Valuation
The principal driver of valuation for WinStar is a DCF analysis. This gives us an absolute sense of the value of the stock. Going a step further, we look at the valuation compared with other CLECs who have similar growth and operating characteristics. Using these approaches we conclude that the stock is undervalued presently, and should reach approximately $61 by year-end. Thus, potential price appreciation makes WCII extremely attractive, deserving our Buy rating.
Table 1 shows that WinStar is more advanced than most of its peers in termsof build out. Out of seven comparable CLECs, only two had more access lines than WinStar at the end of the third quarter, 1997. Of these
comparables, only three had a larger percentage of lines on-net. It should be noted that WCII's on-net lines is defined as customers fully served by WCII, using both switches and wireless connections. This demonstrates that by some important measures WCII is one of the most well-developed CLECs. This implies that management is executing its strategy effectively. Further evidence of success will be provided as the benefit of a wireless strategy is demonstrated through faster and more cost effective deployment.
In addition, WinStar needs to achieve higher revenues per line to show that customers are utilizing its services in ways comparable with other CLECs and ILECs. As the year progresses we think both of these developments will become obvious, which should be key catalysts for the stock.
WinStar's direct wireless CLEC comparables, Teligent and ART are significantly behind WinStar in terms of business development. Certainly Teligent has the benefit of having attracted a strong stable of well-know management talent. But it will take some time for this company to catch up to where WinStar already is. Teligent is in the process of deploying switches and obtaining roof rights and plans to become commercially
operational in the second half of 1998. It's target is to enter ten markets by year-end 1998 and 30 markets by year-end 1999. ART is operational but its business strategy is quite different from WCII as its focus is on the wholesale market, not direct sales to end users. In addition, neither Teligent nor ART has as much spectrum as WinStar, particularly in top markets.
Neither Teligent nor ART generated revenues in the first nine months of 1997 that come close to matching WinStar's. While WinStar produced $49.6 million in revenue in the first nine months of 1997, Teligent only
generated $2.9 million and ART generated $0.9 million. Even if we only consider WinStar's CLEC and CAP revenue, WinStar would still be far and away the more advanced carrier. WinStar's revenue from the first nine
months was $17.2 million.
Our DCF analysis of WinStar leads us to our $61 price target, and the comparison to other CLECs confirms our view that the stock is undervalued relative to this group. As noted earlier, we use a 14% discount rate, a 9x
terminal multiple, and a 20% private to public market discount in arriving at our valuation. The cash flow model, shown in Table 6 shows that we forecast results to 2007, and expect terminal year EBITDA growth of about 12%, with EBITDA margins of 29%. Revenue growth in the final year is about 9%. These financial assumptions are consistent with our other CLEC models, and seem reasonable to us.
Because WCII's wireless approach to the CLEC business requires significantly less plant than the fiber-based CLECs, a comparison of enterprise value to gross plant can be misleading. On that basis, WCII looks expensive, having a much higher multiple than any of the fiber-based CLECs. On the other hand, comparing it on the basis of enterprise value to revenues is a good comparable valuation measure. On this basis WCII's valuation of a 6.1 multiple of forecasted 1998 revenues makes it look relatively cheap compared with the group. Thus, we conclude that our DCF analysis has put us on the right track, and is a good indicator of upside potential in the stock. |
