From TSC
The Anglo File: Bandwidth Glut Could Make for Some Attractive Mergers
By TSC Staff
6/22/00 5:17 PM ET
LONDON -- The world is discovering that you can have too much bandwidth.
Since bandwidth became a buzzword, global carriers like Global Grossing (GBLX:Nasdaq - news) and 360networks (TSIX:Nasdaq - news) have been tripping over themselves to lay the undersea fiber-optic cables that will transmit high-speed voice and data from York to Yokohama.
But amid mounting concerns of oversupply and falling prices, investors have sold off these carriers' stocks, leaving many trading at significant discounts to their former levels. The London-based Flag Telecom (FTHL:Nasdaq - news), for instance, is trading at 18, or 25% below February's initial offering price.
"It is now cheaper to buy some of these companies than to build an equivalent network," argues Terence Sinclair, an analyst with Schroder Salomon Smith Barney, in a recent research report.
Indeed, Flag Telecom may be a part of Bell Atlantic (BEL:NYSE - news) sooner rather than later, according to a person close to the carrier who declined to be named because he is trading Flag's shares.
Once its acquisition of GTE (GTE:NYSE - news) is complete, Bell Atlantic will have a massive telecommunications footprint in the U.S., but little on the international front, something that Flag would provide. Among Flag's other attractions are its valuation, which makes the company one of the cheapest in the sector, and that Bell Atlantic already has a 30% stake in the company.
"It makes tremendous sense," says the person close to the company. "All of a sudden Bell-GTE, which is this huge U.S. monster, gets connected to Japan and Europe and starts to get wiring around the globe."
Executives from Bell Atlantic and Flag declined to comment on the possibility of a full merger.
Yet there are a few hurdles to an outright acquisition, not the least of which is that Flag, unlike its competitors, lacks any type of land-based network. Skeptics also question why Bell Atlantic would want to buy these undersea cables and thereby assume the risk of managing them, when declining prices for broadband would allow it to lease space for less and less.
That first hurdle soon could be cleared. Flag is preparing to either buy or build a European network and will unveil its strategy in the next few months, says the person familiar with the situation.
Currently, Flag leases capacity from local network operators like Colt Telecom (COLT:Nasdaq ADR - news) in order to rout those calls from city to city. With deregulation and more competition opening up these markets, carriers such as Flag have the opportunity to buy or build a network of their own. And they will seize the chance, because owning a land-based network will help them lower costs and give them more control of the customer.
Flag, which offered its first city-to-city network services a year ago, "is about to launch more," says Andrew Evans, Flag's executive vice president of strategy. Although declining to elaborate, he added that providing such services would be a growing part of Flag's business and eventually approach 50% of the company's revenue. To date, it's still just a small fraction of the $162 million in revenue the carrier generated in its most recent fiscal year. The company isn't expected to turn a profit for seven years.
Flag needs to expand its business beyond the rental of its pipes, because oversupply and uncertain demand are combining to push down prices.
"There's no doubt that companies like Global Crossing and Flag Telecom will end up with too much infrastructure," says Tim Stronge, an analyst with TeleGeography, a Washington, D.C.-based market research firm that hasn't performed any consulting for Flag Telecom.
Too Many Pipes?
Undersea Cable Capacity (Gbps)
1997 1998 1999 2000 2001 2002
U.S.-Europe 23 83 178 2,157.40 4,917.40 6,822.40
Europe-Asia 11.1 11.1 31.1 31.1 71.1 91.2
U.S.-Asia 14.1 14.1 104.1 344.1 384.1 864
U.S.-Latin America 10.6 10.6 15.6 275.6 1,595.60 4,165.40
Total 58.7 118.7 328.7 2,808.20 6,968.20 11943.1
Source: TeleGeography
Schroder analyst Sinclair expects prices to fall by as much as 30% annually for the next few years, although he is still bullish on Flag, rating the company a buy. (His firm was the lead underwriter of Flag's initial public offering.) Even so, at an average cost of $1.6 billion to lay an undersea cable, this is not a business that lends itself easily to commodity pricing.
Notwithstanding these economic challenges, Flag is still an attractive proposition for Bell Atlantic because an outright acquisition would allow the telco to consolidate its international infrastructure, which is currently a maze of contracts. Currently, to cross the Atlantic, Bell leases from Flag. Once in Europe, it must do a deal with France Telecom (FTE:NYSE ADR - news) in France, Deutsche Telekom (DT:NYSE ADR - news) in Germany and so on.
"It's a pain in the neck. [Bell Atlantic] can't control the service and they are giving up margin," says the person familiar with the company. "You would always rather own than lease. When you are leasing from other people, you are at their mercy."
That's especially true when Bell Atlantic could buy the 70% of Flag it doesn't already own for a fraction of what it would have to shell out for other players in the field. Flag's enterprise value -- debt plus equity -- is roughly $4 billion. That compares with an enterprise value of $30 billion for Global Crossing and $15 billion for 360networks.
That places Flag's enterprise value at roughly one times its costs for property, plant and equipment, while competitors such as Global Crossing and 360networks are trading at more than twice that measure.
And with bandwidth that cheap, it could prove too compelling an opportunity for Bell Atlantic to pass up
Regards
Neil |
