Goldman, Sachs & Co. Investment Research
GX - Reiterate RL; Market Is Missing the Strong Data Growth In The Qtr
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* The group and GX remains under intense pressure, but the strength of *
* GX's recent quarter eluded some, and the valuation has gotten very *
* attractive. Investors have been worried about the fundamentals, and *
* valuation. Close scrutiny of the quarter should help the fundamental *
* argument, and the valuation is now as attractively valued as the Bells, *
* with triple the EBITDA growth. In the quarter cash revenues rose 48% to *
* $1.367 billion slightly exceeding expectations, while cash EBITDA rose *
* 75% to $355 million, beating our number by 6%. An 18% discount rate in *
* our DCF would produce a $32 value, implying a 10x of '02 EBITDA, and *
* 3.7x of '02 revs. The current price yields a 6x of '02 EBITDA and 2.2x *
* of '02 revs. *
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* WHAT THE MARKET MISSED IN THE QUARTER? The market worries about the
declining voice market, and questions the sustainability of fiber
capacity sales. The results of the quarter should have alleviated
concerns on both issues, but didn't because GX's numbers need to be
really scrutinized to pick out the positive trends. The three key
factors we think most missed were :1) data growth (excluding capacity
sales) is very strong in the carrier business, and should remain strong;
2) because of the nature of its voice business GX's is not under the
same pressure as others, and it is a much smaller piece of the pie than
for others; 3) undersea capacity sales growth is strong now, and should
remain strong, even with 30% price declines that we expect in the
market.
* VALUATION IS VERY ATTRACTIVEWe fully expect GX to be able to achieve
compounded annual growth in cash revenue and cash EBITDA over the next
five years of 29%, and 45% respectively. Despite these robust growth
rates, that we think the next few quarters will demonstrate are
sustainable and quite visible, the market is trading GX like a slower
growing (yet perceived more defensive) Bell ILEC. Our DCF, using a 15%
discount rate produces a $41 price, and at a more extreme 18% discount
rate a $32 price, both providing sharp upside from current levels. At
the current $15.50 price, the EBITDA and revenue multiples are, 8.7x '01
EBITDA, and 2.7x '01 revenues. At the $41 price, the EBITDA and revenue
multiple would be quite conservative for a company with this growth
rate, 17.9x '02 EBITDA, and 5.6x '02 revenues. The Bells now trade in a
range of 6.8 - 9.1 x '01 EBITDA, and 2.9 - 4.1x '01 revenue. GX's
multiples are about in the middle of the undersea carriers' range,
despite the fact that it is up and running, with $5 billion of annual
cash revenues and $1.4 billion of cash EBITDA.
CAPACITY SALES AND DATA LEADS REVENUE GROWTH
Cash revenue of $1,316 million, was up $414 million, or 46% versus the year
ago quarter. The drivers of growth were capacity sales and data services
sales. Cash capacity sales of $407 million in the third quarter ($354
million deferred and $53 million reported in the quarter under GAAP
accounting,) was more than double the $192 million year ago figure. Data
services (excluding capacity sales) rose $119 million to $306 million in
the quarter. We calculate that the $306 million in data services was
comprised of $186 million from commercial and $120 million from carrier
(excluding any capacity sales.) This mix suggests the strong improvement
in end user customer sales for IP VPN and IP transit, as well as
traditional data services, frame relay and ATM. Data services revenue
growth (excluding any capacity sales) represented nearly 30% of the growth
in cash revenues in the quarter.
VOICE GROWTH NOT A SIGNIFICANT RISK AREA
Unlike the incumbent IXCs, where voice is a rapidly disappearing business,
GX serves market segments that will allow it to continue to see growth as a
contributor to the top line and bottom line. We calculate that Commercial
voice revenue was about $153 million in the quarter, and Carrier voice was
$229 million. Carrier voice for the quarter was up about 26% for the year,
and commercial voice appears to be flat year over year. We don't see much
of a deviation in the commercial voice side (although we do expect short
term price hikes by the IXCs), but we do see Carrier sales continuing
relatively strongly. GX has about 3% of the total carrier voice market
share. It is a business GX can focus on, and we believe it can take share
from others not focused here. And, it's profitable with a 20% gross
margin. We don't think this is a driver of growth, but nor do we see it as
the 'toxic waste' that others fear. With commercial voice, excluding CLEC,
representing 11% of revenue and carrier voice at about 18% of revenue, we
see limited risk in the voice business, and moderate upside contribution.
ACHIEVING STREET CONSENSUS '01 REVENUE TARGETS IS NOT A STRETCH
Our model assumes that GX will hit cash revenues of $6.76 billion next year
(28.5% growth), and cash EBITDA of $2 billion. We don't view this as a
stretch. To get there on revenue the following can happen: Comerical Data
growth (excluding IPC) of 100%; Commercial voice down 15%; CLEC revenues
flat; consumer voice down 15%; capacity sales up 30%; carrier data services
up 100%; and carrier voice services up 30%; and then $300 to $400 million
of new networking contracts for multi-national accounts and network
outsourcing. We view all of these figures as very achievable, particularly
in light of the third quarter's growth.
EBITDA GROWTH AHEAD OF PLAN. GX beat our cash EBITDA number by about $20
million. It appears that the improvement was a direct function of a
stronger mix of revenues, as well as better costs within existing
businesses. Data growth, strong carrier growth, and of course the strong
advance in capacity sales all contributed to what believe is a sustainable
improvement in EBITDA margins. To achieve our 2001 EBITDA estimate of $2
billion (which implies an improvement in margin from 26% to 30%), simply
requires the composition of revenue growth fall in line with our
expectations, since the mix shift is producing the margin gain.
INVESTOR CONCERNS REGARDING REVENUE GROWTH UNFOUNDED
This market is obsessed with risk. And, given what stocks have done
lately, this is a healthy paranoia. However, there is value in putting the
risks in perspective, and separating the real risks from the possible
risks. In the case of GX, this is extremely important, because we think
there is so much upside potential. Strong growth in revenue and EBITDA is
indeed possible in this company, and the market is not recognizing this
right now. Below, we address some of the concerns investors are voicing:
(1) Voice revenue not as big a risk. Voice revenues, excluding CLEC
operations, constitute about 32% of Global Crossing's total pro forma cash
revenues reported in the third quarter. This compares favorably to AT&T
and WorldCom which derive about 60% and 55% of their respective revenues
from voice services.
(2) Strong price elasticity in the trans-Atlantic market is spurring
demand, fueling revenue growth opportunities. Average pricing in the trans
Atlantic capacity market has fluctuated around $1 million per STM-1 for the
past four quarters, reflecting continuing strong demand, and not an excess
of supply. In addition, between its AC-1 cable and its 50% ownership
stake in Yellow, GX will control a significant portion on the available
capacity in this market through 2001, which should mitigate competitive
pricing pressures.
(3) Revenue growth will not be materially impacted as Level 3 migrates off
GX's network.
We don't expect that declining revenue streams from LVLT will have a
material impact on revenue growth opportunities for GX. Level 3 will begin
to migrate traffic off of GX's North American network onto its own network
as newly completed portions enter into service. Currently, GX collects
less than $200 million in revenues from LVLT annually, constituting about
only 3.5% of 2000 total revenues. LVLT's traffic roll over should occur in
a very managed way reducing the revenue shock of losing the revenues all at
once, thus allowing for new traffic to come on-line to replace LVLT's
decreasing revenue contribution.
(4) Customers aren't dying off. With the demise of many dot.coms investors
are worried about the sustainability of growth for carries like GX. The
fact is that the vast majority of GX's growth comes from carriers (i.e. 52%
of sales growth) and multinational businesses. The data and internet
explosion are indeed producing the surging demand growth, but its sources
are from more traditional sources than investors fear. One good example of
this is the fact that the company has not experienced any material
deterioration in credit quality and receivables collections. |
