With it's internet strategy, ARTT and SPDE (in BBFW) seem susceptible to the following analysis. ARTT's attempt to increase shareholder value by building internet access (voice is FAR more costly and challenging) may not pay off:
ML Investment Highlights (Reingold / Kastan)
(btw, Hirsch panels at Reingold's telecom conf on Wed at 3 and 3:30 EST:
Message 8280321 )
· Overall, 4Q98 results for the CLEC group were highlighted by stronger than expected growth in revenues and local access lines, although for some CLECs, these positive comparisons were against recently lowered expectations. EBITDA performance, however, was once again disappointing. The key factor behind the weak CLEC EBITDA
performance was gross margin pressure resulting from a higher than
anticipated mix of less profitable LD services (21% of rev's for 4Q vs. 18% for 3Q) combined with higher than expected network costs.
· For the 12 CLECs we track, 4Q98 revenue totaled $872M, up 6%
sequentially and 4% above our estimate of $842M, helped in large part by a stronger than expected contribution from reciprocal compensation which accounted for an estimated 13% of 4Q revenue, up from 10% during 3Q. CLEC sequential revenue growth was 19%, a deceleration vs. the 23%
sequential growth seen in 3Q98 and the 28% sequential growth seen in
2Q98. Y/Y growth, however, was still quite strong, registering 89% growth vs. 4Q97 total revenues of $462M.
· As expected, the FCC's reciprocal compensation ruling on February 25
"jurisdictionally" redefined internet-related traffic as inter-LATA rather than local. In addition, the FCC made it clear that its ruling would not go into effect (and thus CLECs could continue to bill for this traffic) until existing interconnection agreements calling for reciprocal compensation payments for internet-related traffic expire. This ruling is important for the CLEC group as we estimate that internet-related reciprocal compensation revenues comprised 10% of '98 group revenue and assuming a 70% margin, accounted for 50% of CLEC EBITDA.
· The FCC's reciprocal compensation decision supports our expectation that half of internet-related reciprocal compensation revenues will phase out in '00, the other half in '01 as interim interconnection agreements that call for payment for this traffic expire over the next 12-24 months. Nevertheless, as a result of the FCC decision, we expect the RBOCs/GTE to: 1) stop paying current internet-related reciprocal compensation claims by CLECs; 2) go to court claiming that if internet-related traffic is NOW inter-LATA in nature, then it was inter-LATA in the PAST and thus not covered by reciprocal compensation agreements; and, c) seek court help to retrieve past internet-related reciprocal compensation payments made to CLECs.
· 4Q98 CLEC stock performance was quite strong as the group
outperformed the S&P by 15 percentage points with Hyperion (+177%),
WinStar (+82%) and McLeod (+53%) showing the strongest performance
while e.spire (-20%), Intermedia (-17%) and GST (+9%) were the weakest
on an absolute basis. Year-to-date through March 1, CLEC stocks have
outperformed the S&P by 10 percentage points with the strongest
performance exhibited by NEXTLINK (+72%), Teligent (+39%) and RCN
(+36%) while Hyperion (-40%), ICG (-12%) and WinStar (-10%) were the
weakest on an absolute basis. We expect continued strong relative
performance for the group as the year progresses due to a combination of:
1) growing investor confidence as CLEC financial performance tracks more closely to and possibly exceeds quarterly expectations; 2) continued lessening of funding concerns as more CLECs access the capital markets; and 3) renewed investor interest in the potential for industry consolidation following the AT&T/MetroNet deal announced on March 5.
· We continue to highlight the following two stocks: RCN (RCNC, D-2-1-9, $26 1/4) with a 12-18 month price objective of $36 based on our 10-year discounted cash flow model, 39% upside; and Teligent (TGNT, D-2-1-9, $41 1/8) with a 12 month price objective of $48 based on our 10-year discounted cash flow model, 16% upside. For RCN, we like the firm's unique position as the sole facilities-based local competitor to the RBOCs (regional bell operating companies) concentrating on residential customers, a uniqueness not lost on potential acquirers such as AT&T, MCI WorldCom or perhaps Level 3. In addition, we are impressed by RCN's economics of offering three services – voice, Cable TV and high speed internet access – to dense,
urban neighborhoods. For Teligent, we think its wireless local broadband network deployment will allow the company very broad geographic coverage of the local business telecom market at very attractive rates of return on investment. In addition, our recommendations on both stocks follow two similar themes: 1) strategic focus on building local broadband networks, not renting facilities from the incumbents, which should allow for higher margins over time; and, 2) little, if any, dependence on internet-related reciprocal compensation revenues – an issue which has lowered our enthusiasm for other CLECs we follow. |
