DJ TALES OF THE TAPE: Move Toward Value In Start-Up Telecom
16 Apr 14:04
By Christine Nuzum
Of DOW JONES NEWSWIRES
NEW YORK (Dow Jones)--Spring has brought a new focus to investing in startup
telecommunications companies, and it has an unlikely undertone of value. With
the change has come a rethinking of Wall Street's top picks in the sector.
A value focus is relative in this sector where even the more conservative
analysts extoll companies with profits two or three years down the road. The
sector's only profitable company, Pac-West Telecomm Inc. (PACW), draws mixed
reviews while McLeodUSA (MCLD), which lost half a billion dollars last year, is
cheered.
Factors outside of financial statements, such as the quality of corporate
management and the impact of expected changes in the law, continue to play
important roles in how Wall Street assesses these stocks. But over the last few
months, the discussion of numbers already reported has grown louder while talk
of hopes like projected growth and revenue forecasts has dimmed.
For example, UBS Warburg's new analyst for the start-up telecom sector, Glenn
Waldorf, takes a relatively conservative approach, analyzing equity from a
credit perspective and focusing on a company's balance sheet as much as its
earnings potential.
Many research outfits turned the corner during the first week of April,
shaken by a couple of bankruptcies and a broad devaluation of the emerging
telecom stocks.
Shares of Winstar Communications Inc. (WCII), once on many firms' A-list,
suffered the quarter's most dramatic decline, plunging to penny-stock territory
from $16 in seven weeks. A request to delay its annual report took Winstar's
bonds to levels that forecast bankruptcy as concerns over the company's $3.4
billion debt load and ability to raise additional funding heightened.
Several analysts, late to cut their ratings on Winstar, began tweaking their
top picks. Two months ago, four carriers - McLeodUSA, XO Communications (XOXO),
Allegiance Telecom Inc. (ALGX) and Time Warner Telecom Inc. (TWTC) - seemed to
be firmly in the top tier of the sector. Some analysts, including Salomon Smith
Barney and Credit Suisse First Boston Corp., had also put Winstar in that top
tier.
Putting A Hold On XO
Once fears emerged that Winstar would go under, analysts took the company
with the heaviest debt and the steepest recent stock declines - XO
Communications - and either cut their ratings or tempered their
recommendations.
New analysts at UBS Warburg and William Blair put a hold rating - a bearish
call for the sell-side - on XO's stock. Prudential Securities Inc. downgraded
the stock to hold from strong buy and Frost Securities Inc. initiated coverage
with a hold rating. It's worth noting that the preceding analyst at UBS Warburg
had a strong buy rating on XO.
XO Communications' shares closed at $3.61 Thursday, down 87% from Jan. 19,
when they closed at $27.81. Adjusted for two-for-one stock splits in 1999 and
2000, shares are also down more than 50% from the company's 1997 initial public
offering price of $17. The company's bonds were quoted at 50 cents on the
dollar Thursday, showing that those more senior investors were expecting to
take a 50% loss on their XO stake.
The market's disenchantment with XO roughly traced the declines of Winstar.
Like Winstar, the company has heavy losses and only enough cash projected to
carry it into next year. Also like Winstar, XO has much more debt than
shareholder equity. Before a $517 million convertible bond deal in January, the
company had $4.4 billion in long-term debt and $1.8 billion in total
stockholders' equity. This imbalance, combined with the frigid capital-markets
environment, makes the public debt market look inaccessible to XO.
Unfortunately, as its stock price has declined, an equity offering has also
become a less viable option.
One thing XO has going for it that Winstar lacks is confidence in its
financial backers. While the financial troubles of a major provider of
Winstar's vendor financing, Lucent Technologies Inc. (LU), eroded hopes for a
deal from that source, analysts still talk of a likely private investment in
XO. In telecom entrepreneur Craig McCaw and leveraged buyout firm Forstmann
Little, the company has deep-pocketed and well respected financiers.
"XO today is a pure bet on funding," said Morgan Stanley analyst Todd Scott.
He has placed his bets on the company receiving funding, this time not from
Forstmann Little or McCaw, but from another private investor. However, he is
quick to say that others aren't so hopeful.
"Others believe they're not going to get the funding, in which case it would
be a bankruptcy," Scott said.
Still others, including Ken Hoexter of Merrill Lynch & Co. and Waldorf of UBS
Warburg, expect XO to soon cut its $1.9 billion to $2.1 billion capital budget
for the year.
A spokesman for XO said the company is "evaluating all our options" to extend
its cash further, including a scaled back business plan and financing deals.
Scaling back the business plan might change Morgan Stanley's opinion of XO.
"If we saw them scale back in a small way, we would not view that as a
positive signal," Scott said. "If they do scale back, that sends out a signal
that the capital that we believe is there is not there."
If XO were to announce a more dramatic restructuring, Scott would reevaluate
the new business plan, and then determine whether to stay bullish on the
company.
Time Warner Telecom Rising
As XO lost footing on most analysts' lists, Time Warner Telecom edged up.
Merrill Lynch's Hoexter recently listed Time Warner Telecom and Allegiance as
his top picks instead of XO and Allegiance, earlier favorites. UBS Warburg and
Legg Mason Wood Walker initiated coverage with strong buy ratings, William
Blair and Thomas Wiesel Partners with a buy. Gerard Klauer Mattison upgraded
the stock to buy, its highest rating.
Spun off from Time Warner Cable in 1999, Time Warner Telecom is now 45%-owned
by America Online Inc. (AOL).
On paper, what sets Time Warner Telecom apart from its "top-tier" peers is
its smaller debt load. In January, Time Warner Telcom sold $400 million in
bonds, bringing its long-term debt to about $1 billion.
David Rayner, Time Warner Telecom's chief financial Officer, told Dow Jones
Newswires his "conservative approach relative to the sector" has helped buoy
its stock price against a broad devaluation. Compared with its peers, Time
Warner Telecom's stock is doing well to be valued at more than 50% of its
January high.
Among the four widely followed companies in the sector, only Allegiance
Telecom has less debt, $566 million. However, unlike Time Warner Telecom,
Allegiance does not have positive cash flow to help support that debt.
Allegiance also has nearly twice as much shareholder equity, totaling $958
million.
Time Warner Telecom's shareholder equity is roughly equal to its long-term
debt, a balance that is part of the company's financial strategy. The company
ended last year with $585 million in long-term debt and $472 million in
stockholder equity. The company's mixed shelf offering in January lifted both
sums to roughly $1 billion, according to CFO Rayner.
If the debt level is too high, "you're not going to be able to generate
enough of a return to pay the interest," Rayner said. Too much equity dilutes
investor returns, he added.
"Equity holders are looking for something north of 20% in terms of returns on
their investments," over the period of that investment, he said.
Further interest rate reductions might encourage Time Warner Telecom to raise
more debt, perhaps without an accompanying increase in equity, Rayner said. But
he is also wary of the interest costs that come with being considered a risky
concern.
"While we have been very successful, we still are not an investment grade
credit," he said.
-ChristineNuzum, Dow Jones Newswires; 201-938-5172
(END) DOW JONES NEWS 04-16-01
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