BT Alex Brown (Bo Fifer/Jeff Hines) WCII: Williams Deal Gives WinStar
Broadband End-To-End Connectivity
WINSTAR COMMUNICATIONS INC. (WCII)
"STRONG BUY"
Williams Deal Gives WinStar Broadband End-To-End Connectivity
Date: 12/17/1998 EPS: 1997A 1998E 1999E
Price: 37.0 1Q (1.27) (2.59) (3.12)
52-Wk Range: 48 - 10 2Q (1.78) (2.77) (3.21)
Ann Dividend:0.0 3Q (2.01) (2.83) A (3.26)
Ann Div Yld: 0.00% 4Q (2.56) (2.98) (3.29)
Mkt Cap (mm):2,461 FY(Dec.) (7.66) (11.19) (12.88)
3-Yr Growth: 0% FY P/EPS NM NM NM
CY EPS (7.66) (11.19) (12.88)
Est. Changed No CY P/EPS NM NM NM
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HIGHLIGHTS:
WinStar held its first-ever investor community meeting today (17-Dec)
in New York and made a series of announcements that substantiate
WinStar's focus on driving on-net traffic as opposed to relying on
resold facilities.
POSITIVE NEW NEWS: WinStar and Williams Communications signed a
two-part agreement that gives WinStar access to Williams' long haul
fiber and creates an end-to-end broadband network at WinStar. In
exchange WinStar will provide Williams with nationwide local capacity
on its Wireless Fiber network.
As expected WinStar announced expanded domestic market rollout details
on the international plan. WinStar now plans to offer services in 45
domestic markets by YE 1999 (up from 40) and in 6 international
markets by YE 1999.
WinStar also announced the commercial introduction of
point-to-multipoint (PMP) services in Washington DC and New York with
and plans to expand the PMP network nationally throughout 1999.
NEGATIVE NEW NEWS: Until the accounting issues surrounding the
Williams deal are finalized, the impact of the deal and the market
expansion on future EBITDA is uncertain. However, both announcements
mark significant positive strategic developments for WinStar.
STOCK PRICE PERFORMANCE: YTD, WCII is up 48% versus a 44% gain in our
CLEC Index and a 22% gain in the S&P 500.
NET-NET: While at times in the past WinStar's strategy (vis a vis
reselling versus facilities-based services) has been confusing, we
believe there is no longer any question that WinStar is entirely
motivated by driving on-net penetration. We continue to believe that
WinStar is positioned to offer a lower-cost, higher-speed,
higher-value service than its principal ILEC competitors (now on an
end-to-end basis), and therefore to attract significant market share.
VALUATION: Based on our 10-year DCF, using a 20% equity discount rate
and a 10x terminating multiple, our 12-month price objective for WCII
is $51/share.
Maintain "strong buy (1)" rating. We are placing our model under
review pending a discussion with management on the financial
implications of the Williams deal and the expanded market rollout.
DETAILS:
WinStar held its first-ever investor community meeting yesterday
(17-Dec) in New York with over 200 investors in attendance. WinStar
made a series of announcements that substantiate WinStar's focus on
driving on-net traffic as opposed to relying on resold facilities.
NEW MARKETING FOCUS
WinStar's focus remains capturing market share from the Regional Bell
Operating Companies (RBOCs). Management outlined a slightly new model
for attaining this goal based more on WinStar's own network and less
on reselling RBOC facilities. In fact, the overriding theme of the
meeting was "driving on-net traffic."
We believe WinStar is taking a positive step by addressing the size or
breadth of its network footprint, thereby allowing WinStar to keep
more traffic on net. WinStar announced it has signed building access
rights for 4,200 buildings YTD, versus our year-end estimate of 4,000,
and expects to have access to 8,000 buildings by YE 1999. We believe a
better-than-expected response to the Project Millennium effort
(WinStar's innovative pricing/marketing program offered only to on-net
customers) could result in higher-than-expected percent of on-net
traffic in 4Q (currently estimated at 19%), and a commensurate
improvement in gross margins.
NOW A BROADBAND, END-TO-END SERVICES PROVIDER
In the spirit of keeping traffic on net, WinStar and Williams
Communications agreed to a two-part agreement designed to give each
company broadband access on an end-to-end network. The deal requires
WinStar to provide Williams with nationwide local capacity in exchange
for dark fiber on Williams' long-haul network.
Under the terms of the deal, Williams will pay WinStar $400 million
for 2% of WinStar's ultimate network capacity. WinStar has agreed to
build out 270 hub sites (minimum) nationally by YE 2001 and to provide
2% of the capacity at each hub site to Williams. Williams will pay
WinStar on a pro rata basis as hub sites are built out based on the
number of hub sites constructed. Today, for example, WinStar can
provide Williams with capacity on 60 hub sites, implying a $89 million
payment from Williams (60 / 270 x $400M).
Part two of the deal calls for WinStar to pay Williams $640 million
over 7 years for 15,000 route miles and 60,000 fiber miles of dark
fiber across the country. WinStar's payments will be made in equal
monthly installments over the 84-month payment cycle, implying nearly
$23 million per quarter for long haul services. While WinStar does
not break out local versus long haul service costs, we estimate
WinStar would have spent in the range of $1.5 billion over the next 7
years (heavily dependent on subscriber growth and usage) for long
haul services, implying a savings of 50%-60%.
The deal was literally signed during yesterday's analyst meeting, and
therefore the accounting issues (mostly revolving around when and how
WinStar will recognize the Williams revenue) have not been resolved.
WinStar can recognize revenue as capacity is provided, or on a
straight-line basis over the life of the contract. The former would
have positive implications for WinStar's EBITDA in 1999, while the
latter would likely have negative implications. However, the true
cash flow is real and is positive for WinStar over the 3-year build
out window. WinStar will collect a total of $400 million through
2001, while paying approximately $275 million to Williams over the
same period.
The deal also values the WinStar network alone at $20 billion dollars
at YE 2001. In present value terms, under our current WinStar model,
the implied value of WinStar's equity would be valued at $142/share:
2001 Network Value $20,000 mil.
2001 Net Debt $3,500 mil.
2001 Equity Value $16,500 mil.
PV @ 20% discount rate $9,500 mil.
Diluted Shares out 66.8 mil.
Implied Value Per Share $142
This analysis does not take into account the incremental revenue from
the Williams contract or the incremental cash flow implications from
the international roll out, nor does it account for the value of
WinStar's content and ISP businesses. But it does demonstrate the
value of a high-speed local loop solution in the eyes of
communications providers.
MARKET ROLLOUT EXPANSION
As expected WinStar released details on an expanded domestic market
rollout and the first details on the international plan. WinStar now
plans to offer services in 45 domestic markets by YE 1999 (up from 40)
and in 6 international markets by YE 1999. We believe this move is
also consistent with the notion of increasing WinStar's network
coverage and keeping as much traffic as possible on net. Our model
already assumed that WinStar would be in 60 markets by 2001, which it
confirmed at yesterday's meeting. On the international front, WinStar
announced it would be in 6 markets by YE 1999, and 50 markets within 5
years, and will focus on 3 regions: Europe, Asia-Pacific, and Latin
America. We expect the first markets to be rolled out late in 1Q
1999.
Europe
Partners: None. Lucent to provide capital and turnkey network builds.
Initial Markets: Netherlands (Amsterdam launch scheduled 1Q 99).
Current Deals: Point-to-point (PP) and point-to-multipoint (PMP)
licenses acquired in Amsterdam. Filed for licenses in 7 German
cities. Will file in UK, Belgium, and France in early 1999.
Asia/Pacific
Partners: Joint venture with 2 companies in Japan pending. JV with
companies in Australia.
Initial Markets: Japan (planned 2Q 99 launch in 5 markets), Australia.
Looking at others.
Current Deals: Australian auctions expected Feb-99.
Latin America
Partners: None.
Initial Markets: Argentina, looking at others.
Current Deals: LOI to acquire 400 MHz in the 38 GHz range. Deal could
close Jan-99, service would begin shortly thereafter.
Canada/Mexico
Until regulatory restrictions on foreign ownership are lifted, WinStar
will focus on other opportunities.
FINANCIAL IMPACT
According to WinStar, the Williams deal and the expanded market
rollout will have the following incremental financial effects:
Incremental 4Q 98E Effects Revenue EBITDA
Expansion -- ($25M) - ($35M)
Williams $0 - $80M $0 - $70M
Incremental 1999E Effects Revenue EBITDA
Expansion -- ($140) - ($160)
Williams $15M - $125M $14M - $110M
Source: Company documents.
The impact to our model will be less severe since our model already
assumed cash flow losses associated with a 60 market rollout by 2001.
We are placing our model under review pending a discussion with
management regarding international losses and the Williams accounting.
POINT TO MULTIPOINT NOW COMMERCIAL
WinStar also announced the commercial introduction of
point-to-multipoint (PMP) services in Washington DC and New York with
plans to expand the PMP network nationally throughout 1999. While
this is consistent with our projections, the move signals WinStar's
comfort with the technology, given that it has been "sitting" on these
PMP networks for months. We would not view this as an indication that
PMP technology is commercially available in large quantity.
NET NET
While at times in the past WinStar's strategy (vis a vis reselling
versus facilities based services) has been confusing, we believe there
is no longer any question that every move WinStar makes is motivated
by driving on-net penetration.
How successful will WinStar be? According to management, November -
the first month of the Millennium project - was the best month ever
for WinStar's sales team. In five major markets, around 75% of new
subscribers were Millennium (and therefore on-net) subscribers, which
is why we believe 4Q 1998 gross margins and beyond could come in ahead
of our expectations.
EVERY MAJOR ANNOUNCEMENT MADE AT THE ANALYST MEETING DROVE HOME THE
NOTION THAT WINSTAR IS FOCUSED ON IMPROVING THE AMOUNT OF ON-NET
TRAFFIC. WE BELIEVE WINSTAR IS NOW THE FASTEST GROWING, MOST
UBIQUITOUS BROADBAND END-TO-END NETWORK PROVIDER OUT THERE.
We continue to believe that WinStar is positioned to offer a
lower-cost, higher-speed, higher-value service than the its principal
competitors (now on an end-to-end basis), and therefore to attract
significant market share. |
