This otherwise dullard is on the DSL train now (think RTHM/AWRE)-
from regarded Bear Stearns telco analyst Jim Henry:
MGC Communications, Inc.* (MGCX-$11 5/8-BUY)
MGC Announces xDSL Initiatives, New Strategic Investor
_________________________________________________________________
***Providence Equity Partners Will Take A 16.6% Stake In MGC For
$37.5 Million.
***New Capital Will Be Used To Pursue Rollout Of Business-Centric
xDSL Strategy.
***We Reiterate Our BUY Rating With A Raised Year-End 1999 Target
Price Of $35.
_________________________________________________________________
Enterprise Value Data Relative Value Data
Common Stock Price $11.625 1999E Revenue $45.7
Fully-Diluted Shares 25.1 2000E Revenue $129.3
Market Cap. $292.0 TEV/1999E Revenue 6.1x
Debt & Cap. Leases $157.3 TEV/2000E Revenue 2.1x
Cash & Equivalents $171.8 4Q98 Gross PP&E 122.9
Total Entpr. Value $277.5 TEV/Gross PP&E 2.3x
Source: Bear, Stearns & Co. Inc. Financial data is based on
MGC's 4Q98 results and Bear, Stearns & Co. Inc. estimates and is
pro forma for the $47.5 million equity investment announced on
April 5, 1999 by Providence Equity Partners and two other
entities. All financial data is in millions except multiples and
per share amounts.
_________________________________________________________________
INVESTMENT VIEWPOINT
New Partners & A New xDSL Strategy. MGC Communications, Inc.
announced on April 5, 1999 that Providence Equity Partners and
two of its existing investors will make an equity investment of
$47.5 million in the company. Concurrent with this positive news
MGC announced that it would employ the proceeds of this
investment in order to rollout a business-centric digital
subscriber line (xDSL) offering in order to further leverage the
substantial central office (CO) collocation assets that it has
deployed. Based on this very positive news and the upside that
it creates to MGC's business plan, we are reiterating our BUY
rating on MGC and raising our year-end 1999 target price to $35
per share. The following paragraph outlines our thoughts on this
news and the investment case for MGC Communications:
Providence Is A Strong & Seasoned Partner. We believe that
Providence Equity Partners will play an instrumental role in
driving the growth and development of MGC going forward.
Providence is the leading private equity investor in the CLEC and
competitive telecom arena. The company is very much a "hands on"
investor that has played an vital role in the funding, growth,
strategic development, and M&A initiatives of success stories
such as Brooks Fiber Properties, MetroNet Communications, and
Verio. As such, we think that Providence can make a very
positive impact on MGC by providing strategic guidance,
recruitment of key senior executives, and establishing commercial
relationships with its other portfolio companies. It is worth
noting that MGC is Providence's only US CLEC investment, which,
given the large number of players in this landscape, speaks
volumes about the opportunities that it sees at the company.
Moreover, given the typical required rates of return for a
typical private equity shop, it is fair to say that Providence
expects to make at least 3x its investment at $9.00 per share.
We think that public investors should feel very comfortable going
along for the ride.
xDSL Business Plan Creates Significant Upside. We believe that
MGC's new business-centric xDSL rollout is a logical move for the
company that will add a significant amount of upside to the
original business case. MGC is better positioned than any other
CLEC to rollout xDSL as a result of its extensive network
footprint. At year-end 1998 MGC had the largest number of
central office (CO) collocations of any company in the industry.
Its 207 collocations in 7 first-tier markets enable the company
to target a base of 11 million ILEC access lines. We expect the
company to upgrade its existing collocation facilities for the
provision of xDSL service by year-end 1999 while it
simultaneously moves into 15 new markets. By leveraging the
unbundled network elements of the ILECs coupled with xDSL
technology, we believe that MGC be able to offer a bundle of
local, long distance, data, and Internet service to small and
medium-size businesses across its territory. The ability for MGC
to lease a digitally conditioned 64 Kbps unbundled loop for $15
per month and to use xDSL technology to soup up the capacity of
that line to 1.54 Mbps (i.e., equal to the capacity of 24 phone
lines) provides a powerful cost structure for offering voice
service coupled with high-speed data and Internet. We expect to
hear more about the timing and mechanics of MGC's xDSL rollout
after it finalizes its strategy during the next 30 days.
Financial & Operational Outlook. The Providence investment and
the rollout of its xDSL strategy comes at a point when MGC has
been demonstrating substantial acceleration in its financial and
operational performance. MGC's 4Q98 results exceeded our
expectations for revenue growth and access line installations.
The company posted 32.7% sequential revenue growth and installed
11,387 access lines. In a call with management yesterday we
gained comfort that the company is on track to meet or exceed our
1Q99 estimates for revenue of $7.8 million (up 20%) and 17,000
access line installations. The momentum that MGC is
demonstrating in growing its business and provisioning local
dialtone provides us with a high degree of confidence that it can
successfully deploy xDSL. The company possesses the key
collocation real estate necessary to gain access to the ILECs'
unbundled loops. More importantly, MGC has developed the rare
core competencies (i.e., both personnel and systems) necessary to
provision those loops in a timely and cost effective manner. We
would expect management to provide some revised guidance to its
financial targets over the next 30 days as it fine-tunes its new
business plan. Revisions to revenue and EBITDA guidance should
be expected as the company will likely slow its focus on
residential consumers going forward and increase operating
expense and SG&A in order to ramp up its product portfolio,
network resources, and sales staff for the xDSL strategy. That
being said, we think that any incremental expenses incurred in
the near term are well worth while given the significant value
that will be created in the expansion of MGC's business plan.
A Very Compelling Relative Valuation. We believe that MGC offers
investors the most attractively valued play in the CLEC space.
The company possesses scarce and strategic assets that we expect
to deliver returns on invested capital higher than any fiber-
based CLEC in the market today. Moreover it now plans to
leverage those key assets to deploy xDSL technology in order to
pursue one of the largest and most potentially profitable
business opportunities in the telecom space. In light of its
compelling valuation, the introduction of a key strategic
investor, and the new xDSL strategy, investors should take a
fresh look at MGC. We believe that the stock offers significant
upside based on our discounted cash flow (DCF) model and based on
the fact that company trades at a dramatic discount to any of its
"smart build" or xDSL-centric comparables. MGC trades at only
2.3x its gross PP&E and 2.1x 2000E revenue while the other "Smart
Build" comparable Allegiance Telecom trades at 10.5x gross PP&E
and 5.7x 2000E revenue. In the xDSL pureplay space Covad trades
at 66.9x gross PP&E and 21.7x 2000E revenue. Rhythms
NetConnections is expected to trade at least in Covad's range
when its vastly oversubscribed IPO finally prices this week. We
expect that MGC will at least partially narrow the gap between
its current depressed level and the levels of its peers of the
next number of months.
We Reiterate Our BUY Rating With A $35 Target Price. Another way
to look at the relative valuation is in terms of enterprise value
per addressable line. This measure looks at the enterprise value
of the company divided by the number of lines that it can address
through its CO collocations - similar to looking at POPs in the
early days of the cellular industry. xDSL pureplay Covad
Communications Group currently enjoys $725.00 in enterprise value
per addressable line. Allegiance Telecom's enterprise value is
equal to about $450.00 per addressable line. Rhythms
NetConnections is expected to come out at about $137.00 per line
- and will no doubt double in its first day of trading. By
contrast, MGC's enterprise value per addressable line is only
$25.00. Does MGC deserve a discount because it does not offer
marquis management like Allegiance Telecom's Royce Holland or
Covad's strategic partners like AT&T and Qwest? Sure it does.
But does it deserve a 95% discount? No way. We expect that
investors will be willing to pay significantly higher multiples
for MGC based on the introduction of Providence as a strategic
investor, the company's new xDSL strategy, and the accelerating
operating momentum that the company is demonstrating. As such,
we are raising our target price to $35.00 per share. At $35.00
MGC would have a total enterprise value of $864 million equal to
$79.00 per addressable line - still a healthy discount to the
group. Please refer to table 1 for a look at the relative
valuations in this sector.
Table 1. CLEC Relative Valuation ($ in millions except for
network stats and per share data)
ALGX COVD MGCX RTHM
Stock Price $30.00 $70.00 $11.63 $17.00
Fully-Dil. Shares 62.5 64.0 25.1 75.0
Market Cap. 1,875.0 4,480.0 292.0 1,275.0
Long-Term Debt 471.7 347.6 157.3 158.3
Cash & Equivalents 731.4 480.5 171.8 335.4
Enterprise Value 1,615.2 4,347.2 277.5 1,097.9
Markets In Operation 9 6 7 10
Targeted Markets 15 16 15 40
Total Markets 24 22 22 50
CO Collocations 101 168 207 200
Addressable Lines 3.6 6.0 11.0 8.0
1999E Revenue 92.5 56.7 45.7 12.5
2000E Revenue 285.0 200.5 129.3 55.0
EV Per Addr. Line $448.70 $724.50 $25.20 $137.20
EV/1999E Revenue 17.5x 76.7x 6.1x 87.8x
EV/2000E Revenue 5.7x 21.7x 2.1x 20.0x
Source: Bear, Stearns & Co. Inc. ALGX data is pro forma for the
company's pending offering of 10.0 million shares of common
stock. COVD data is pro forma for the company's IPO and follow-
on high yield offering. MGCX is pro forma for the Providence
Equity investment. RTHM is pro forma for the company's IPO
assuming the successful pricing at the high end of the range this
week.
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