From Lehman / Blake Bath:
Headline: MCI WorldCom, Inc:Mix Shift & Reinvestment Drive Growth-Raise Target(P1/2)
Author: Blake Bath (202)452-4732, Lara Warner (202)452-4705
Rating: 1
Company: WCOM T FON
Country: COM CUS
Industry: TELECM
Ticker : WCOM Rank(Old): 1-Buy Rank(New): 1-Buy
Price : $87 11/16 52wk Range: $94-$39 Price Target (Old): $95
Today's Date : 04/09/99 Price Target (New): $110
Fiscal Year : DEC 10 Uncommon Values
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EPS 1997 1998 1999 2000
QTR. Actual Old New Old New Old New
1st: 0.05A 0.18A 0.18A 0.35E 0.35E - -E - -E
2nd: 0.08A 0.21A 0.21A 0.45E 0.45E - -E - -E
3rd: 0.12A 0.21A 0.21A 0.54E 0.55E - -E - -E
4th: 0.15A 0.23E 0.23E 0.66E 0.65E - -E - -E
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Year:$ 0.40A $ 0.83E $ 0.83E $ 2.00E $ 2.00E $ 2.85E $ 2.85E
Street Est.: $ 0.72E $ 0.68 $ 1.98E $ 1.97 $ 2.82E $ 2.83
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Price (As of 4/7): $87 11/16 Revenue (1999): 34.8 Bil.
Return On Equity (99): 12.6 % Proj. 5yr EPS Grth: 33.0 %
Shares Outstanding: 1903 Mil. Dividend Yield: N/A
Mkt Capitalization: 166 96Bil. P/E 1999;2000 : 44.3 X; 31.1 X
Current Book Value: $24.52 /sh Convertible: None
Debt-to-Capital: 26.9 % Disclosure(s): C, A
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Highlights:
* WCOM's industry leading position in growth markets (data, internet, int'l)
is driving powerful mix shift and enabling high teens revenue growth over
next few years.
* We continue to believe WCOM will deliver on the MCI synergies and as a
result generate $20+B in free cash flow over the next 5 years. These cash
flows will be used to aggressively attack Int'l and Internet opportunities.
* WCOM's Internet Business continues to grow dramatically. Backbone traffic
is growing at 10X per year. We estimate that overall internet revenue growth
will be at least 60% in 1999
* WCOM Vice Chairman John Sidgmore recently suggested global deregulation
will accelerate investment opportunities in Europe. Asia/Pacific will also
see increasing emphasis - represents only $70M of revenues for WCOM today.
* Raising price target to $110 or 38X 2000 earnings. Given position in
industry, WCOM should trade at earnings multiples approaching other mega-cap,
high growth industry leaders (e.g. MSFT, DELL, CSCO trade between 62X and 64X
2000 earnings)
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Summary:
Following a series of meetings with John Sidgmore, we believe WCOM will
continue to make aggressive moves, especially in the internet and
internationally, to fuel on-going 15-20% revenue growth and 30%+ earnings
growth over the next 5 years.
REVENUE MIX, COST SYNERGIES FUEL STRONG FREE CASH FLOW
Revenue Mix:
Revenues: 1999e 2000e 2001e 2002e 2003e
Voice 20,935 22,233 23,522 24,699 25,884
Data 7,529 9,536 11,662 13,878 16,335
International 1,789 2,540 3,501 4,800 6,500
Internet 3,596 5,322 7,382 9,900 12,900
Comm Svcs 33,849 39,631 46,067 53,277 61,619
% Revenue Growth 1999e 2000e 2001e 2002e 2003e
Voice 7% 6% 6% 5% 5%
Data 29% 27% 22% 19% 18%
International 58% 42% 38% 37% 35%
Internet 60% 48% 39% 34% 30%
Comm Svcs 18% 17% 16% 16% 16%
% of Ttl Rev 1999e 2000e 2001e 2002e 2003e
Voice 62% 56% 51% 46% 42%
Data l 22% 24% 25% 26% 27%
Int'l 5% 6% 8% 9% 11%
Internet 11% 13% 16% 19% 21%
Comm Svcs 100% 100% 100% 100% 100%
We believe the revenue profile of WCOM is that of the quintessential telecom
company of the 21st century. While voice today represents nearly 2/3rds of
all revenues (below the industry norm of 80%), and enables enormous scale
benefits, the non-voice areas are growing so powerfully that they will more
than overwhelm voice in a few short years. Pressure in Consumer and
Wholesale voice revenues are being more than offset by on-going growth in
data, internet, and international. As a result, we believe these growth
areas(internet, int'l, data) will go from contributing 38% of revenues in
1999 to over half of revenues in 2001. In addition, we believe that because
of the building free cash flow position, WCOM is increasing its flexibility
to not only preserve, but extend its presence in growth areas. We,
therefore, expect that revenue growth continues to accelerate in one or more
of these growth markets as they gain scale, most likely international.
Cost Synergies:
At the same time, the company is on track to meet the $2.5B synergies for
1999. Corporate streamlining has fueled strong savings in SG&A, and the
creation of one network organization has also enabled significant savings in
line costs. Information systems and technology savings however, have been
coming a little more slowly. However, the recent outsourcing deal with EDS
will assist WCOM in delivering these savings. At this stage in the year, we
are not increasing the synergy levels in our model above the $2.5B level in
1999, but we continue to believe WCOM has on-going opportunities to further
reduce costs and therefore meet their synergy commitments beyond 1999. As
the table below depicts, WCOM ended 1998 with the highest SG&A as a % of
revenue versus AT&T (T, 1-Buy, 83 7/8) and Sprint (FON, 1-Buy, 108 _). Both
AT&T and Sprint have announced targets for the next few years in the low 20%
range. As WCOM achieves their synergy targets over the next few years, we
expect their SG&A as a % of revenue to reach similar levels.
SG&A as a % of Revenue
4Q98
$B % of Rev
WCOM 2.2 27.3% (versus approx 21% pre-MCI acquisition)
AT&T 3.0 22.5%
Sprint 1.0 24.1%
Summary:
Free Cash Flow:
As a result of robust revenue growth and strong cost synergies, WCOM will
generate significant free cash flow over the next 5 years as the table below
shows. This will give the company increasing financial flexibility.
1999e 2000e 2001e 2002e 2003e
EBITDA 11,453 14,258 17,577 21,430 25,499
CAPEX 6,551 6,990 7,572 8,197 8,197
Interest 984 920 900 900 880
Taxes 2,816 4,051 5,342 6,872 8,509
Free Cash Flow 1,103 2,297 3,762 5,462 7,914
Cumulative FCF 1,103 3,400 7,162 12,624 20,537
Based on our recent meetings with John Sidgmore, we believe WCOM plans to use
this funding to invest aggressively in the two major deregulated areas of the
telecom industry: the internet and international markets.
Investment in Internet and International - Leveraging Today's Market Strength
WCOM plans to further enhance its leadership position in internet and
international over the next few years.
UUNET, WCOM's internet business, is one of the premier Internet Service
Providers (ISP's) with projected revenues of nearly $3.6B in 1999
representing 60% growth over 1998, with gross margins of 50%. They currently
serve many of the largest U.S. internet players (e.g. AOL, Microsoft) and
therefore are participating in the phenomenal growth in this sector. AOL in
fact is one of WCOM's largest customers with a long-term contract. In the
last 3 years, UUNET has seen their backbone capacity requirements increase 10
fold each year.
UUNET also has $.5B in international internet revenues today with strong
opportunties for growth as Europe moves toward U.S. levels of internet usage.
Based on our estimates, we expect 60% revenue growth from UUNET in 1999
decelerating to 30% by 2003, which may be highly conservative.
Given their current market position and customer base, we believe WCOM is the
cheapest way to play the usage growth in the internet. If you believe that
the AOLs and Microsofts of the world will need additional capacity, then
UUNET will continue to see strong growth. UUNET's 50% gross margins and low
SG&A will also provide another catalyst for WCOM to continue to improve its
cost structure going forward.
International: WCOM begins from an equally strong position in international.
We expect revenues in 1999 to approach $1.8B (nearly all in Europe) with
growth of almost 60%. This does not include WCOM's acquisition of Embratel in
Brazil which generates another $3B in revenues annually. In 1999, WCOM will
spend $1.5B to enhance their global networks. In Europe, WCOM currently has
operations in all major countries, facilities in 22 cities, and connections
to 5000 buildings. They also plan to triple the size of its all-fiber, high-
capacity pan-European network to nearly 7,000 miles (11,265 km) by the end of
1999 (Ulysses). WCOM also continues to build out local city networks to
connect to its 2,000 (3,218 km) mile trans-continental long distance
network(Gemini). In addition to capital investment, WCOM has also been
putting feet on the street (sales and network operations), adding 2000 jobs
in Europe over the last 2 years.
Based on our meetings, we believe WCOM has aggressive plans for the future.
John Sidgmore stated that WCOM's goal is to be a prominent player in Europe
and they will use both their own capital and acquisitions to get there.
Although in recent years, WCOM has been constrained by a lack of suitable
acquisition targets, this may change with deregulation (as it did in the U.S.
market). Asia / Pacific will also become a stronger point of focus going
forward. Today, Asia generates only $70M of revenue for WCOM. WCOM recently
announced investments in a network in Tokyo and the purchase of Ozmail,
Australia's largest E-Mail provider. Sidgmore stated that he expects on-
going acquisitions in Asia Pacific to substantially increase WCOM's presence.
On the topic of wireless, WCOM clearly recognizes that this business
generates growth. Regardless of how or when the company addresses wireless
going forward, WCOM's track record for making disciplined investments that
create long term shareowner value speaks for itself.
Valuation: We are raising our price target on WCOM to $110 or 38X 2000
earnings. We believe, given its position in the industry, that WCOM should
trade at earnings multiples approaching the levels of other mega-cap, high
growth industry leaders. If you look at Microsoft, Dell, and Cisco, all
trade between 62X-64X 2000 earnings with long term EPS growth rates between
25% - 35%. We therefore believe that a 38X multiple is not unreasonable for
WCOM, who is clearly well positioned to also deliver 30+% EPS growth over the
next few years.
BUSINESS DESCRIPTION: MCI WorldCom is the 2nd largest long distance company
in the US. It has assets in the key growth areas of telecom services
including local, international, data/Internet and very stong management.
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