cribbed this from YHOO, not complete but close:
-- SL: Global Crossing: Near-term Opportunity In Weighing Positives vs. Negatives P --
09:03am EDT 6-Jun-01 Lehman Brothers (Fletcher, Dan 212-526-3375) GX AGCX BRW
Today`s Date: 06/06/01
Ticker: GX Fiscal Year: 12/31
Price: 12.94 52wk Range: 38 - 9
Rank(New): 2 - Buy Target(New): 28
Rank(Old): 2 - Buy Target(Old): 28
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EPS 2000 2001 2002 %Change
Act. Old New St.Est Old New St.Est 2001/2002
1Q -0.39 -0.69A -0.69A -0.69A - -E - -E -0.84E - - - -
2Q -0.61 -0.85E -0.85E -0.82E - -E - -E -0.83E - - - -
3Q -0.69 -0.87E -0.87E -0.82E - -E - -E -0.81E - - - -
4Q -2.35 -0.84E -0.84E -0.81E - -E - -E -0.79E - - - -
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Yr. -4.04 -3.25E -3.25E -3.17E -3.19E -3.19E -3.15E - - - -
P/E - - - -
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MARKET DATA FINANCIAL SUMMARY
Shares OutStanding (MM) 884.7 Revenue (B) 6.7
Mkt Capitalization (B) 11.4 Five-Year EPS CAGR - - %
Dividend Yield 0.0 Return On Equity (2001) - -
Convertible Yes Current Book Value - -
Float - - Debt To Capital - - %
Disclosure(s) None
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INVESTMENT CONCLUSION
* With the stock approaching all time lows, we believe positives outweigh
negatives here, and stock offers good near term upside.
SUMMARY
* While long term challenges remain, such as dependence on IRUs for
growth/funding, GX is off 24% in last two weeks, is making good progress in
Commercial and is a clear leader in the bandwidth sector. We believe there
is good near term upside. In terms of DCF valuation, we get to
$15-$20/share, even haircutting our (below guidance) #`s by 20%.
* GX has signed >$600M in Commercial contracts year-to-date, and Comm Svcs
grew 7% seq, in Q1, and should grow 9%+ in Q2.
* The subsea market is rationalizing, and the 4 major subsea players could
become 2 over next 12 mos.
* Long-term challenges include IRU sales, and 01 guidance may prove
aggressive, though we believe that is in the stock, and we believe the
company can hit our 01 Cash Rev number of $6.71B, +26% Y-Y.
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Weighing The Positives Vs. The Negatives.
In this piece, we explore what we believe are the key positives and negatives
of the GX story and stock. While we remain cautious on the bandwidth sector,
and IRU revenue streams, we believe the stock has good upside from current
levels.
Positives:
+ Commercial Services getting traction. GX is moving off a wholesale model.
+ The capacity outlook is showing signs of rationalizing,
+ GX has a global network which is nearly fully built, and would likely cost
$8-10B, and 3-4 years to replicate.
+ About to close Citizens.
+ Stock approaching all time low.
Challenges:
- Dependence on IRU sales,
- Aggressive growth expectations, although we believe our 01 numbers (below
guidance) are achievable.
- Lot of leverage considering the company will have approximately $10.3B in
debt and preferreds (post the Access line sale to Citizens, including the
removal of roughly $180M in debt related to Citizens).
In terms of near term data points, we believe they are likely to be, on
balance, positive for the stock. They include additional signs of progress in
building the Commercial business, continuing stumbles of competitors (i.e.
TSIX), which cant deliver the network promised to some customers, closing of
the Citizens deal providing GX of $1.6B in cash (post taxes, and bridge loan
paydown), and weaker players will become less meaningful in the market (i.e.
funding issues, Chapter 11 and Chapter 7, and consolidation). The biggest
potential negative we see for the stock includes a reduction in guidance for
all the reasons weve cited in the past (see GX Notes dated 11/14/00, 3/2/01,
and 5/11/01), although we believe, at the current price, the market already
incorporates some reduction for 01, and we also believe our below guidance 01
numbers are achievable.
THE POSITIVES
Commercial Showing Traction
Over the past half year, GX has made considerable progress in terms of its
focus, and in terms of account wins, as it moves away from the pure carrier
model. GX has announced over $600M in Commercial Contracts year-to-date
(excluding EXDS ($4B over 10 years)), and by the end of the first quarter the
number of large commercial customers signed had doubled since January. It has
signed some major customers including Enron, Hoffman-La Roche, JP Morgan Chase
and the Chicago Stock Exchange, as well as a major deal in SWIFT. Most
recently it announced a deal to carry MPEG and embedded audio traffic for
CNBC. Earlier this year, GX refined its focus into 7 areas, including
Financial markets, Media and Entertainment, MNC, Government, Carrier, NextGen,
and Bandwidth trading. The logic behind this is to focus on the bandwidth
users with the most global needs (which by definition is high-Bandwidth) and
focus heavily and only on these accounts, so as to leverage the fact that the
GX network is very global. More specifically, GX has narrowed its hit list
down to 7,500 accounts sitting in 20,000 buildings in 200 cities that GX will
aim to serve better than any given its footprint (US, Europe, Transatlantic,
Transpacific, Intra-Asia, Central America, South America). Q1 Commercial
revenues did show an uptick, to 7% sequential growth from -4% in Q4 (although
some of this was related to seasonality). With the momentum in customer
signings, the relative uniqueness of the GX footprint (200 cities currently),
and a salesforce which numbers 950+, we believe there is a good case for
acceleration in Commercial Services. While we believe current expectations
are aggressive, we do believe a material pickup will occur, as shown in the
table below.
Figure 1: Lehmans Commercial Expectations
Source: Lehman Brothers.
Expected Supply Starting To Collapse: Survivors Pick Up Business From The
Weaker Ones
As we outlined in our piece on TCM (`TCM Potential Stake in FTHL = Market
Getting More Rational` dated 5/25/01), the expected ramp in subsea supply is
starting to collapse, as are the number of serious global bandwidth
providers. Its not clear to us that the amount of rationalization weve seen
thus far supports near term supply demand equilibrium, and therefore near
term stabilization in bandwidth price declines. However, the implication is
that there will only be a small handful that can provide high-bandwidth
circuits on a global basis, and we continue to believe the ever increasing
importance / pervasiveness of corporate data networking, the Internet, and
deregulation means the demand for bandwidth will be strong for some time to
come. As we stated in our piece on pricing (What Stabilization, dated
5/18/01), the bandwidth buying universe is already discerning between the
strong and weaker providers. A key risk weve pointed to for GX has been its
dependence on IRU sales (discussed in more detail below), and while we still
believe this is risk to the growth outlook, the fact that contracts that have
been put in place by players with major funding constraints (such as TSIX),
and were based on a network build out plans that are not likely to be
achieved. Therefore there is good potential that these customers migrate to
those that actually have near fully built networks, such as GX.
As of the end of March, 360Networks reported a backlog of $1.4B, of which
$1.3B was IRUs (rest was services). About half of this IRU backlog is
terrestrial and half subsea. With TSIX announcing that it needs $300M over 3
months, and that its network build has been substantially scaled back (only
lighting four OC-48`s on completed North American terrestrial backbone and
scrapped Pacific build), there is potential GX picks up some of this buisness.
Figure 2: Subsea Rationalization
While we have certainly seeing rationalization, lit global subsea capacity
still likely to double over the next year (30% of this growth from the
transatlantic), so we are not out of the woods yet but more rationalization
is likely to come. The biggest positive to this is GX picking up global
bandwidth business from weaker players. We believe rationalization trends
will continue and the catalysts likely to have the biggest impact in getting
the market back to equilibrium are systems getting scrapped (i.e. 360Pacific),
systems getting co-built (i.e. TCM / FTHL in the Pacific), and the tightening
of the capital markets causing a reduction in the number of players (i.e.,
TSIX). GX and AGCX are positioned well to capitalize on these trends, now
operational in the Atlantic, Pacific, Asia, and Central and South America.
Rationalization of supply in the Pacific and potentially in Asia directly
helps AGCX, and thus GX. On the terrestrial side in the US, companies like
360Networks and XO Communications as examples of companies operating under
capital constraint which now will spend the capital to buy lit services versus
light the capacity they had originally planned.
Fully Built Global Network
Bandwidth may be a commodity, but building an industrial grade network on a
global scale is no cheap or quick endeavor. Maybe a so what argument could
be made in times of easy to access/cheap capital, but thats not the world we
live in now. Of all the new era bandwidth players, Global Crossing is
furthest along in building its network: It is nearly complete on lighting
101,000 route miles spanning North America, Latin/South America, Europe,
Transatlantic, Transpacific, and the Asia-Pacific regions. It should have 20
metro networks operational by year end, and the long-term plan is for 40
metro networks (for a more complete comparison of GX`s network against the
others in the bandwidth group, please see our `2001 Network Company
Statistics` Poster, published and distributed today). It would probably cost
$8-$10B and 3-4 years to replicate its network. We believe this market
position does win GX some business, as we believe some accounts use GX as one
of their telecom/ data services providers simply because GX has a global
footprint, and as evidenced by the SWIFT contract, and success of the Global
Network offer, where customers can purchase capacity in advance without
indicating which segment of the Global Network it will take delivery on until
the need arises.
About to Close Citizens
An issue that has dogged GXs stock for the last several months is whether the
company would actually close on the sale of its local assets to Citizens for
two reasons: 1) Citizens was put on negative watch about six weeks ago by
the major credit rating agencies, and 2) the deal was struck in July of 2000,
when asset valuations were a good deal higher. While the price was
marginally reduced, we do not expect any further reductions and expect the
deal to close this month, per the company`s commentary. The transaction
should net approximately $1.6B -- this is net of taxes and repayment of a $1B
bridge loan.
All Time Lows
GX is off 24% in the last two weeks, and 53% over the last 52 weeks. In the
Broadband Network/Bandwidth area, GX is clearly a leader, and its high yield
debt trades in the low 90 cents range, vs. a range of low 40`s to low 60`s
low for other bandwidth players, excluding the very weak ones. Weve also
looked at GXs recent share price as compared to the other Network companies,
and found that though it has outperformed the group over the long term, GX
stock has underperformed the index by 15% in the last two weeks and 10% in
the last two months.
THE CHALLENGES
Dependence on IRU Sales
IRU Sales (part of Carrier Services revenues) are currently 35% of total Cash
revenues and 59% of Carrier (revenue run rate of $2.3B). IRU revenue is
expected to decline (guidance was for just over $2B in IRU Sales for `01 and
this implies 8% average sequential decline 2Q-4Q). Commercial Services (26%
of revs) are picking up some of the slack, but we consider IRU dependence a
risk worth watching for the following reasons: 1) We believe IRU sales are
chunky (i.e. less recurring in nature), as a big bandwidth buyer is not
obligated to pay any additional revenues beyond the initial up-front purchase
(which GX recognizes as Cash revenue up front); 2) Funding for many bandwidth
buyers is difficult; 3) Wholesale price declines for bandwidth are not
showing signs of stabilization, in our view; and 4) Adjusted EBITDA is highly
dependent on IRU sales. This last point is the most important.
In Q1, GAAP EBITDA was negative $101M, and Adjusted EBITDA was $441M, implying
non-GAAP adjusted EBITDA (dominated by IRUs) was $542M, and declining
sequentially. Looking at it on an annual basis, in 2001, guidance is for
$2.0B-$2.1B in Adjusted EBITDA. Assuming GAAP EBITDA is negative $87M, and
Total Adjusted EBITDA is $1.92B, IRU EBITDA is approximately $2.0B.
Importantly, this is on a declining sequential trajectory. Global Crossings
01 Adjusted EBITDA guidance is for $2.0B-$2.1B. As IRU`s are 120%+ of Adjusted
EBITDA, and they are on a declining sequential trajectory, this suggests 02
growth in the 35%-40% range is aggressive.
Figure 3: Adjusted EBITDA Composition
Source: Lehman Brothers.
The quality/value of IRU sales is a hotly debated topic. IRU, standing for
Indefeasible Right of Use, means the buyer buys a slice of capacity on a
system, for the useful life of the system, and pays all the money up front,
as opposed to a more traditional lease arrangement whereby the buyer pays on
a monthly basis. The pessimistic view is that an IRU sale is nothing more
than a non-recurring asset sale, not dissimilar from a real estate
development once it is sold, there is no more recurring revenue (except a
relatively small amount of annual maintenance). The optimistic view is that
because bandwidth demand is growing so strongly, buyers will need more and
more capacity every year, and the bandwidth vendor will be able to sell more
and more bandwidth every year to Carriers and Enterprises. We believe the
reality is somewhere in between. Because sales are predicated on new demand,
not more traditional service contracts, bandwidth in IRU form is more like a
product or equipment customers have to fully utilize the ones they have
before they buy any more (PCs, Routers may be good analogies). And because
this is a product in a somewhat commoditized industry, we believe it is a
cyclical one. Furthermore, IRUs are part of the capex budget for many
service providers, right alongside equipment such as optronics and
switches/routers. As telecom industry capex has likely peaked, so too has the
IRU business in our view. The opportunity for GX is that some of the weaker
players, particularly TSIX, are scaling back significantly, and GX will pick
up the global business of those Carriers which are finding they dont have
enough money to be really global.
Aggressive Growth Expectations
In light of the current backdrop, the fact that GX has delivered its headline
numbers over the past year is a major accomplishment. As weve stated, for the
past 4 quarters, it has been the carrier business, which has been driven by
IRUs, which has allowed this to happen. As weve also stated many times
before, we believe 01 company expectations ($7.2B in Cash Revenue and
$2.0B-$2.1B in Adjusted EBITDA) are on the aggressive side, as Revenues
require average sequential growth of 7.8% versus 4.7% growth in Q1, and
Adjusted EBITDA 11.0% average sequential growth vs. 5.4% in the first
quarter. An important risk going forward is that the IRU business has
peaked, and that the commercial business (26% of cash revs) cannot outrun the
slowdown in Carrier (59% of Cash Revenue) and particularly IRU sales, to hit
the companys 5 year (99-04) objectives of 30% CAGR in Cash Revenue and
35%-40% in Adjusted EBITDA. Below are our expectations. While our numbers
are below guidance, we do believe our numbers are achievable, and show good
acceleration in Commercial Services. Risks to this are IRU trajectory, and
impact on Adjusted EBITDA.
Figure 4: Revenue Mix (Lehman Brothers) and Adjusted EBITDA
Source: Lehman Brothers.
Lots of Leverage
Currently, GX has $7.35B of debt on the balance sheet and additionally $3.16B
in Preferred and Convertible Preferred securities for a total of $10.5B in debt and preferred (excluding the $1B bridge loan which will be repaid with
proceeds from ILEC sale). Post the sale GX will have $10.3B in debt and
preferred, which will require approximately $150M / Q to service. We do
expect capex to come down materially in 02 (roughly cut in half). If Adjusted
EBITDA CAGR (01-04) is in range of 35-40%, GX is fully funded and should end
02 with $200M-$250M in cash and 04 with $2B in cash. If the 01-04 CAGR is 10
percentage points below, and is 25%-30%, the company should end `02 with no
cash, and need $280M-$320M to be funded through FCF+ which is in late `03.
If the Adjusted EBITDA CAGR is 20 points below, and is 15%-20%, the company
should end `02 with a $200M-$2
should end `02 with a $200M-$250M cash deficit, and need $1B+ to be funded
through FCF+ which in early `04.
Near Term Upside
With the stock off 24% in the last two weeks, and 53% in the last year, we
believe most of the negatives (i.e. downside to expectations) are priced in,
while news flow near term (i.e., Commercial Services contracts, closing
Citizens sale) likely to highlight advantages of GX (built out global
network, building a customer base). Longer term, we believe clear evidence of
Commercial growth of 30% / year, with good margin expansion is needed for a
sustained uptrend in the stock.
In terms of valuation, GX trades at 10.9X our 01 Adjusted EBITDA, and 8.8X 02.
This is 90% of the average multiple GX has traded at YTD. In terms of
valuation, if we haircut our below guidance numbers by 20%, our DCF is $17
suggesting some good near term upside as Comm Acct wins continue coming and
Citizens deal is closed. Longer term, we believe evidence that co is getting
EBITDA leverage out of its non IRU businesses will be necessary for a
substantial and sustained upward trend.
Figure 5: Valuation
Source: Lehman Brothers. |
