NXLK (part 1 - looong) from Fahnestock's John Bauer and James Lee:
NEXTLINK Communications, Inc.
(OTC-NXLK-74 3/4)
Raising Rating to Buy. Data Does it Again; Asset Value Raised to $155; Target Raised to $108.
Investment Opinion: We are reiterating our BUY rating on NEXTLINK. Our year end target price of
$108 reflects a 30% public market discount to our year end 1999 net asset value of $155 per share. Key
points:
· Wireline Strategy: NEXTLINK intends to be operational in “most” of the top 30 U.S. markets by the
end of 2000. The resulting footprint will cover nearly half of the business access lines in the country.
The local fiber networks being built in these markets are extremely robust (new-builds contain up to
400 fiber strands per mile). These local networks (there are 24 built already) will ultimately be
connected via the company's 16,000-mile nationwide fiber backbone (currently under construction).
· Wireless Strategy: NEXTLINK has the largest portfolio of Local Multipoint Distribution System
(LMDS) spectrum in the United States. This spectrum will be used to reach customers (via
microwave links) that would be uneconomical to reach with fiber. As a result, NEXTLINK should
(over time) have a greater percentage of “on-net” traffic than its wireless-less peers. This should
produce higher cash flow margins than its wireless-less peers.
· Right Tools for the Right Job: By deploying its own digital subscriber line (DSL) technology,
NEXTLINK intends to further extend its reach into areas where it lacks fiber or wireless coverage.
The combination of fiber, wireless and DSL technologies virtually assures that NEXTLINK will
capture an above-average share of the current voice and future data market.
· Attractive Valuation: Our revised net asset value of $155 per share reflects higher penetration, higher
margins and $6 billion of data revenues in 2009. Our year-end target price of $108 reflects a 30%
public market discount to this estimated asset value. NEXTLINK is trading at a 51% discount to our
year-end 1999 net asset value. With the company clearly on track to meet our full-year estimates, we
think this discount will shrink to a historically more normal level of 30%. This would fuel a 44% rise
in the stock.
Key Themes
· Multiple networks = multiple options. Within two years, NEXTLINK's local fiber networks will
cover most of the top 30 U.S. markets. The company's national backbone (being built with Level 3
Communications and slated for completion around 2001) will cover an estimated 16,000 miles.
Finally, its portfolio of wireless licenses covers markets with an aggregate population of over 150
million. Over time, this combination should allow NEXTLINK to carry roughly 70% of its traffic on
its own network. In cases where wireless or fiber access is not feasible, NEXTLINK intends to deploy
its own (Digital Subscriber Line) technology to reach customers over copper lines.
· The Company's Tier I market presence is expanding rapidly. NEXTLINK currently serves 12 of
the top 30 U.S. markets. Six to eight additional (Tier I) markets are on track to be launched in the
second half of this year. This will result in coverage of 13 of the top 14 markets and 15 of the top 30
markets. Assuming the current pace of new market deployments persists, NEXTLINK will make good
on its plan to cover “most” of the top 30 markets by year-end 2000 (27 million addressable business
access lines, representing nearly half of the business access lines in service nationally).
· Local networks. To date, NEXTLINK had completed the construction of 24 broadband networks that
served 40 cities in 16 states and Washington, D.C. NEXTLINK is building these networks using
fiber-optic-cable bundles that are capable of carrying unprecedented volumes of data, voice, video and
Internet traffic as well as other high bandwidth services. In its newer markets, the company is
installing up to 400 fiber strands per route mile in its network. To put this in perspective, RBOC
networks average about 79 strands of fiber per route mile and Cable TV networks typically contain
less than 10 strands per route mile.
· Long-haul network. In July 1998, NEXTLINK joined sister company Eagle River LLC (a McCaw
family entity) to form INTERNEXT. This partnership is making a $700-million investment in a
nationwide inter-city fiber network being built by Level 3 Communications. This network is expected
to be completed by early 2001. NEXTLINK will begin activating segments of its long-haul network
during this year.
· Wireless network. In January 1997, NEXTLINK and NEXTEL jointly bid for (and won) 42 LMDS
licenses auctioned by the FCC. LMDS is a fixed wireless technology that allows voice and data to be
transmitted from rooftop antennae to distant hubs where it can be interconnected with the public
telephone network with the same speed and reliability as fiber networks. With its buyout of
NEXTEL's stake in the joint LMDS portfolio completed on June 3, 1999 and WNP Communications
(another LMDS auction winner) in April 1999, NEXTLINK is the largest holder of LMDS licenses in
the U.S. Management recently noted that direct fiber connections (while preferable) may be overtaken
by LMDS (wireless) connections as the dominant means of accessing customers over the longer term.
· 30 Tier I markets + 3 access technologies + 1 national backbone = Major data player. We
estimate NEXTLINK's data opportunity to be $28 billion in 1999. Our forecast calls for the overall
data market to grow to $230 billion by 2009. Our new net asset value of $155 per share accounts for
NEXTLINK's potential to capture 3% of the U.S. data market.
· MCI and Sprint are fixed wireless converts. Since this spring, MCI WorldCom and Sprint have been
gobbling up MMDS (wireless Cable TV) operators. As a third player in most markets, Cable and
Satellite operators being the first two, wireless cable has failed to flourish. Last fall, the FCC
deregulated this spectrum so it can now be used to provide wireless high-speed Internet Access. With
MMDS establishing residential inroads and LMDS penetrating the business market – the logic of a
long distance player owing both types of operations is compelling and likely to occur.
NEXTLINK was founded in 1994 by cellular pioneer Craig McCaw. The company is located in
Bellevue, Washington – home of the old McCaw Cellular headquarters. This undoubtedly makes
commuting easy for the dozens of McCaw Cellular expatriates who populate the management ranks.
At present, the company provides local, long distance and enhanced telecommunications services
to small- and medium-size businesses via 24 facilities-based networks, which serve 40 markets located in
16 states across the U.S. Over the course of this year and next the company plans to nearly double its
addressable market from 16 million business access lines to 27 million. At that point, NEXTLINK's
addressable market will include nearly half the country's business access lines.
Unlike many other competitive local exchange carriers (CLECs) which have chosen to operate in
smaller and less competitive markets, NEXTLINK is focused on large Tier I markets i.e., markets with
populations exceeding 1.5 million. The company targets businesses with 10 to 200 access lines and
competes on the basis of: 1) a “highly responsive customer service ethic”, in other words “marketing,
marketing, marketing”; 2) bundled service packages (local, long distance, and Internet access)
accompanied by a consolidated bill; and 3) modest (10% to 15%) price discounts.
At present, NEXTLINK has no international operations. However, the company has stated that it
is “talking to a number of (international) players” and is interested in pursuing international expansion.
We expect to see additional announcements regarding international beachheads and partners by year-end.
NEXTLINK reports “consolidated” revenues (i.e., no segment breakouts). However, with
supplemental information from management, it is possible to break out the company's operations into the
four discrete categories identified in the table below. The two drivers of long-term growth are highlighted
in this table. The CLEC operations (which provide competitive access (CAP), switched local and long-distance
services) are expected to contribute roughly 43% of the company's revenues by 2009. We
forecast data service offerings to contribute the remaining 57%. Our current data estimate reflects slightly
more than 3% share of a $230-billion data market in 2009.
Table 1
NEXTLINK
Segment Revenues and Growth Estimates
Compounded
1998 % of Annual 2009E % of
Business Segment Revenue Business Growth Revenue Business
CLEC 76,654 54.9% 51% 4,603,585 42.2%
Enhanced & Data 23,420 16.8% 75% 6,269,169 57.5%
Shared Tenants 12,845 9.2% 5% 21,215 0.2%
LD Resale 26,748 19.2% -9% 10,383 0.1%
Total 139,667 100.0% 55% 10,904,352 100%
Source: Company Reports and Fahnestock estimates
Corporate History
NEXTLINK was founded in 1994 by Craig O. McCaw - the founder of McCaw Cellular
Communications, Inc. In January 1995, NEXTLINK acquired two competitive access networks in
Tennessee (one in Memphis and one in Nashville) from City Signal, Inc. Four months later (May 1995), it
began constructing an extensive regional fiber optic network in Pennsylvania, designed to connect
Harrisburg, Reading, Lancaster and Allentown. At the same time, it acquired a local exchange reseller in
Spokane, Washington. With beachheads established in the CAP, local exchange resale, and long-haul
arenas, NEXTLINK was poised to act swiftly when Congress passed The Telecom Act of 1996.
In July 1996 (a scant five months after passage of the Act), the company began offering switched
local service in Memphis and Nashville, Tennessee and in Pennsylvania, thus qualifying it as one of the
first competitive local exchange carriers in the U.S. In late 1996, the company installed a switch in
Spokane and transformed its resale operations in this market into a switch-based CLEC. Subsequent
market launches in Ohio, Utah, Nevada and California expanded the company's addressable market to
nearly 11 million (business) access lines by year-end 1997. A consistent stream of new market launches
since has driven the addressable market to the current 17-million line level and, as noted, is expected to
result in an addressable market of 27 million business access lines by year 2000.
Friends and Family
NEXTLINK has three sister companies all tethered in various manners to Craig McCaw. The
ability of all four of these companies to create synergies is the key to Mr. McCaw's GRAND PLAN.
Imagine routing a call made by a Nextel (wireless) customer to a NEXTLINK local fiber and wireless
network, which would hand it to an InterNEXTlong-haul fiber network which would hand it to a Teledesic
satellite up-link, which could send the call to any destination in the world. Sounds crazy? So was buying
cellular POPs at $20 each in 1980. (ALLTEL recently paid $250 per cellular POP for 360
Communications company.) Note that Teledesic was named in 1984 before the “NEXT” family name was
adopted.
Nextel Communications, Inc. (OTC-NXTL) provides fully integrated wireless communications via its own
national, all-digital, wireless network in the United States. This network covers 92 of the top 100 U.S.
markets. On the international front, Nextel has operations in South America and Asia. The company serves
in excess of three million subscribers and reported $1.8 billion in revenues for 1998. Nextel's primary
customer base is what it calls mobile work groups, primarily contractors and the like. However, this
company is entering the white-collar market by offering subscribers its new Motorola i1000 series phones
that are smaller and have more features than those of the earlier generation.
InterNEXT Communications, is beneficially owned by NEXTLINK and Eagle River LLC (a McCaw-controlled
entity). InterNEXT has teamed with Level 3 Communications (via a $700-million investment)
to build a long-haul network, which will connect the country's top 50 markets, cover 16,000 route miles in
U.S. and Canada, and offer 100 times the current long-distance capacity. The network is scheduled to be
completed by early 2001.
Teledesic Corporation, is a McCaw / Microsoft partnership formed in 1994 to create a global, broadband
"Internet in the Sky." The venture's plan to offer high-speed Internet access via satellite is expected to cost
an estimated $9 billion and will consist of a 288 low-Earth-orbit satellite constellation set to begin
commercial service in 2002.
Large Market Bias
NEXTLINK operates in 40 markets located in 16 states and the District of Columbia covering, to a
great degree, the important four markets on the East and West Coast, Florida and Texas. The map below
identifies the company's operating markets. For example, of the 27 million access lines that are expected
to comprise NEXTLINK's addressable market in 2000, over 40% are located in Tier I markets (i.e.,
markets with populations in excess of 1.5 million). This big city bias is in striking contrast with many
CLECs that have focused their attention on Tier II and III markets where the competition is less intense.
Network Infrastructure
Local Network
NEXTLINK's local networks are comprised of 2,897 “route miles”(the physical miles of plant)
and 222,463 “fiber miles” (the number of miles of fiber carried within the physical plant) of high capacity
infrastructure. By dividing route miles by fiber miles, we can calculate the average fiber count or cross-section
within these networks. This figure represents a good proxy for capacity. NEXTLINK's average
fiber count has risen steadily from 67 fiber strands per mile in the first quarter of 1997 to 80 fiber strands
per mile in the first quarter of 1999. The increase reflects the huge capacity the company is building into
many of its newer markets (some of which boast cross-sections of 200 to 300 fibers per mile). To put
these numbers in perspective, RBOC networks currently average 50 strands of fiber per fiber mile. GTE
and Sprint average closer to 30 strands per fiber mile. Cable Television fiber networks typically contain of
8 to 10 strands of fiber.
NEXTLINK has begun to add IP (Internet Protocol) switches and routers to its network to enable
it to carry Internet traffic more efficiently. It is also adding ATM (Asynchronous Transfer Mode) switches
that enable the network to serve high volume customers. Interestingly, management notes in its recently
filed S-3 that “as IP technology evolves and matures, we believe it will gradually replace ATM and we therefore
intend to invest heavily in optimizing our networks for present and future IP implementations.” It
is anticipated that future IP technologies will allow broadband networks to carry voice, data and ultimately
video (in addition to entirely new classes of IP services).
National Network
NEXTLINK's long distance backbone will cover 16,000 miles and connect almost every major
city and large market in the U.S. and Canada. The capacity and reach of this network is expected to
represent the centerpiece of NEXTLINK's data strategy. Capacity is the key word here. According to
CEO Wayne Perry, “our goal is to provide customers with national access to the largest
telecommunications pipes imaginable, giving them the freedom to communicate by voice or data without
capacity constraints or inconvenience.”
In July 1998, NEXTLINK joined sister company Eagle River LLC to form INTERNEXT which,
in turn, announced it would make a $700-million investment in a nationwide inter-city fiber optic network
to be built by Level 3 Communications. As part of the agreement, NEXTLINK will receive 24 fibers, one
empty conduit and 25% of the fibers in conduits with over five strands. The network is expected to cover
more than 16,000 route miles and connect more than 50 major cities in U.S. and Canada. NEXTLINK is
responsible for 50% of the capital and will be obligated to invest $150 million in year 2000 and $175
million in 2001. (The company paid $50 million in 1998.) This network is expected to be completed in
early 2001. NEXTLINK will begin moving its long haul-traffic to this network as early as this year.
Wireless Network
In February 1998, the FCC concluded its LMDS auctions. NEXTBAND (the 50-50 joint venture
between NEXTLINK and sister-company NEXTEL) was the second largest bidder in these auctions,
paying $137 million for 42 licenses. (NEXTLINK's contribution totaled $67 million.) On June 3, 1999
NEXTLINK completed its buyout of Nextel's 50% of the venture for $137.7 million (double the price
NEXTBAND paid at auction). NEXTLINK has also acquired WNP Communications, Inc. (another LMDS
auction winner) for $695 million. Of this amount, NEXTLINK paid approximately $542.1 million (in
stock and cash) to WNP and $152.9 million in license charges to the FCC. (NEXTLINK did not qualify as
a designated entity. Therefore, FCC rules required that the discount received by WNP be paid back to the
agency.) As a result of these transactions, NEXTLINK is the largest holder of LMDS licenses in the
world.
LMDS is a fixed wireless transmission technology that allows voice and data traffic to be
transmitted from rooftop antennae to distant hubs where it can be interconnected with the public switched
telephone network. LMDS transmissions will offer the speed and reliability of fiber optic cable, just as 38
GHz wireless networks have operated efficiently for years.
By using fixed wireless as an alternative means for reaching customers, the company can further
reduce its reliance on the incumbent local exchange carriers (ILEC), thereby relieving its provisioning
bottleneck, accelerating installation time, and increasing the number of on-net buildings served. LMDS
wireless links will act as spurs from the company's SONET fiber rings in major cities. Since wireless
building antennae are portable, the combination of fiber and fixed wireless will give NEXTLINK
tremendous flexibility to design its networks for maximum capital efficiency. NEXTLINK has the
capability of running the equivalent of up to eight OC-3s per hub site (for its A-Band licenses) over its
proposed point to multipoint network. Because the company can choose the best transmission solution for
each customer, it enjoys cost- and service-quality advantages over both the wired-only and wireless-only
local service providers.
Data Opportunities
Addressable market for data: The following table shows our estimates of NXLK's national data
opportunities. Based on the explosive demand of the data market, we expect a compounded annual growth
rate of 21% through year 2009, resulting in a U.S. data market of approximately $230 billion in year
2009. NEXTLINK's portfolio of data services includes three major categories:
· Basic services: Providing retail transport services to its customers through dedicated lines or wholesale
transport services to ISPs utilizing its national Internet backbone. This market opportunity is estimated
to be $20 billion today, growing 11% compounded annually to approximately $60 billion by 2009.
· Internet connections: Providing high-speed connections to the Internet by leveraging its various
technologies: (1) Fiber-optic network– for moving large amounts of data traffic; (2) wireless
broadband – an alternative access technology with speed-to-market advantages as well as capital and
cost benefits that fiber doesn't yet offer; (3) DSL – a way to leverage the huge copper plant available
for lease. This market opportunity is estimated to be $5 billion today, growing 31% compounded
annually to approximately $100 billion by 2009.
· Applications: Providing value-added service -- such as web hosting, management and web security
services. This market opportunity is estimated to be $3 billion today, growing 33% compounded
annually to approximately $70 billion by 2009.
Data Revenues and EBITDA contributions: Our DCF model (page 17) reflects minimal data revenues
in year 2000. However, with the exceptional opportunity in the data market, combined with
NEXTLINK's triple-threat technology portfolio, we estimate data will contribute $6 billion in revenue in
2009, representing a 60% compound annual growth rate and the capture of 3% of the U.S. market. Based
on our expectation that NXLK could reach 45% EBITDA in 2006 and then maintain that profitability, data
revenues should contribute approximately $2.7 billion in EBITDA in 2009.
Management
NEXTLINK's roots in McCaw Cellular organization are illustrated in the Table 4 below. Each of
the top three members of the management team worked together at McCaw Cellular prior to that
company's sale to AT&T in 1994 and five managers held extremely senior positions at other companies
prior to joining NEXTLINK. The company's cites its decentralized management structure as key to
attracting and retaining top-name talent. This structure allows managers who are accustomed to calling
their own shots – often at their own companies- to “run their own shows” with little interference from
above. This wealth of management talent has, in our opinion, played an outsized role in the company's
ability to raise capital. (NEXTLINK raised roughly $1.5 billion or nearly half its public market
capitalization in 1998 alone.) The roots in McCaw help explain the company's recent $900-million
investment in wireless LMDS licenses and suggests its longer-term aspirations to become a global player
on par with AT&T, WorldCom, etc. are real.
Craig O. McCaw
Mr. McCaw is the founder and principal shareholder of NEXTLINK and had served as Chief
Executive Officer until being replaced by Wayne M. Perry in 1997. Prior to joining NEXTLINK, Mr.
McCaw spent 10 years in the cellular industry where he was founder, Chairman and Chief Executive
Officer of McCaw Cellular until it was acquired by AT&T in 1994. Mr. McCaw also enjoyed great
success in the cable industry, where he developed a small, family-owned cable business of 4,000
subscribers into the nation's 20th largest cable operator (450,000 subscribers). In 1981, Mr. McCaw
introduced paging and conventional cellular technology to the cable company's product portfolio. At the
same time, he made a hard push into the development of broad-based cellular services. These early
beachheads served as the staging area for McCaw Cellular.
In addition to his current involvement in NEXTLINK, Mr. McCaw is also Chairman, Chief
Executive Officer, founder and owner of Eagle River L.L.C., a firm specializing in strategic investments
in the telecommunications industry. Furthermore, he is a principal owners of Teledesic Corporation, a
private company formed in 1994 with Microsoft's Chairman Bill Gates, which announced plans for a
worldwide satellite-based telecommunications system. Finally, Mr. McCaw is a significant stockholder, a
director and Chairman of the Operating Committee of Nextel Communications.
Table 3
Management Position With NextLink Prior Position Affiliation
Craig McCaw Founder and Director Founder and CEO McCaw Cellular
Steven Hooper Chief Executive Officer President and CEO McCaw Cellular
Wayne M. Perry Vice Chairman Vice Chairman McCaw Cellular
George M. Tronsrue III President and COO COO ACSI
Kathy H. Iskra Chief Financial Officer President and CEO Horizon Air
R. Gerad Salemme SVP, Industry Relations VP, Government Affairs McCaw Cellular
Douglas Carter Chief Technology Officer SVP, Technology McCaw Cellular
Janice E. Loichle VP, Local Exchange Operations EVP U.S. Signal
Michael J. Mchale, Jr. Chief Marketing Officer Regional VP Teleport
Source: Company Reports
Steven W. Hooper
Mr. Hooper was named as the Chief Executive Officer replacing Wayne Perry on March 18,
1999. Prior to that position, he had been Chairman of the Board of NEXTLINK in July 1997 and had
served as a Vice Chairman of the company during the preceding month. He is also the Co-Chief Executive
of Teledesic Corporation. Before joining NEXTLINK, Mr. Hooper served as President and Chief
Executive of AT&T Wireless Services, following its merger with McCaw Cellular. For the two years
leading up to this appointment, he served as the company's Chief Financial Officer. Prior to joining
AT&T, Mr. Hooper spent five years as the Regional President of Cellular One's Pacific Northwest/Rocky
Mountain Division where he was responsible for managing operations in a seven-state region. Mr. Hooper
is a member of the Audit Committee of the Board of Directors.
Wayne M. Perry
Mr. Perry has also spent much of his career with Steven Hooper and Craig McCaw. He was
replaced by Steve Hooper on March 18, 1999 as the CEO after serving as the company's CEO for the
prior two years. Mr. Perry will focus on NEXTLINK's business development and strategy and will
continue to serve as NEXTLINK's Vice Chairman and member of the Board of Directors. Dating back to
1989, Mr. Perry was Vice Chairman of AT&T Wireless Services (following the merger with McCaw
Cellular) and Vice Chairman of the Board of McCaw Cellular (prior to its merger with AT&T.) Before
that, he was President of McCaw Cellular since 1985 and Executive Vice President and General Counsel
since 1976. Mr. Perry was appointed Vice Chairman of the Board of LIN Broadcasting Corporation on
March 1990. He also served as Chairman of the Board of the Cellular Telecommunications Industry
Association, the nationwide wireless industry association, for the 1993-94 term. Mr. Perry is a member of
the Executive Committee of the Board of Directors.
George M. Tronsrue III
Mr. Tronsrue has been President of NEXTLINK since July 1998 and Chief Operating Officer
since October 1997. Prior to that, Mr. Tronsrue was part of the initial management team of ACSI (now
e.Spire) from February 1994 to September 1997, and was responsible for planning and overseeing the
operations of ACSI for its first three years while serving as Chief Operating Officer, President, Strategy
and Technology Development Division and Executive Vice President, Planning and Development. Prior to
that, Mr. Tronsrue served as the Regional Vice President of the Central Region of Teleport
Communications Group (TCG), and as Vice President, Emerging Markets managing the start-up of TCG's
initial eight cable television partnerships. Before TCG, Mr. Tronsrue was at MFS Communications from
its inception in 1987 until 1992. At MFS, Mr. Tronsrue served in various executive positions involving
strategic planning, information systems and field services. Prior to MFS, Mr. Tronsrue served at MCI
from 1983 to 1986 in a variety of engineering and operations roles, culminating as Director of Operations,
Michigan and Ohio.
Kathleen H. Iskra
Ms. Iskra has been Vice President, Chief Financial Officer and Treasurer of NEXTLINK since
January 1996. Unlike the aforementioned directors, Ms. Iskra does not come from a telecom background.
Instead, she comes from the airline industry where she spent nine years with Alaska Airlines. She started
her tenure as staff vice president of finance and controller of Alaska Air Group and ended it as President
and Chief Executive of Horizon Air, a wholly-owned subsidiary of Alaska Airlines. Prior to joining
Alaska Airlines, Ms. Iskra was an audit manager with Arthur Andersen.
1Q 1999 Results
Access lines: The table below outlines our access line forecast through year 2000. During 1Q99,
line additions broke the 50,000 mark and sequential growth topped 29%. The strength reflected the launch
of service in San Diego and improving sales productivity in existing markets (“average” sales reps sold 72
lines per month during the quarter with some reps selling over 100 lines per month). The company plans to
add seven additional markets by year-end. A total of 109 sales representatives were added during the
quarter to staff up for these launches. (Total sales headcount now stands at 428.) The combination of an
expanding geographic presence, increased sales manpower, and improving productivity is reflected in our
year 2000 estimates.
Gross Margin: Gross margins dipped slightly during the quarter reflecting the startup costs
associated with the expansion into six markets. Gross margins for NEXTLINK's most mature markets
(launched in 1996) were in the 60% range in 1Q99, reflecting 20% to 30% on-net traffic. As the
percentage of on-net traffic increases (ultimately to 70%), gross margins could approach 80% -- a
probability our current model does not reflect. |
