
company just three months ago taking over for Kathy Iskra who decided against the move to Virginia. William Hoglund, an Eagle River
veteran, will assume the duties of interim CFO while a successor is found.
* We recommend investors use any pullback in NEXTLINK shares to add to positions. We believe integration risk is minimal and
that the strength demonstrated with the line count for the fourth quarter will show through in 2000.
* We maintain a Buy rating on NXLK shares with a 12-month price target of $105 per share (under review) based on our
preliminary revised DCF analysis.
OVERVIEW
NEXTLINK continues to assemble the pieces it will need to compete effectively in the new telecom environment against all comers.
The acquisition of Concentric gets the company into the data service arena overnight with a product set rivaling that of UUNet,
GTEinternetworking, PSINet and the other business-focused IP providers. Concentric's third quarter revenues of $38.4 million were
split roughly 36% for virtual private networking, 33% for access, 15% for hosting and 16% for consumer dial-up. Based on our
expected growth rates of each area, we expect the company's fourth quarter 2000 revenues to consist of roughly 38% for voice
services, 38% for data, 15% for data transmission and 9% for other services.
Based on our estimates for both companies, we expect the company to end 2000 with annual revenues of roughly $766 million. This
implies a TEV/2000 revenue multiple of approximately 25x and a TEV/2001 multiple of 14.4x.
The transaction makes strategic as well as financial sense for NEXTLINK which had stated its intention to develop its own data
service platform in the second quarter. To this end, the company had hired a management team and was developing the infrastructure
that are required to support a full suite of data services including an IP backbone, transit and peering agreements with major
Internet carriers and data centers. Currently, NEXTLINK is selling dedicated Internet access in six markets but has yet to begin
hosting operations.
Concentric operates five data centers, 19 SuperPOPs, and operates a Tier I IP backbone with over 200 private peering arrangements.
It provides DSL service in 19 cities with through resale agreements with Covad. At the end of the third quarter, the company had
6,632 lines in service, well on its way to hitting our estimate for almost 10,000 lines by year-end. NEXTLINK has an aggressive DSL
strategy of its own that will focus on deploying DSLAMs in focus markets while reselling Covad services in other markets that
complement its own offering. NEXTLINK owns a small stake in the DSL CLEC.
SUBSTANTIAL SYNERGIES EXPECTED
Combination of functional areas and network synergies make up the majority of the $400 million in synergies expected over the period
from 2001-2004. Data service expertise is difficult to find and Concentric's 608 (as of the end of the end of the third quarter)
will be a welcome addition to the NEXTLINK team. Additionally, NEXTLINK's 433-person salesforce will welcome the additional
products that can now be added to the product bundle offered to small and medium-sized businesses.
Concentric's pending acquisition of ITG will give the combined entity a bridgehead in Europe. ITG is the second largest ISP in the
UK and has a strategic positioning on the Continent with data centers in London and Stockholm and transatlantic fiber capacity.
In all, management estimates that combined cost synergies should total $40 million in 2001, bringing our estimate for EBITDA losses
in that year from $186.8 million to $146.8 million. Cost savings in years 2001-2004 are expected to total $400 million.
Additionally, we believe the advantages of selling a bundled set of services in major markets will accelerate the growth either of
these companies would have experienced as stand-along entities.
FINANCIAL CONSIDERATIONS
The number of shares Concentric shareholders will receive depends on the 20-day moving average of NEXTLINK shares subject to a
collar. The deal is expected to close in the second quarter. At the current price this would equate to 0.584 shares of NEXTLINK
for every share of Concentric. If NEXTLINK shares trade above $90.91, the conversion rate would not decrease to less than 0.495
while below $69.23 per NEXTLINK share, the rate would be capped at 0.650 per share. The deal is tax-free to NEXTLINK and Concentric
shareholders. The combined company will be 16-20% owned by Concentric holders depending on the final ratio. SBC and Microsoft also
become small shareholders of NEXTLINK.
VALUATION
We are increasing our price target to $105 from $68 per share based on our revised discounted cash flow analysis that employs a 14%
cost of capital and a new 16x 2008 EBITDA multiple to account for the company's expected ability to penetrate the fast growing data
services market. This analysis was completed using our preliminary model for the combined company that incorporates the synergies
estimated to occur in the suggested time frame. The new 12-month price target provides 36% upside to the current price of $77 per
share and equates to a total enterprise value of just over $21 billion or 23x our estimate for 2001 revenues.
CONCLUSION
The company pre-released fourth quarter line adds of 78,881, beating our estimate for 71,000. This should provide upside to our
quarterly revenue estimate for $133 million and give the company added momentum as it heads into 2000 with its new product
portfolio.
In sum, we continue to believe NEXTLINK management is putting the assets in place that will create a leading carrier in the emerging
telecommunications landscape. We believe this transaction complements the company's current capabilities and that it is not likely
to be the last.
RISK
Risks include technological change, potentially adverse regulatory rulings, mounting losses, continued reliance on the capital
markets, high degree of operating and financial leverage and increasing competition from larger, better established carriers.
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