part 1) WCOM: Still a Cool Co.-Stk Appears
Cheap-Aggressively Reiterate Buy
Salomon Smith Barney
Jack Grubman
Monday, February 07, 2000
--SUMMARY:--MCI WorldCom, Inc.--Telecommunications Services
*We are aggressively reiterating our Buy Rating on WCOM because we believe
it has more "sexy IP assets" than any other company in the world.
*WCOM's capital allocation is skewed towards the fast-growing, horizontal
data/IP segments.
*WCOM UUNET is an IP network bigger than most of the IP backbones around
the world by a factor of 4-5.
*UUNET has as much value-added services, hosting, IP VPNs,and secured
content as any IP player, and likely future JVs with systems integrators
will spur growth in managed services.
*WCOM has the most ubiquitous and pervasive mix of local/long haul backbone
infrastructure in the world.*We would be aggressive buyers of the stock.
*Salomon Smith Barney is advising WCOM in its pending merger with Sprint.
--EARNINGS PER SHARE--------------------------------------------------------
FYE 1 Qtr 2 Qtr 3 Qtr 4 Qtr Year
Actual 12/98 EPS $0.12A $0.14A $0.14A $0.15A $0.55A
Previous 12/99 EPS $0.24A $0.30A $0.37A $0.42E $1.33E
Current 12/99 EPS $0.24A $0.30A $0.37A $0.42E $1.33E
Previous 12/00 EPS $N/A $N/A $N/A $N/A $1.90E
Current 12/00 EPS $N/A $N/A $N/A $N/A $1.90E
Previous 12/01 EPS $N/A $N/A $N/A $N/A $2.70E
Current 12/01 EPS $N/A $N/A $N/A $N/A $2.70E
Footnotes: Our 2001 EPS estimate is Cash EPS proforma for Sprint.
--FUNDAMENTALS--------------------------------------------------------------
Current Rank........:1M Prior:No Change Price (02/04/00)....:$44.31
P/E Ratio 12/99.....:33.3x Target Price..:$87.00 Prior:No Change
P/E Ratio 12/00.....:23.3x Proj.5yr EPS Grth...:28.0%
Return on Eqty 98...:N/A% Book Value/Shr(99)..:17.00
LT Debt-to-Capital(a)26.7% Dividend............:$N/A
Revenue (99)........:34094.00mil Yield...............:N/A%
Shares Outstanding..:2907.0mil Convertible.........:No
Mkt. Capitalization.:128809.2mil Hedge Clause(s).....:#
Comments............:(a) Data as of the most recently reported quarter.
Comments............:
--OPINION:------------------------------------------------------------------
We are aggressively reiterating our Buy Rating on WorldCom because we
think this stock is at a level that is absurdly cheap. As we see it, the
market completely fails to recognize the triangulation of size, growth
and valuation embedded in it and, most importantly, completely ignores
the fact that WCOM has more "sexy IP/Data assets" than any other company
in the world. In fact, on this last point we believe that a major reason
for WorldCom's lagging performance has been the view that somehow the
world is passing WorldCom by and the new breed of bandwidth companies (as
well as other companies such as webhosting) are grabbing the growth
opportunities away from WorldCom. Whereas in the past, we believe
WorldCom was always viewed as the company with the initiative in driving
growth opportunities.
We are probably partially to blame for this, given our advocacy of the
bandwidth-centric view of the world, as evidenced by our support of new
bandwidth players including Level 3, Qwest, Metromedia Fiber Network,
Williams, BroadWing, Global Crossing as well as emerging CLEC/integrated
communications providers such as NEXTLINK, McLeod, Allegiance, etc. In
addition, we tend to wax eloquently about companies like Akamai and other
companies in the Internet infrastructure, network caching, web-navigation
space--all of which are attempting to make the worldwide web a
commercially-ready-for-prime-time vehicle.
The bottom line is we see demand for bandwidth exploding and no danger of
capacity gluts. We believe companies who are focused on the horizontal
bandwidth infrastructure layer (most notably LVLT, WCG, MFNX), which
enables web-centric companies to take bandwidth and add value, are
companies who will take large shares of a horizontal layer and drive huge
value, given the growth in bandwidth requirements on the part of
web-centric players -- such as web-hosters, network caching and ASPs.
Web-centric companies who use bandwidth as the core of their service
offerings are dependent on low-cost, highly reliable bandwidth, which is
why LVLT and WCG are so focused on optimizing cost at the network layer.
This phenomenon, coupled with the fact that WorldCom now is a large,
vertically-integrated enterprise, we think, has led people to view
WorldCom as somewhat yesterday's news. However, a vertically-integrated
company like WCOM who happens to have a huge horde of growth assets, and
large customer base, along with a low-cost structure, will significantly
participate in the accelerating growth segments of the industry. Pure
plays are fine, but don't ignore the powerful growth prospects of a
well-positioned global vertically-integrated company.
Therefore, we thought it would be opportune to remind people that
WorldCom is in fact a company that while having almost $40 billion of
revenue and almost 20 million customers, also has very cool assets, in
our view, which should help it participate in the growth trajectory of
this industry. In fact, WorldCom, being a completely
vertically-integrated company with a global set of assets, is in a
position to take advantage of its scale and scope to leverage its cost
structure via its geographic reach in network and its ability to spread
SG&A over many millions of customers. At the same time, we believe WCOM
has as many hot new IP assets as anyone on the planet, off which WCOM can
sell a full suite of IP services to a huge existing WCOM corporate
customer base.
We believe the toughest challenge for IP players is to scale their
businesses. Given WCOM's corporate customer base, we believe UUNET has a
tremendous built-in advantage, especially since 60% of Fortune 500
customers have said they will increase enterprise IT spending and 100%
have said they will spend more on IP-based services. Thus, we believe
WCOM's combination of scale in both IP infrastructure, and its huge base
of corporate customers is unmatched by any company in the global telecom
industry, firmly placing WCOM in the sweet spot of the industry growth
curve, in our view. In fact, WCOM's capital allocation is skewed towards
the fast-growing, horizontal data/IP segments (50% of capital) as well as
large international or U.S. local markets (40% of capital) where WCOM has
no market share.
As we see it, WorldCom is going to be much more of a participant in the
growth parts of this industry than they will ever be a victim of the
devaluation of legacy services such as voice. Don't forget, WCOM has a
base of data/IP revenues of $12 billion (more than any player by at least
2:1) and will add almost $5 billion in new data/IP revenues in 2000.
WCOM adds more data/IP revenue than virtually any other carrier has as a
base. WCOM's blended growth rate of 40% in data/IP probably means that
WCOM is gaining share despite already being a market leader.
WORLDCOM'S SET OF ASSETS AND VALUE-ADDED SERVICES IN IP SPACE
In the IP space, UUNET has over 2,000 points of presence, 500 of which
are outside the United States. This is bigger than any other IP network
on the planet by at least a factor of 2 and is bigger by a factor of 4-5
than most of the IP backbones around the world. Thus, while people get
excited about companies like PSINet -- which we believe they should since
we view PSINet as a very well-run capable company with a very attractive
set of assets -- we see UUNET the biggest game in town by a longshot.
In addition, UUNET has 1.6 million modem banks which is over 4x the size
of its next rival. We wrote a note a few weeks ago about the whole
vulnerability or lack thereof of AOL revenues and as we pointed out at
the time: Of the $3.5 billion or so in IP revenues that WorldCom will
derive in 1999, about $1.75 billion is from dial-up revenues and of that,
about 1/2 is coming from AOL. Of the 1/2, only about 40% is up for
grabs, given that the other 60% is tied in to a 3-year contract. Thus,
there is about $350 million of annual revenue from AOL that is
consistently subject to rebid, so even if pricing goes down by 50%, we
are only talking about $175 million or so of annual revenue vulnerability
on an overall WorldCom base of close to $40 billion.
Our point is that companies like AOL and others which use IP backbones
for dial-up traffic need IP backbones with modem banks. As we said,
WorldCom has 1.6 million modem banks which is 4x the size of anyone
else. In fact, the only other companies that are ever even in the game
for AOL's business are LVLT, BBN, and FON. In addition, WorldCom's UUNET
backbone runs on multiple OC-48s with the backbone going to OC-192 this
year. Again, most IP backbones run at OC-12 at the most. The fact of
the matter is that if you look at the UUNET infrastructure, there is no
IP company in the world that has its physical reach or points of
presence, its density of modem banks (which still is important for the
dial-up world, which is still a big part of the revenue generation) and
the backbone speed of UUNET.
We also still don't believe that investors understand that WorldCom is
actually a very significant player in the upper end of the value chain
within IP. A company like Exodus, which is a leading webhosting company,
had $260 million of total 1999 revenue, of which two-thirds is bandwidth
and co-location, as opposed to true hosting. Of the $3.5 billion of 1999
UUNET revenue, we estimate at least $130 million and maybe double this is
in complex webhosting and secured content services for customers. This
is a very high-end business and we would argue WCOM's revenues in this
segment probably compares favorably to the level of revenues Exodus gets
from complex webhosting and security services, if not exceeding Exodus
revenues, since WorldCom does very little in actual co-location. In
2000, Exodus should see organic revenue growth of 150% while UUNET's
high-end revenues will likely grow over 200%. Thus, we would argue
WCOM's most likely the world leader in high-end IP services.
WorldCom also gets over $700 million a year from IP virtual private
networks which, of course, will continue to proliferate as people augment
their frame relay and ATM networks. Thus, there is almost $1 billion of
revenue within the UUNET business in 1999 that is truly value-added,
high-end services as opposed to transport. In addition, WorldCom gets
about $850 million from dedicated Internet access, 70% of which comes
from corporations and that obviously dovetails nicely with the rest of
their product portfolio in the business markets.
As far as hosting centers are concerned, we believe WorldCom, over the
course of the next 2 years, will have 30 hosting centers around the
world, 15 of which will be in place in 2000, including international
cities (London, Hong Kong, Tokyo, Singapore with hosting centers in
Germany and France planned as well). These hosting centers will be your
typical hosting centers with a 50,000 square foot hosting center able to
have 2,000 racks on it, which obviously will enable WorldCom to offer
everything from co-location to hosting to managed services as well as
application service, ASP-type offerings. In fact, we would argue that
the complex web-hosting and security area of WorldCom could triple in
revenues over the course of the next 12 months. This would mean the
UUNET growth rate should continue to be at a 50% plus level despite the
fact that they are working off of a $3.5 billion base. More importantly,
the mix of business within UUNET will continue to be skewed towards
value-added services, hosting, IP VPNs, managed services and away from
dial-up revenue which is still growing rapidly but slower than the
triple-digit rates of these value-added areas.
Also, most publicly-traded IP companies have EBITDA margins ranging from
0% to 30%. UUNET's EBITDA margin is 40% which tells you something about
its mix of revenues, its ability to premium price and the fact that they
have the most ubiquitous and pervasive IP backbone infrastructure in the
world which allows it to drive high value over its network and is why it
is able to command premium pricing for its services. This margin should
only be enhanced as the mix of revenues from more value-added services
such as complex webhosting, managed services, and ASP services come on
board.
WCOM LIKELY TO ENTER INTO JV WITH CONSULTING/SYSTEMS INTEGRATOR
TO DRIVE
ASP SERVICES
We would venture to guess that WorldCom is likely to enter into a
partnership with a systems-integrator/consulting type of company--much in
the way Qwest has with KPMG. Such a venture would allow WCOM to
consolidate revenues in a triple-digit growing category (i.e. managed
services,) enhancing WCOM's overall growth rate. In fact, companies in
this space are very good at applications-management and
applications-service provision. They have an incredible suite of
e-commerce services especially in the areas of electronic accounting and
HR which businesses need. These types of companies bring product
application capabilities, a robust set of services, consulting know-how,
and of course, people. However, these companies need network services,
real estate and bandwidth, all of which WCOM has, not to mention over 2
million business customers.
It is incredibly clear that the economics in the entire value-added space
and IP--namely hosting and managed services--work in favor of putting the
hosting facilities on the fiber so you can have instantaneous
provisioning, the ability to look into networks and, of course, lowest
cost structure--which remains important regardless of the trend in cost
for bandwidth. The point is WorldCom, Qwest, or Global Crossing, which
own their underlying network and who are doing hosting, or managed
services, will by definition have a lower cost for the bandwidth than a
company which is buying bandwidth from someone else. The more important
factor, though, is that these complex hosting and managed services
applications tend to be very mission-critical where you need to be able
to handle bursts of demand at a moment's notice--something you cannot do
unless you own the underlying network.
In addition, there is massive revenue pull-through for network services
led by the value-added hosting type of capabilities. Thus, we strongly
believe that WorldCom will likely enter into a joint venture where
WorldCom will be able to consolidate the revenues of this joint venture,
which will have the effect of increasing WorldCom's revenue growth while
giving WorldCom weapons that will allow it to retain its corporate
customers as the competitive landscape gets more intense. In fact, given
WCOM's array of assets and capabilities, they have a tremendous ability
to package in voice with data and IP Services, which of course works to
protect the revenue stream. Voice will never be "free," but could
clearly be part of a package of services on an all-you-can-eat bandwidth
basis, similar to how email is priced today.
The bottom line is that in the IP world, WorldCom takes a back seat to no
one--not Exodus, not PSINet--all of which are good companies. WCOM has
the largest physical footprint on earth. WCOM has the highest speed
backbone. WCOM has product capabilities at the high-end that are
probably second to none in terms of absolute revenue and WCOM is likely
to enter into a joint venture that will highlight these capabilities and
work to add to the growth rate of WorldCom's topline.
WORLDCOM'S NETWORK ASSETS HAVE PLENTY OF BANDWIDTH POTENTIAL
AND HUGE
REACH
We think that with all the talk of new-age networks and the debate on
cost-structures of fiber, people do forget a bit about what drives the
economics in this business. Again, we are a great believer that in a $1
trillion global market that is growing at perhaps close to a double-digit
rate in revenues, there are many ways to drive value. Companies that
look to optimize one part of the value chain or another are going to
drive tremendous value, especially those companies that are leveraged
towards provision of bandwidth services such as Level 3 and WCG. In this
space, relative costs at various layers of the network are critical since
the customers are very sophisticated players who need bandwidth at the
core of their services.
However, vertically-integrated companies which have huge scale and scope
of network facilities, as well as tons of customers, are also going to be
able to participate in the growth of this industry and drive value as
well. The key for network economics, especially for a vertically
integrated company, is the reach of one's network which means the more
customers you can directly connect to, the lower your cost of network
will be (i.e. access and interconnection are far more important to the
cost of the network than the pop-to-pop transport within an intercity
network). Worldcom has more direct access to more business locations
around the world than any company, which allows them to drive down cost
of customer connectivity. Secondly, SG&A is critical towards managing
one's cost structure. As we see it, WCOM's management of costs is
legendary as evidenced by the fact WCOM has accounted for 25% of the
growth in the telecom industry over the past year with only 10% of the
headcount.
Specifically, if one looks at WorldCom's network, it has 60,000 route
miles around the world, 48,000 in the US long distance, 8,000 US local
and 7,000 outside the US (6,000 long haul, 1,000 local) with about 6,000
of the total international being in Europe. Peeling the onion back
further, WCOM has almost 600,000 fiber miles outside the U.S. and
approximately 3 million fiber miles within the U.S., giving WCOM an
enormous global bandwidth platform. WorldCom has points of presence that
proliferate around the globe and its points of presence are all connected
with its own fiber. In addition, WorldCom has almost 50,000 buildings
lit with its own fiber (8,500 outside the U.S.) and has a pervasive frame
and ATM platform to go along with the UUNET IP network. Specifically,
WCOM has 1,300 frame relay switches globally and 164 ATM switches on a
worldwide basis to go along with 150 local switches, 56 of which are
outside the U.S. In Europe, specifically, where obviously a lot of new
companies have generated a ton of value, WorldCom has 6,000 miles of
inter-city network; WCOM has SONET rings in 30 cities, over 50 local
points of presence (not counting the UUNET points of presence in Europe)
and is very actively driving services such as DSL. In Asia, they have
between 1,000 and 2,000 miles of fiber, 20 points of presence and 6 city
rings with 5 more to come on board.
Our point is that when it comes to the cost structure of an enterprise
that is a vertically-integrated enterprise, serving a full suite of
services to a full array of customers, the absolute gating factors are
direct connection to customers and the ability to drive SG&A. No company
has a set of network assets that comes close to being as pervasive as
WorldCom. Again, there are companies with $30-$40 billion market caps
with European networks that are no bigger than WorldCom's and have
nowhere near the metropolitan presence of WorldCom.
As far as WorldCom's ability to keep up with bandwidth, we are not going
to get into a physics debate about old fiber versus new fiber. Suffice
it to say that the earlier generations of single mode fiber tend to be
optimized for driving LAMDAs whereas the newer generations tend to be
optimized for bit rates. We could debate this trade-off all day long
but the proof is in the pudding. WorldCom, as we speak, has commercially
available one terabit route carrying customer traffic using Nortel
equipment. WorldCom is driving 100 LAMDAs or wavelengths over selected
routes with an OC-192, 10 gigabit bit rate speed. As far as we know,
there is no other terrestrial one terabit commercial live network segment
up and running. It is interesting to note that even though WCOM went
from 16 LAMDAs to 100 LAMDAs on certain routes (thus decreasing unit
costs at the WDM layer by a factor of 6,) it hardly moved the needle on
WCOM's overall cost structure. Adding 10 more city networks and 1000
more lit buildings would have orders of magnitude more impacting to
WCOM's cost structure.
WorldCom has 60,000 global route miles with high fiber counts. Its view
is that it is much more cost effective to add LAMDAS versus lighting up
new fiber. With the fiber it has in place, WCOM believes it can handle
multiple hundreds of LAMDAs at OC-192s speeds. Its regeneration spacing
is about 300 kilometers today going to 1,000 to 1,500 kilometers and it
has already tested OC-768 or 40 gigabit bit rate speed on their network
and it works. The fact is WorldCom's network can use more channels of
WDM than probably any of the newer networks being built and certainly can
run hundreds of LAMDAs at a 10 gigabit and probably 40 gigabit speed.
Thus, there is nothing that WorldCom cannot do; there is no managed
bandwidth service or bandwidth on demand or dynamic allocation of
bandwidth offering that WorldCom cannot offer over its network.
Furthermore, even if WCOM's cost per wavelength is not equal to an LVLT,
so what? In WCOM's game, which is selling a full array of services to a
full complement of coporate customers, direct customer connectivity and
SG&A are far more important drivers of cost than the optical transport
layer. LVLT needs to be optimizing costs at the optical layer given its
very focused horizontal strategy. The success of each to execute their
business plan is not mutually exclusive.
In fact, WorldCom has in the marketplace today a service coined "Smart
Bandwidth On Command." It is a web-based interface where its corporate
customers can order bandwidth on demand via the web from locations that
are directly connected to WorldCom's network. The customers can specify
what kind of bandwidth they want, where they want it and over what type
of platform they want it, (e.g. ATM, frame-relay or IP.) We believe this
is a perfect application for customers who want a robust and real-time
way of managing their virtual private networks, extending their intranets
and extranets, and having real-time inter-exchange of traffic between
their corporate networks and the web.
WorldCom is actually "delivering" new products because its network has as
much horsepower as anyone's and more importantly, it has more physical
facilities and physical connections to corporate customers around the
globe than anybody else on the planet. This enables WCOM to offer real
time, high-end services in a cost-effective way that drives down unit
cost and drives up margins and returns.
As we see it, WorldCom's ability to do this on a global basis is its key
differentiating advantage. In addition, given that WorldCom, with MCI
and eventually Sprint, will have a significant base of residential
customers (although only representing about 20-25% of revenues) and the
dial-up business of UUNET tends to be residentially-oriented, WorldCom is
able to use the entire Erlang curve of its network for traffic. Thus,
during the off-peak hours where its business customers tend to be idle,
the AOL and other dial-up traffic on UUNET plus the consumer traffic on
the regular long distance networks work for a very good load-balancing in
the network.
Finally, on MMDS, in typical WorldCom and Sprint fashion, they have been
very opportunistic in getting what we believe is a great way to offer
high speed data to consumer customers. Between WorldCom and Sprint, they
will have MMDS spectrum at the 2.5 gigahertz level to serve 58 million
households serving 90% of the top 50 cities. In addition, WorldCom
probably is serving with these 58 million households--80-90% of the top
demographic households in the United States. Unlike PCS that has only 30
megahertz, this spectrum has anywhere from 120-200 megahertz of spectrum
per market, which, when you do the math and make a reasonable assumption
about penetration, means that WorldCom will be able to deliver 1-2
megabit or more of speed downstream and upstream to these consumer
households which will clearly make WorldCom cost-effective and
competitive with either DSL or cable modems. The MMDS spectrum is yet
another asset that we think people have forgotten about with WorldCom and
clearly it enables WCOM to extend the reach of its network to its
consumer customers and offer sticky products, like high speed data, which
will protect Voice LD revenue.
To: VFD who wrote (5853)
From: SteveG
Tuesday, Feb 8, 2000 2:38 AM ET
Respond to Post # 5869 of 5879
(SSB Grubman part 2) WCOM WILL PARTICIPATE IN GROWTH OF INDUSTRY
WorldCom is as "cool a cat" as any company out there. There is no one on
the planet that has the reach of IP network like WorldCom. We would
argue that WCOM is competitive with any company in the world in the
high-end value-added areas of IP especially with likely joint ventures to
come. In the bandwidth game, WCOM could whip as many wavelengths around
the world as anyone else and more importantly, it has more direct
connections to more business locations than any other carrier, allowing
it to whip these wavelengths around in a much more cost-effective way and
enables it to get directly to customers with hot products.
Thus, we would argue that anyone who thinks that WorldCom is going to
take a back seat in the growth trajectory of data/IP value-added services
is mistaken. We believe WorldCom will continue to be the leader of the
pack. WorldCom in 1999 has a combined data/IP revenue stream of about
$12 billion and it has said it will grow that by almost $5 billion in
year 2000. Its incremental growth in data/IP swamps the entire data/IP
base of most of the companies out there and WCOM is growing off of the
biggest base on the planet at a 40% clip.
As far as WorldCom's voice revenues go, revenues which are still about
60% of WCOM's total revenues and which will over time become devalued, we
think it's clear that WorldCom is not going to be victimized by this but
instead will clearly leverage its new-age assets to grow in the data/IP
world and thus maintain overall double-digit topline growth. Also,
WorldCom is trading at 23x 2000 GAAP earnings, 19x 2000 cash earnings and
only 16x 2001 cash earnings pro forma for Sprint. Yet, WorldCom is a
company that has top-line growth projection of roughly 14%, bottom-line
growth of over 20%, and as we said, has the best and most ubiquitous set
of bandwidth, IP and value-added assets on the planet, by our analysis.
If the stock was at 50x earnings, we'd be worried about the legacy voice
revenue stream. With WCOM at big discounts to the market multiple
despite its growth rate and size and set of assets, we hardly worry about
the fact that voice will become a very low contributor to top-line
performance.
The bottom line is we believe WorldCom has a set of assets that compares
quite favorably to all the stories that are out there, stories which have
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