6/14 - Highlights of Vic Grover/Needham’s Ntop analysis.
June 14, 2004
NTOP
Upgrading to BUY from HOLD / $8
We are upgrading shares of Net2Phone, Inc. (NTOP) to BUY from HOLD and establishing a target price of $8 in anticipation of accelerating voice over broadband growth. The company, a pioneer in the voice over IP (VoIP) market, has been streamlining its operations, exiting unprofitable product lines, expanding internationally, and creating a wholesale strategy to enable cable multiple system operators (MSOs) to offer voice services to their own customers.
Initial cable VoIP trials in Puerto Rico moved into full commercial launch in May 2004, and NTOP has been announcing additional contracts provide visibility to the company’s voice over broadband strategy. Meanwhile, NTOP’s “traditional” retail VoIP business “Net2Phone Global Services – NGS” is being managed for cash flow rather than market share, which limits growth but could provide upside as VoIP proliferates at the edge of the network and becomes a growth driver abroad. We believe the company’s launch of voice over broadband services, initially targeted at the U.S., can build a sizable direct business that leverages the billions of dollars of investment in last mile infrastructure by ILECs, CLECs, cable MSOs and wireless operators and NTOP’s top global brand name.
Key Points
• We are upgrading NTOP to BUY from HOLD and establishing a target price of $8 in anticipation of accelerating voice over broadband growth.
• The company reported solid 3QFY04 (ended 04/30) results highlighted by a return to growth in core Net2Phone Global Services (NGS - excluding calling card and other) and continued indications of interest and orders from cable MSOs using NTOP for outsourced and/or wholesale VoIP solutions in the company’s NCT unit (a thorough performance analysis is attached later in this report).
• Total revenues of $21.5MM were up 8% QoQ, driven by 4% growth in core global services excluding disposable card sales. Disposable card sales were nil in the period down from $300k in the prior three months and $1.7MM in the prior year’s same period, indicating improved revenue mix and inline with management’s goals to exit this low margin business. Cable VoIP revenues were $1.4MM, well ahead of our estimate on $1.3MM on sales to Liberty Cablevision in Puerto Rico which went commercial across its entire system earlier this year and is using NTOP for systems integration and wholesale services. It is difficult to model equipment and installation revenues on a go forward basis making this segment’s performance potentially lumpy; therefore, we are modeling NCT performance using recurring end user revenues only.
• Gross margins were stable at just over 40% but were adversely impacted by low margin equipment sales/installation in the period. Near-term, we expect margins to remain under pressure as the company ramps cable VoIP business on systems with high start-up costs, bit over time, we expect margins to lift to the mid- to high-40% range as recurring services in the VoIP space dominate the mix and the company achieves scale.
• Normalized EBITDA losses of ($3.1MM) were QoQ, with EPS of ($0.01) significantly better aided by variable cost accounting related to 12/01 stock options issuance.
• Global Services FCF+, but Investment in Voice Over Broadband Likely Cuts into EBITDA. Though NGS remains operating FCF+, on a blended basis we expect NTOP to continue to burn EBITDA as the company ramps sales to new and existing cable MSO partners, which have just over 2.3MM marketable homes (Liberty Cablevision 300k homes passed, Northland Cable 315k homes passed in 10 states, Bresnan Comm. 500k homes passed in four states, Codetel in Luxembourg Belgium 210k homes passed, CeBridge 720k homes passed in nine states, EST Video in France 310k homes passed, and The Cable of St. Kitts with 10k homes passed). Further, we believe the company’s ramp of direct sales of voice over broadband in the U.S. and abroad (VoiceLine -http://web.net2phone.com/solutions/broadband/ - which parallels Vonage’s strategy with plans ranging from $19.99/mo. to $34.99/mo.), will eat into cash flow as NTOP invests in customer acquisitions including sales and marketing and subsidization of network interface devices for DSL and cable modem lines. We have increased our estimated EBITDA losses for the company in FY04/FY05 to accommodate investment in voice over broadband growth using direct sales, hosted telephony and managed services.
• Cash remains strong at $138.8MM, or almost $2 per share, with little debt; we believe NTOP is fully funded for its current business plan.
• Naked DSL and an End to Forced Bundling an Open Door for NTOP. On the industry front, we believe the launches of naked DSL products by certain Bell companies, like Qwest and Verizon, which aim at stemming customer defections to wireless and cable, open the door for NTOP and its partners to win voice over broadband subscriptions.
Further, last week’s legal ruling in California that SBC cannot force customers to bundle DSL with dial-tone, which follows similar rulings in Georgia, Kentucky and North Carolina over the past several months, opens the door for new entrants like NTOP to win customers from Bell territories where such illegal forced bundling has acted as a subsidy to Bell monopolies.
We view the stripping of DSL from dial-tone, either on a voluntary basis by the likes of Q and VZ or by the Courts, as a significant leading indicator for success and elimination of a barrier to growth for NTOP and a catalyst.
Case Study: Liberty VoiceLinks by Net2Phone
• Puerto Rico Deployment
– 60 days to dial tone
– Trial proved technical viability
– Footprint-wide launch in May 04
– Liberty keeps brand and customer
• Primary line replacement phone service with quality equivalent to the “PSTN”
• Full functionality
– Local service, Domestic and International LD
– Class 5 features
– Regulatory Features (911, CALEA)• Managed QoS with Real Time Service Assurance
15% to 20% below incumbent
•87% of customers said the service met or exceeded expectations
•90% of customers use the service on a daily basis •96% of customers were satisfied or extremely satisfied with their bundled telephony and cable service
•75% of customers rate their LPR service better than that of the local incumbent carrier
•10% are only customers of LPR’s telephony service
• Updating Estimates for NGS Growth and Expected NCT Investment. We are updating our estimates for the company’s return to growth at NGS and rising momentum in cable VoIP. NTOP has been launching additional cable VoIP contracts which could translate into revenues in the next fiscal year, and the firm’s direct voice over broadband business should leverage NTOP’s leading global brand name which is difficult to value but should accelerate sales worldwide, in our view, and give the company better positioning internationally than domestic headline-maker Vonage.
• Upgrading to BUY. The company looks to us like a FY05 story (ends 7/31/05), at which time NTOP should be able to report accelerating growth on the heels of contract wins and deployments at MSOs, the firm’s NGS business should begin to bear fruit with its recently launched SIP based broadband telephony product, and direct sales of voice over broadband products (VoiceLine) should take off. Against this backdrop, we are upgrading NTOP to BUY from HOLD and establishing a target price of $8, which represents a target EV of $456MM or 4.2x FY06E revenues and roughly $70 per fiscal year end 2006 marketable home (POP).
• Risks and considerations include continued cash burn, limited contributions from the company’s cable telephony unit NCT, limited information on the economics of the company’s cable VOIP plan, potential heightened domestic and international regulation, and the need to make payments to and derive revenues from affiliates of the company’s
former parent, IDT Corp.
Company Description
Founded in 1995, Net2Phone is a leading provider of voice services over IP networks worldwide, enabling toll-quality calls between computers, telephones, and broadband devices. Recognized as the first company to bridge the Internet with the public switched telephone network (PSTN), Net2Phone has routed billions of minutes of traffic over its network. Incorporated within the company are (1) Net2Phone Global Services, which sells retail VoIP solutions globally and (2) Net2Phone Cable Telephony, which has developed a fully outsourced standards-compliant telephony solution for cable operators. Net2Phone's strategic partners and investors include Liberty Media Corp. and IDT Corp. |
