04
Digital Island: Enabling Global, Mission Critical E-Commerce, Pt 1/3
Ticker : ISLD Rank(Old): 9-Not Rated Rank(New): 1-Buy
Price : $24 7/16 52wk Range: $40-8.66 Price Target (Old): $ N/A
Today's Date : 07/28/99 Price Target (New): $40
Fiscal Year : SEP
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EPS 1998 1999 2000 2001
QTR. Actual Old New Old New Old New
1st: - - -0.21A - -0.70E - -
2nd: - - -0.32A - -0.69E - -
3rd: - - -0.52E - -0.75E - -
4th: - - -0.66E - -0.75E - -
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Year:$ -1.39A $ - $-1.71E $ - $-2.89E $ - $ -
Street Est.: $ - - $ - - $ - - $ - - $ - - $ - -
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Price (As of 7/28): $24 7/16 Revenue (1999): 11.7 Mil.
Return On Equity (99): N/A Proj. 5yr EPS Grth: N/A
Shares Outstanding: 35.5 Mil. Dividend Yield: N/A
Mkt Capitalization: 867.5 Mil. P/E 1999; 2000: N/A; N/A
Current Book Value: $1.39 /sh Convertible: None
Debt-to-Capital: 4.3 % Disclosure(s): A,C
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* We are launching coverage on Digital Island with a 1-Buy rating and a YE'00
price target of $40. Digital Island is a high-end colo/hosting provider
focused on enabling global e-commerce by distributing mission critical
content worldwide.
* ISLD offers customers a high quality, global Internet platform to
distribute mission critical content including software, time sensitive
financial data, large graphic and text files, and streaming media using
advanced Internet capabilities (caching & mirroring).
* ISLD has sold its global services to an impressive list of customers,
including E*Trade (owns 6%), Cisco, Novell, Autodesk, and National Semi.
* We're forecasting Rev to grow from $3.4M est. this quarter to $17M in CY99
and $60M in CY00. Customer backlog is 30% of billing customers providing
good visibility into expected 35%-40% growth over next several quarters.
* ISLD trades at 15X '00 Rev, 7X '01 Rev and 0.16X to growth (15x/96%
growth), vs. Exodus (EXDS, 128, 1) at 15X, 10x, and 0.28X respectively.
Given its earlier stage and faster expected growth, we believe the stock
could trade up to $40 or 11.7X '01 Rev, and 0.26X to growth.
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The Federal Express Of the Internet
Digital Island is a high-end Internet provider focusing on high quality, cost
efficient, global distribution of mission critical e-commerce applications
and content for large multinational business customers. Digital Island is to
the regular internet what Federal Express is to the post office. Digital
Island has a global private internet network, with 4 major hubs, and
distributes content from 7 points worldwide (Honolulu, London, New York,
Santa Clara, Munich, Sydney, and Tokyo) and is capable of distributing
content to 20 countries worldwide. The network provides customers with the
global reach of the public Internet, coupled with the high quality and
performance of private networks, at significant discounts vs. companies
deploying their own servers and network.
Investment positives for Digital Island include 1) Large market opportunity -
Colo/Hosting market expected to grow from $1Bil. to $11Bil.by 2002 with
global e-commerce applications fueling among the fastest growing segments 2)
Attractive financials - Annuity revenue streams, high gross margins (50%+),
term contracts, low churn and long term EBITDA margins in mid 20% range. 3)
High profile customer base including Cisco, National Semi, Novell, Autodesk,
E*Trade, Mastercard International, Stanford University High Wire Press, and
Ebsco Publishing. 4) Experienced management - Ruann Ernst, Pres. & CEO has
30 years exp. most recently at HP as Gen. Mgr of the Fin. Svcs Unit where she
developed Internet applications for clients. Tom Thompson, CFO, has 30 years
exp. working at Ziff Davis, and most recently was CFO of Narrowline. Allan
Leinwand, CTO, has 11 years exp. working at Cisco and HP. 5) Consolidation -
Digital Island is developing value-added products, and a strong customer
base, assets which are likely to be coveted by larger players. We believe
consolidation of Internet providers will continue.
Digital Island Value Proposition
Digital Island offers customers a highly reliable, better quality Internet
network to distribute mission critical e-commerce content & applications to
20 countries worldwide and saves them from having to deploy servers and
network infrastructure globally. IDC estimates customers could save approx.
50%/yr by outsourcing their global networking requirements rather than having
to invest in deploying servers and network worldwide.
We believe Digital Island's Internet network platform is well-suited for the
high growth high bandwidth e-commerce applications including software
downloads, streaming media applications, large text/graphic files, and other
applications that are acutely time sensitive and prone to packet loss.
How Differ From Other Colo/Hosting Companies
We believe Digital Island is differentiated from other colo/hosting companies
in 3 key ways: 1) Worldwide reach - ISLD reaches 20 countries today (with
plans to reach add'l countries over time), better than anybody else, 2) More
focused on using tools like caching and mirroring, which reduce transport
costs that are much higher for int'l network than for domestic and provides a
higher quality of service and faster content delivery, and more focused on
building proprietary software enablers like Traceware that help customers
tailor global content (in local language and pricing), and 3) More focused on
multinational corporations who use the Internet for mission critical
applications and global e-commerce vs. "dot.com" companies that are more
domestic, page view focused where quality of service is relatively less
important.
Customer Validation
Cisco - Digital Island hosts Cisco's worldwide (outside US) customer support
site for 1st level client support. Cisco customers who access the site can
download software patches, router configurations, and Frequently Asked
Questions, thereby obtaining timely, automated solutions.
Numega -(Compuware) - Digital Island provides the platform for the global
distribution of Compuware's Numega product line - software that helps
software developers test/debug programs. Pre Digital Island, Compuware
experienced complaints from international customers trying to download the
software; after outsourcing to Digital Island, complaints plummeted.
E*Trade - Digital Island is the international network provider for E*Trade,
providing customers trading and research requests worldwide.
Growth Drivers & Catalysts
Digital Island's growth will be driven by 1) Ramping of the sales force from
45 current (vs. 29 in March) to mid 50s by the end of '99, 2) Value-added
product rollouts, 3) Development of worldwide agent channel, and 4) Growth in
current revenue/customer - The company has seen average monthly billing per
customer rise 40% during the past 18 months from $12K/mth to $17K/mth.
We believe catalysts for the stock will be news flow around customer wins,
new product deployment, market and network expansion, deployment of a 5th
data center in Hong Kong by year-end, sales force ramp, and quarterly results
with 30%-40% sequential growth.
----- Lehman Est. -----
2Q 3Q 4Q
Total Customers 62 75 98
Billing Customers 48
Sales Reps 29 45 55
Countries 20 will add a few over time
Local Hosting Ctrs 7 will increase to 20+ over time
We believe the company will dramatically increase the deployment of its Local
Content Managers (LCMs) from 7 today to 1 in every country (20 countries)
over the next several quarters. We also believe the company will continue to
expand its market/network reach beyond its base of 20 countries, albeit at a
slower pace than LCM deployment.
Continued in Part 2
BUSINESS DESCRIPTION: Digital Island is a high-end, value-added Internet
colo/hosting provider focusing on high quality, cost efficient, global
distribution of content for multinational businesses.04:44am EDT 28-Jul-99 Lehman Brothers (Bill Garrahan (202)452-4727, Geoff) ISLD
Digital Island: Enabling Global, Mission Critical E-Commerce, Pt 2/3
Ticker : ISLD Rank(Old): 9-Not Rated Rank(New): 1-Buy
Price : $24 7/16 52wk Range: $40-8.66 Price Target (Old): $ N/A
Today's Date : 07/28/99 Price Target (New): $40
Fiscal Year : SEP
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EPS 1998 1999 2000 2001
QTR. Actual Old New Old New Old New
1st: - - -0.21A - -0.70E - -
2nd: - - -0.32A - -0.69E - -
3rd: - - -0.52E - -0.75E - -
4th: - - -0.66E - -0.75E - -
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Year:$ -1.39A $ - $-1.71E $ - $-2.89E $ - $ -
Street Est.: $ - - $ - - $ - - $ - - $ - - $ - -
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Price (As of 7/28): $24 7/16 Revenue (1999): 11.7 Mil.
Return On Equity (99): N/A Proj. 5yr EPS Grth: N/A
Shares Outstanding: 35.5 Mil. Dividend Yield: N/A
Mkt Capitalization: 867.5 Mil. P/E 1999; 2000: N/A; N/A
Current Book Value: $1.39 /sh Convertible: None
Debt-to-Capital: 4.3 % Disclosure(s): A,C
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Continued From Part 1:
Valuation
Our DCF results in a price target of $40 based on a 5 year model with 24%
EBITDA margins, 16% discount rate, 20X terminal EBITDA multiple, and a 20%
public market discount. Comps (Exodus, AboveNet, Globix) trade at 9.5X-15X
'00 Revenue and 5X-10X '01 revenue, and 0.1X-0.3X FV/'00 Revenue to growth
vs. Digital Island trading at 15X '00 Rev, 7X '01 rev and 0.16X FV/'00
Revenue to growth. At $40, Digital Island trades at 0.25X to 3 year growth.
Net Firm FV/'00 FV/'01 '00-'03 FV/'00 Rev
Price Shares Debt Value Rev Rev CAGR To Growth
ISLD 24 7/16 39M (22M) $ 928M 15.4X 7.4X 96%* 0.16X
ABOV 37 7/16 35M (121M) $1186M 12.1X 5.9X 92%* 0.13X
EXDS 128 56M 134M $7258M 14.9X 9.9X 52% 0.28X
GBIX 40 5/8 10M 25M $426M 9.5X 5.1X 84%* 0.11X
* Calendarized
Financial Forecast
We expect sequential revenue growth to accelerate from approx. $1M in the
March '99 quarter to $3M/quarter in March '00 and $5M in March '01. We
estimate that Digital Island will turn gross margin positive by Dec. '00 as
network economies of scale drive margin improvement. We believe that Digital
Island has the opportunity to capitalize its network lease expenses to reduce
overall costs and improve gross margin and EBITDA as many peers have done.
We believe that Digital Island will reach its peak EBITDA loss in the middle
of '00 and will reach EBITDA breakeven in late 2002.
We also believe the company has very good visibility into the next several
quarters of revenue. At the end of 2Q (March '99), Digital Island reported
62 total customers and 48 billing customers. With a 30-60 day install cycle,
and a 30% backlog (14/48), we think 3Q & 4Q estimates of 35%-40% sequential
revenue growth is easily achievable.
Dec-98 Mar-99 Jun-99 Sep-99 Dec-99 Mar-00 Jun-00
1Q99a 2Q99a 3Q99e 4Q99e 1Q00e 2Q00e 3Q00e
Rev 1.4 2.4 3.4 4.5 7.0 9.9 13.0
Q/Q Growth 49% 74% 40% 35% 55% 40% 31%
Grs Mgn (111%) (100%) (171%) (205%) (117%) (69%) (37%)
EBITDA (5.6) (8.6) (14.8) (22.2) (23.1) (23.4) (22.8)
EBITDA Mgn (405%) (356%) (439%) (491%) (328%) (237%) (176%)
We have also compared our projections over the next four quarters (and
previous 2 quarters) for Digital Island with historical results from Exodus,
the market leader in the colocation space. Adjusting for stage of
development, our Digital Island numbers track fairly close to historical
Exodus results over the next 4 quarters and then are more conservative at
10%-20% below Exodus's reported results.
Exodus 1.7 2.4 3.4 4.9 7.1 10.1 14.5 21.1
Dig. Isle 1.4 2.4 3.4 4.5 7.0 9.9 13.0 16.5
We expect 3 year revenue growth (fiscal '00-'03) of 106%, gross margin
expansion from (163%) in 1999 to 53% in 2003, and EBITDA margins of 16% in
2003 (from (438%) in '99). Digital Island will spend approximately $40M in
capital in fiscal 2000 (Sept. year-end) and $50M in fiscal '01. We believe
that proceeds from the recent offering coupled with bank lines of credit,
cover the company's funding requirements for the next 12 - 15 months.
Fiscal Year End September, 30
1998A 1999e 2000e 2001e 2002e 2003e
(Sep-98) (Sep-99) (Sep-00) (Sep-01) (Sep-02) (Sep-03)
Revenue 2.3 11.7 46.4 117.9 236.7 404.4
Grs Mgn (286%) (163%) (47%) 14% 40% 53%
EBITDA (16.3) (51.2) (90.9) (78.7) (18.8) 64.4
EBITDA Mgn (696%) (438%) (196%) (67%) (8%) 16%
Calendar Year Estimates (12/31)
1998 1999 2000
Revenue 3.4 17.3 60.4
Gross Profit (6.6) (25.7) (13.0)
Gross Margin (190%) (148%) (22%)
EBITDA (18.8) (68.7) (88.8)
Global Network & Data Centers
Digital Island has deployed a global, IP network that reaches 20 countries
worldwide including all of North America, Germany, France, England, Japan,
Australia, China, and Hong Kong. The network has an ATM backbone which gives
Digital Island the capability to provide quality of service and bandwidth
guarantees to its customers. The company has 4 data centers today in NY, CA,
Hawaii, and London, and will deploy a 5th data center in Hong Kong by year-
end. The company is also deploying Local Content Managers (or LCMs) (in
Munich, Sydney, and Tokyo today) to bring content closer to end users. An LCM
could be viewed as a mini data center that stores one or more of Digital
Island's customers content in-country (for example Munich, Germany) which
reduces transport costs and provides a higher quality of service and faster
content delivery. Digital Island utilizes mirroring (replicating) and
caching (storing) products in its LCMs. These products can update/refresh
content as often as every 15 minutes or once a week/month.
Continued in Part 3
BUSINESS DESCRIPTION: Digital Island is a high-end, value-added Internet
colo/hosting provider focusing on high quality, cost efficient, global
distribution of content for multinational businesses.Products & Distribution
Digital Island offers its customers a high quality, and scalable line of
network/bandwidth services, hosting/co-location and access (to the Dig. Isle
Network), and value-added services to its customers depending on customer
needs. The company recently announced a Service Level Agreement (SLA) that
guarantees network availability and minimal packet loss levels to 19
countries and across its peering partner networks (many companies only
provided guarantees for the traffic on their own network).
Network/Bandwidth - Digital Island provides customers with global
connectivity to 19 countries. The company charges customers based on usage
and distance. On average, we estimate a gigabyte of content delivered costs
around $100. The price could vary materially dependent on distance and
bandwidth service chosen. The company can provide customers with guaranteed,
always on connectivity, or bandwidth as required.
Hosting/Co-Location - Digital Island houses its customers content or
applications in 1 of its 4 global data centers (NY, London, CA, and Hawaii).
Customers pay approximately $2k-$3k/month to house their content on servers
in Digital Island data centers. Data centers serve as the launching point
for the global distribution of customers (which drive network/bandwidth
revenue).
Globeport - Is a high speed access product for customers that choose to keep
its content in-house (rather than in a Digital Island data center) but want
to utilize the Digital Island global network. Globeport customers pay
approximately $4000/month to access the Digital Island network, and then pay
for bandwidth usage.
Value-Added Products/Services - The company provides customers with
monitoring, and technical services including design and operation, and a
suite of high end products called "Application Service Enablers" or ASEs.
The company's flagship ASE product is called Traceware a tool that provides
customers with the geographic location of end users (maps IP addresses to
countries with 95%+ accuracy). Traceware allows Digital Island's customers
to tailor the content deployed to a particular country to include, for
example, local language and local pricing.
Distribution
The company has both a direct sales force in the US, and is in the process of
developing an indirect reseller/partner channel worldwide. The direct sales
force has 45 quota carrying reps today, up from 29 at the end of March. The
company plans to ramp its sales force to the mid 50s by the end of September
(fiscal year end) and plans to significantly grow the sales force in fiscal
'00. Fully productive sales reps generate approx. $10K-$15K/month in new
business. Given the complexity of the sales, the sales cycle runs 4-6
months, with installation another 1-2 months.
Digital Island's indirect channel has been the primary driver of sales
outside the US, but the company is developing a US indirect channel as well.
Overseas, the company uses local ISPs including Telefonica in Spain, and
system integrators as channel partners to drive sales. In the US, the
company recently signed a co-marketing agreement with Compaq to jointly
market Compaq equipment and Digital Island's hosting/network distribution
capabilities. We believe the company will look to expand its indirect
channel over the next 12-24 months via joint ventures and strategic
partnerships.
Management
Digital Island has a strong management team with significant experience in
data applications, data networking, and solutions. Ron Higgins is Chairman
of the Board and founder of Digital Island. Mr. Higgins has 18 years
experience developing high tech companies in the networking, communications,
and multimedia fields. Ruann Ernst, President and CEO since June '98,
previously worked at Hewlett-Packard, most recently as general manager of the
Financial Services Business Unit. Tom Thompson, CFO since Jan. '99, worked
previously as CFO of Narrowline, an Internet marketing firm and at Ziff
Davis. Allan Leinwand, VP Engineering and CTO since Jan. '97, previously
worked at Cisco, and HP. Rick Schultz, VP of North American Sales, has
worked in the telecom industry for 20 years at AT&T and Pacific Bell. |
