Reingold from today:
Investment Highlights:
· AT&T announced last night that (a) it will cut
operating costs by another $2B by year-end
'00 and (b) is making a hostile bid for Media
One (UMG; 6-6; $77). Both are positive in our
view.
· We are lowering our 2000 EPS estimate by
$0.33 to $2.00 on the assumption T wins. EPS
likely will be diluted 14%, but EBITDA/sh
only 4%, EPS growth will accelerate from
18% to 21% and EBITDA growth from 13 to
16%.
· We reiterate our Accumulate Buy rating but
expect the shares to trade some what soft until
the final outcome is clear. Our 12 month price
objective remains $67 (upside of 18%)
representing an expansion in EV/EBITDA
from 9.8x to 11.4x our preliminary $25.5B
estimate of '00 EBITDA.
· The cost restructuring likely will boost EPS by
14% ($0.32) by year-end '00 and thus is
significantly positive, independent of the UMG
bid, in our view.
Last night's dual announcements that AT&T (a) will cut
operating costs by another $2B by year end '00 and (b) is
making a hostile bid for Media One (UMG) are positive in
our view. We are lowering estimates on the assumption
that T wins (see below) and are reiterating our rating but
expect the shares to trade some what soft until the final
outcome is clear. The cost restructuring will boost EPS by
14% ($0.32) by year-end '00 and thus is significantly
positive, independent of the UMG bid.
Major positives if T wins UMG:
1. T's local telephony footprint including affiliates and the
Time Warner (TW) JV will cover 50% of US homes,
helping to defend consumer LD market share,
2. EPS likely will be diluted 14% but EBITDA/sh only 4%,
3. We estimate EPS growth will accelerate from 18% to 21% and EBITDA growth from 13% to 16%,
4. Result in a merged entity selling at only 9.8x '00 and
9.0x '01 EBITDA which looks cheap vs our est. of 16%
growth and given WorldCom (WCOM, B-2-1-9, $92 7/16)
trades at 16x EBITDA with 19% growth.
5. Likelihood of bringing the TW letter of intent to
definitive agreement increases substantially since T would
then own UMG's 25% interest in TWE,
6. The return of Amos Hostetter, former CEO of UMG, is
a major positive management addition,
7. Possible revival of the tracking stock idea floated last
year - which would offload EPS dilution and raise
prospects for a sum-of-the-parts value (which we estimate
at $79/sh and T estimates at $73).
8. If successful, we believe this will be AT&T's last cable
acquisition with all subsequent deals done as JVs, not
buyouts. The need to acquire UMG is unique in that UMG
has considerable influence, perhaps even veto power, over
TW's attempt to JV with T.
Despite these positives, we expect some near term
weakness in T shares given the 14% EPS dilution and the
fact that T has traditionally traded on EPS.
However, like last summer when AT&T announced its
25% dilutive acquisition of TCI, we expect the shares to
rebound as its EBITDA valuation is appealing, capex is
peaking within 24 months and T's cable and wireless
(traditionally valued on EBITDA) exposure has grown to
27% of pro forma '99 revs.
Our 12 month price objective remains $67 (upside of
18%) representing an expansion in EV/EBITDA from 9.8x
to 11.4x our preliminary $25.5B estimate of '00 EBITDA
(our calculations assume the UMG acquisition closes by
January '00 and approximately $18-20B of cash is raised as
non-cable assets are divested over the next 2-3 years).
We are lowering our post-3:2 split and post-UMG '00
estimates as follows: EPS to $2.00 from $2.33; and
EBITDA/sh to $6.60 from $6.90. For now, we assume
AT&T wins at its offer price of $87 3/8 per UMG share.
Risks: Our main concern is that Comcast, perhaps aided
by another company, and T enter a bidding war-creating an
overhang on T shares. Regardless of which company
wins, we expect Comcast and UMG to ultimately end up
as partners with AT&T in offering local cable telephony.
Implications for RBOCs: No change in our positive view
that the RBOCs have a very attractive cable-like vertical
model, benefiting from an expanding pie and selling new
"vertical services" at low incremental cost (over existing
infrastructure and channels to existing customers)
including high speed DSL lines, ISP service, numerous
voice features and -eventually-long distance. We have
always assumed T would bring UMG, Time Warner and
perhaps Comcast and Adelphia into the fold as partners in
offering cable telephony. Our assumptions on RBOC
share loss remain unchanged: On a nationwide average,
we expect RBOCs to lose 25% share of the local market
over a 10 year period that began about 3 years ago
comprised of 15-20% loss in residential markets and 30-
35% in business markets. We continue to assume AT&T
will achieve 15% share in its and its affiliates/partners'
cable footprints over the next 5 years. We do not see a
zero sum game nor a price war scenario because even far
out in the future we think the industry's structure is
oligopolistic at worst.
Implications for CLECs: It is clear AT&T has resolve
(presumably motivated by some fear too) to get into the
local market. Much remains to be done in the business
markets outside the center city and thus it is not
unreasonable to expect AT&T to continue looking for
CLECs with extensive owned local infrastructure (beyond
just switches) and/or special assets such as broadband
wireless (e.g. Teligent). Owning Teleport already,
however, we believe AT&T can afford to be patient and
selective, perhaps waiting until some CLECs merge and/or
each CLEC's dependence on reciprocal compensation
becomes clearer. |
