Governali:
BUY
WinStar Communications (WCII)
Summary
The revenues and EBITDA WinStar reported for its third quarter
were slightly below our estimates, however, demand trends
continue to accelerate and the company continues to
successfully meet its previously stated business plan. In
addition, WinStar has made several strategic announcements
since the beginning of the fourth quarter that should help to
ensure that its current build out plan are not curtailed and
that management is taking steps to improve the efficiency of
its execution. We are making no changes to our estimates or
our Buy rating.
Price Target Mkt.Value 52-Week
11/05/981(Y-E) Div Yield (MM) Price Range
29.625 $61 None None $1,182.0 47 - 13
Annual Prev. Abs. Rel. EBITDA/
EPS EPS P/E P/E Share
12/99E (10.68) NA NA (2.73)
12/98E (11.35) NA NA (4.99)
12/97A (7.68) NA NA (4.65)
March June Sept. Dec. FY End
1999E (2.85) (2.81) (2.61) (2.42) Dec. 31
1998E (2.54)A (2.77)A (2.83)A (3.05)
1997A (1.29) (1.85) (2.01) (2.50)
ROIC (12/97)
Total Debt (9/98) $1,694 mil
Book Value/Share (9/98) NM
WACC (12/97)
Debt/Total Capital (9/98) 108%
Common Shares 39.9 mil
EP Trend2
Est. 5-Yr. EPS Growth
Est. 5-Yr. Div. Growth
1On 11/05/98 DJIA closed at 8915.5 and S&P 500 at 1138.9.
2Economic profit trend.
WinStar is a competitive local exchange provider using 38 GHz
technology to build out local telecom networks in major markets
throughout the country.
Summary
WinStar reported third quarter revenues and EBITDA slightly below our
targets. Revenues were $61.1 million compared with our estimate of $64.5
million and EBITDA was a loss of $48.3 million compared with our estimated
loss of $47.6 million. Despite the slight downside in the quarter we remain
confident that management is on track to execute on its game plan, that
demand trends remain strong, and that greater efficiencies should continue
to be incorporated into the business. Therefore, we are not altering our
current EBITDA loss estimates for 1998 and 1999 of $191.8 million and
$112.7 million, respectively. The reported loss per share of $3.36
included a $0.53 charge per share for discontinued operations. The
normalized loss per share of $2.83 was just a penny better than our
estimated loss of $2.84.
Revenues Off Slightly Despite Strong Demand
Total revenues were $61.1 million compared with our estimate of $64.5
million. All revenue lines were a shave off from our estimates. CLEC
revenues were $37.2 million versus our $39.4 million estimate. These
results were despite higher line growth than our model had targeted. As
previously disclosed, WinStar added 60,000 lines in the quarter compared
with 50,000 last quarter and our estimate for the quarter of between
58,000-59,000. Sequential growth in line additions this quarter was 20%
compared with 22% last quarter. Total lines in service now equals 255,000.
WinStar includes in its line count long distance customers that do not
purchase local service. It has indicated that 15% to 20% of the total
"lines in service" are long distance only customers.
The slight revenue shortfall this quarter was likely a function of lower
than expected revenues per access line. Our model had targeted that the
revenue per line this quarter would remain flat with last quarter, however,
the company reported that this statistic actually declined a bit during the
third quarter because of lower business usage during the summer months.
Management explains this occurrence as a seasonal phenomenon that it had
not factored into its internal modeling and guidance. We think that the
mix of business also explains at least partially the decline in revenue per
line.
During September, WinStar reported that its CLEC revenues were about $15
million, generating an annual run rate of close to $180 million. Using the
$15 million per month run rate, we believe we could expect revenues in the
fourth quarter of at least $45 million. Then applying a conservative 25%
sequential growth rate (lower than the 27% growth reported in the third
quarter) we arrive at a fourth quarter estimate for CLEC revenue of
between $55-$57 million, leaving us comfortable with our current fourth
quarter estimate of $55 million.
Other revenues (primarily WinStar's long distance resale business that it
has stated plans to eliminate) were $11.2 million versus our $12 million
estimate. WinStar must have been able to shed more of these long distance
customers during the quarter than we had expected. Information services
revenues were $12.8 million, just slightly below our $13 million target.
Improving Efficiency In Third Quarter and Going Forward
In the third quarter WinStar reported an EBITDA loss of $48.3 million.
This compares with our estimated loss of $47.6 million and last quarter's
loss of $48.6 million. WinStar's business plan has been to improve upon
EBITDA each quarter, after having reached its EBITDA inflection point in
the fourth quarter of 1997. Thus far, management has achieved this goal
every quarter and we believe that certain strategies that are being folded
into its business will help it to continue to meet this promise. For
instance, the Millenium marketing plan that WinStar announced a few weeks
ago that offers $1,000 of free local service to new customers in specified
buildings that are on WinStar's network should significantly increase the
percent of customers that WinStar has operating on-net and on-switch.
Currently, WinStar's reported on-switch percentage is below the CLEC
industry norm which is between 50-80%. This is largely due to the fact
that the company put a priority on generating revenues in markets and
buildings even before facilities were constructed. In the third quarter
WinStar reported that about 18% of its subscribers were on-net and 37% were
on-switch. However, excluding WinStar's long distance only lines, which we
noted represent between 15-20% of its total CLEC lines, its statistics
appear a little better. Assuming 20% of lines are long distance only, and
also assuming that these lines are never counted as either on switch or on
net, the denominator in the calculation of on switch and on-net shrinks,
raising the percentages to 23% and 46%, respectively. While this isn't a
huge change, it is slightly better and closer to industry norms. WinStar
also indicated that its provisioning rate improved this quarter, but at
this point, we haven't yet obtained the actual data.
Also notable in the third quarter, WinStar's New York operations reportedly
turned EBITDA positive. This was achieved after 18-21 months of
operations. The New York operations had 54% of its customer on-net and 80%
on-switch at the end of the quarter. Logic would suggest that if WinStar
is successful in bringing more customers in its other markets on-switch and
on-net and churning out its existing long- distance only customers, it
should be able to break EBITDA positive in its other markets within the
same time-frame, if not faster. The Millenium sales initiative should
again assist in this goal if the cost of customer acquisition and
maintenance remains within plan.
Vendor Financing Increases Comfort Level For Future Outlook
WinStar recently announced a $2 billion vendor financing facility with
Lucent Technologies. The funding becomes available in $500 million
tranches as Lucent syndicates the outstanding loans to banks. This
arrangement covers WinStar's financing requirements through cash flow
positive and earnings positive plans. It should allow WinStar to easily
follow through with its existing business plan to be in 40 cities in the
U.S. by year-end 1999. It should also assist WinStar in entering
additional U.S. cities, if desired, or to enter the international arena as
WinStar has indicated it would like to pursue. Since the financing
agreement provides WinStar greater flexibility in its ability to roll out
its networks, we remain confident in our existing 1998 and 1999 EBITDA
estimates, assuming WinStar does not accelerate or expand upon its
currently stated business plans.
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