Microsoft Investor
April 10, 1998
Phone Stock for the Future?
Intermedia Communications has plunged 20% after last year's 360% zoom. So why are some analysts still so hot for it?
By Barbara Grady
For the better part of the past five years, the phone has rung off the hook for investors in Intermedia Communications (ICIX). One of the new breed of local telephone companies that emerged from telecom deregulation over the past decade, the Florida-based company has rewarded shareholders with a spectacular gain of 360% in the past year alone.
The company's stock has recently taken a pounding along with the entire telecommunications sector, but analyst Tim Horan of BancAmerica Robertson Stephens thinks its $18 plunge in the past two weeks has just created a "real buying opportunity" for any hardy tech investors who haven't caught up with the story yet. His reasoning: Nothing much happened to cause the fall, and the stock ought to resume its climb before long.
Why consider buying a piece of a firm that lost $241 million last year on revenues of $247.9 million and already has had a fast run-up? Mainly because Intermedia, along with its fellow competitive local exchange carriers, or CLECs, has effectively situated itself in front of a $103-billion market opportunity that is just opening up.
The CLECs are non-Bell local telephone companies that sell voice and data services to businesses. Some own high-speed transmission lines and sophisticated switches that let them also lease lines to other telephone companies and sell long-distance service. Intermedia does all those things, but also just last week announced a 20-year, $450 million deal to lease carrying capacity from a Williams Cos. (WMB) fiber-optic network.
If you've never heard of the CLECs before, it may be because the legal challenges to Congress' Telecommunications Act of 1996 has put them under a cloud. Those efforts have largely been thwarted, and the vast U.S. telecom market is finally opening up to unbridled competition. Federal and state regulators are eager to wrest business away from the Bells and GTE.
Standing most to gain, in the minds of many securities analysts, is Intermedia. James Henry, telecommunications analyst at Bear, Stearns & Co., says he believes the company is "the best positioned of the CLECs -- if not the whole telecom industry -- to capitalize on the deregulatory opportunities in telecommunications as well as the growth in Internet traffic and data communications."
The reason: While relatively few were paying attention, Intermedia created local service networks that cover the top 15 markets of the United States with data and Internet services. Henry believes it has "best-in-class" product offerings in local service, long-distance service, and enhanced data and Internet services, and the rare distinction of having strength across all those areas. "Bundling these services, Intermedia can offer all of a customer's telecom needs under one bill. That is very compelling," he concludes. And those customers are only high-margin business and government customers. Henry has a $115 price target on Intermedia's stock.
Another reason to hold Intermedia is its status as a very eligible bachelor in a merger-crazy telecommunications industry. Many analysts expect that Intermedia and ICG Communications (ICGX) will be the next CLECs at the altar for one of its larger rivals. And despite the sharp recent jump, Intermedia's stock is selling at a lower multiple of assets -- or gross property, plant and equipment -- than either of the two most recently acquired big CLECs: Teleport Communications Group, which was bought by AT&T (T), and MFS Communications Corp., which was bought by WorldCom (WCOM).
The Long-Term View
So why have shares plunged recently? On March 31, Intermedia declared that it had less "visibility" on the results of this quarter than usual because of its many pending business deals and acquisitions. Still, it remained confident it would meet analysts' fiscal year-end estimates of $84 million in earnings before interest, taxes, depreciation and amortization. The stock started falling immediately, even though most analysts said the immediate quarter doesn't matter.
Merrill Lynch telecommunications analysts Dan Reingold and Mark Kastan raised their rating on Intermedia on April 3 to "strong buy" from "long-term buy." A few weeks earlier, they wrote: "We expect consolidation will continue through 1998. It has become strategically imperative for domestic long-distance companies as well as large international players to gain control of both local assets and customer bases."
Indeed, some larger telecommunications firms aren't even shy about expressing their interest. Edward Whitacre Jr., chairman of SBC Communications (SBC), in a recent talk to investors mentioned Intermedia and two other CLECs by name as companies the Baby Bell would like to acquire.
Tricky Territory
Despite the nice ring to this story, there are, of course, numerous risks ahead.
Intermedia has had to spend heavily to build its local networks, data switches and long-distance pipes, and doesn't expect a net profit for another three years at least. The company has also spent a lot on acquisitions to round out its product line and become a one-stop telecommunications shop. Many analysts think it will take even longer for a net profit; Merrill's team projects it will be 2004.
Ted Moreau of Robert W. Baird Securities, one of two analysts who currently rate the stock a "hold," says the stock's valuation is too dependent on takeover speculation and generally has gotten too high for a company with no earnings. "I don't like to rely on a buyout for a valuation," Moreau said. He said Intermedia is at the forefront of many promising trends, but its payback is five years away. Moreau noted that the stock market has gotten used to investing in companies based on EBITDA, market share, new growth and asset base. "When the cash flowing into the stock market slows down, these EBITDA stocks will have less to support themselves," he cautioned. "So we're trying to lock in some profits."
Likewise, Lehman Bros. analyst Bill Garrahan downgraded Intermedia to "neutral" when it was trading at around $89, saying the stock was close to its full value and that the company may face increased competition.
Room to Grow
Intermedia itself thinks its stock has lots more potential. "The opportunity before us is huge and growing. By recent data, the U.S. market for local and long-distance and data service is somewhere around a $222-billion-a-year opportunity," said Christopher Brown, Intermedia senior vice president, in an interview.
Brown said Intermedia has been acquiring companies and network assets to round out its product line and add customers in its existing markets. Last year it acquired DIGEX, a leading business Internet service provider in the Southeast, and also made deals to scoop up Shared Technologies Fairchild, LDS Communications, National Telecommunications and three other firms.
Brown said the Shared Technologies deal completes Intermedia's effort to round out its product line, while most of the rest were about gaining customers in 60 major cities the firm has targeted for local or long-distance service. Even without those deals, the company's organic growth, or revenue excluding that gained from acquisitions, was an impressive 98% last year, and its gross margin jumped 12% last quarter to 29%. With its recent acquisitions included pro forma, Intermedia counts 92,209 business customers and a total of 207,064 access lines.
Amid this growth and buying spree, short positions in Intermedia stock have risen sharply. Between mid-February and mid-March, short interest rose just shy of 25% to 5.1 million shares. The bears are clearly in control of the stock now, but Henry believes the company is undervalued relative to its gross property, plant and equipment expenses and its forward revenues.
Even at $87 on March 20, Henry said his research showed Intermedia trading at 5.8 times gross property plant and equipment expenses and 5.3 times estimated 1998 revenues -- lower than the 7.6 average gross property and 15 revenues multiples for the 12 CLECs he follows. With the stock trading around $72 now, it could be a good time to make the call. |
