A buy in this market?
You betcha: That's what WorldCom's recent $6 billion bond sale says to me.
By Jim Jubak
techstocks.com
Want to get a handle on a company's future earnings? Try looking at its bonds.
Most of the time, I don't pay a lot of attention to corporate bond issues when I try to analyze a stock. But when the economic outlook is fuzzy, the earnings picture foggy, and investor sentiment volatile, I can't get all the information I need from the tools that I commonly use. So I cast my net wider, taking whatever clues the financial markets are offering.
Last week, WorldCom (WCOM) sold the largest corporate bond offering in history -- $6.1 billion. What I learned from that sale gave me the last bits of information I needed to complete my analysis of the company and add the stock to Jubak's Picks. Let me tell you how the bond deal helped me reach a decision to buy this stock.
The window offered by the bond deal couldn't come at a better time. Thanks to the recent rout in the market, WorldCom's stock has tumbled more than 10% since mid-July, to $49.75 on Aug. 11. Is this the moment to buy?
WorldCom is notoriously hard to value since the company's history of growing by acquiring other phone and networking firms and then taking big charges against earnings makes most standard measures virtually useless. For example, the recent pullback in the stock took WorldCom's price-to-earnings ratio down to a modest 260.
Details
--------------------------------------------------------------------------------
Price 50 3/16
Change -0.531
ÿCompany Facts
3-yr Chart
Press Releases
Earnings Estimates
Growth Rates
10-yr. Summary
Details
--------------------------------------------------------------------------------
Price 60 15/16
Change -7/8
ÿCompany Facts
3-yr Chart
Press Releases
Earnings Estimates
Growth Rates
10-yr. Summary
And valuing the stock is about to get even harder. With approval from the U.S. Department of Justice and the European Commission finally tucked under its belt, WorldCom is set to consummate its $37 billion acquisition of MCI Communications (MCIC) sometime in the third quarter. WorldCom will take a huge write-off from the deal -- some $6 billion to $7 billion if the Securities and Exchange Commission goes along -- that would pretty much wipe out earnings. Follow that with a likely stream of special charges as WorldCom cuts and slashes overhead at MCI and investors could wait years to see earnings numbers that actually mean anything.
While future earnings -- theoretically the reason that an investor is buying the stock -- are pretty much at the mercy of the accountants, it's possible to put together a reasonably accurate picture of the growth rates we can expect from the combined company. Lehman Brothers did just that after MCI reported its second-quarter earnings on July 30. Here's what the combined company looked like:
Putting the pieces together (Q2 revenue)
ÿBusiness segmentÿ ÿMCIÿ ÿWCOMÿ ÿCombinedÿ ÿYr. to Yr.
Growthÿ ÿSequential
Growthÿ
ÿVoiceÿ ÿ$3,934ÿ ÿ$1,208ÿ $5,142ÿ 11%ÿ 2%ÿ
ÿData and Internetÿ ÿ$912ÿ ÿ$1,062ÿ $1,974ÿ 32%ÿ 13%ÿ
ÿInternationalÿ ÿnaÿ ÿ$299ÿ $299ÿ 52%ÿ 15%ÿ
ÿInformation Technologyÿ ÿ$464ÿ ÿnaÿ $464ÿ 21%ÿ naÿ
ÿOtherÿ ÿ-$29ÿ ÿ$42ÿ $13ÿ naÿ naÿ
ÿTotal ÿ$5,281ÿ ÿ$2,611ÿ 7,892ÿ ÿ16.70%ÿ 5%ÿ
-- Source: Lehman Brothers
-- All figures in millions
-- Excludes MCI's Internet business sold to Cable and Wireless
Knowing the growth rate for the combined company helps me get a handle on its relative value versus other telecommunications stocks. For example, now I can compare not only the price per dollar of current sales at MCI WorldCom to AT&T (T), GTE (GTE) and Sprint (FON), but I can also factor the sales growth rate into my decision. Here's how the companies stack up:
Relative value?
ÿCompanyÿ ÿQ2 sales ($bil.)ÿ ÿQ2 growthÿ ÿPrice-to-Q2-
Sales Ratioÿ
ÿAT&T (T)ÿ $12.86ÿ -2.80%ÿ 8.03ÿ
ÿGTE (GTE)ÿ $6.28ÿ 10.80%ÿ 7.60ÿ
ÿSprint (FON)ÿ $3.97ÿ 8.40%ÿ 7.52ÿ
ÿMCI WorldComÿ $7.89ÿ 16.70%ÿ 12.17ÿ
Clearly, if I were just buying current sales, I'd never think of plunking down my money for MCI WorldCom. A dollar of second-quarter sales at the combined company is more than 50% more expensive than a dollar of AT&T sales and more than 60% more expensive than a dollar of Sprint sales. But I'm not just buying current sales for my money. I'm also buying sales growth. And compared to Sprint, for example, MCI WorldCom gets me almost twice the growth for my 60% premium. If I look at both sales and sales growth, the combined MCI WorldCom is a buy.
If I look at both sales and sales growth, the combined MCI WorldCom is a buy.
It's dangerous to buy a stock just on sales, however. While some industries, such as cable television, can apparently trade forever on just the promise of earnings, most stocks have to actually produce earnings sooner or later. And thanks to the uncertainties of all the write-offs to come at MCI WorldCom, I don't have a clear sense of how good a job the combined company will be at turning sales into earnings.
That's why I found last week's bond sale so interesting. Interest rates on bonds reflect the risk that the borrower might not be able to repay the loan. So U.S. Treasury bonds usually pay the lowest interest rates since borrowers are certain that, short of a collapse that would take down the entire global financial system, the U.S. government will pay its debts. Corporate borrowers pay more since companies have a history of going bankrupt more frequently than the U.S. government. And some corporate borrowers pay higher rates than others because bond buyers assess the associated risks as higher.
Bond investors actually believe management's claim that it can wring substantial cost savings out of the merger of these two companies.
WorldCom, for example, once paid a pretty high rate on its debt because the company's ability to cover payments of interest and principal were in doubt. As late as last April, Standard & Poor's, one of the three major bond-rating agencies, said that WorldCom's bonds weren't investment grade. That's not terribly surprising. WorldCom does have more than $8.3 billion in long-term debt on its books. And it's not unusual for a fast-growing telecommunications company to get such a rating. The bonds of Level 3 Communications (LVLT), a new competitor to WorldCom, currently have a similar "junk bond" rating -- when Level 3 sold its bonds, investors demanded a 9.125% interest rate.
But when WorldCom went to the bond market last week to raise $6 billion to cover most of the $7 billion owed to British Telecom as part of the MCI deal, the company only had to pay 6.4% interest on notes due to mature in seven years. (The offering also included three-, five-, and 30-year maturities.) That's only about 80 basis points (or 0.8 percentage points) more than the U.S. government pays on seven-year Treasury notes.
That narrow spread tells me a couple of important things. First, bond investors, who have carefully looked at the company's books, see more than enough cash flow to cover existing liabilities and the new debt. Second, bond investors actually believe management's claim that it can wring substantial cost savings out of the merger of these two companies.
I don't think WorldCom will trade on earnings for some time anyway. But I can get comfortable with buying the stock at its current price.
The upgrade in WorldCom's debt began with the deal to buy MCI -- the bigger company had a better bond rating and that helped produce the two-notch improvement to the BBB rating that WorldCom now enjoys. But bond buyers were also willing to take such a modest interest rate premium because they anticipate future upgrades in WorldCom debt. An upgrade would increase the price of the bonds on the market so that investors who already own the bonds would get not only the 6.4% interest, but also price appreciation on the bonds.
In other words, bond investors, who care about cash flow before charges and depreciation, are giving the management of this company a strong "thumbs up." I can't turn that into a precise earnings number -- and I don't think WorldCom will trade on earnings for some time anyway. But I can get comfortable with buying the stock at its current price. In this case, at least, I feel reasonably confident that the market has created a genuine bargain.
And any little comfort one can get from today's market is a very nice thing indeed.
|
