ML Research:Big Buying Opportunity
Drop in Price Unwarranted ? 8/17/99
Big Buying Opportunity
Investment Highlights:
ú After beginning a long-overdue recovery in
the beginning of July, RSL shares have been
beaten down by over 40%. We know of
nothing fundamental to justify this kind of
valuation correction.
ú We attribute the decline to 3 factors: (1) the
general market decline that has hit most
telecom start-ups over the last 3 weeks, (2) the
negative sentiment following two recent
announcements, including the restructuring of
operations and the termination of a European
wholesale contract, and (3) investor concerns
regarding continued price declines in the
international wholesale sector that has
recently hurt stocks like Star (STRX, $6 13/16,
D-4-3-9) and Pacific Gateway.
ú We believe the 40%+ decline in RSL is an
overreaction to all of these issues ?
compounded by its inefficient float -- and has
created a substantial buying opportunity.
ú We think our last published price objective of
$45 remains supportable based on a sum of
parts and DCF valuation.
Over the past 3 weeks, RSL shares have been under
extreme pressure, which we feel is unwarranted, and at
current levels would be aggressive buyers of the stock.
Recent Announcements: In the last week, RSL has made
two announcements which we feel are positive, or at worst
neutral, although sentiment was clearly negative: (1) On
August 10, RSL updated the investment community on its
plans to centralize management functions, improve
operating efficiency and shift its business away from lower
margin pre-paid calling card and wholesale services
(currently about 23% of total revenues) to selling higher
margin packages of data, internet and international
services on RSL?s existing network facilities; and (2) On
August 13, RSL announced the termination of a its
network contract with Debitel, which will result in a
DM24 million ($13M) payment to RSL from both Debitel
and Metro as well as the return to RSL from Debitel both
the 70,000 customers currently signed up for service and
the prefix used to gain those customers.
2. Expanded services to include data and other high
growth services, de-emphasizing the commodity
businesses: Under this more efficient management
structure, RSL plans to continue to de-emphasize the low
margin, highly volatile US-outbound international
wholesale and pre-paid card business and focus on its
much high margin small-to-medium sized business
segment. RSL plans to more aggressively expand
Westinghouse and European operations to provide ATM,
Frame Relay, internet and web hosting services to
small/mid sized businesses. Because RSL already has its
own network assets in place, it can make this product shift
with relatively low incremental cost, and without
additional CAPX. By the end of the year, RSL plans to be
offering a full bundle of services in 7 countries (U.S.,
Finland, U.K., Canada, Germany, Italy and Australia) and
within 12-18 months in RSL?s remaining 14 markets.
3. Debitel Contract Overhang is Gone: For the
past 2 quarters, RSL has cautioned investors that its
wholesale contract with Debitel, a German wireless
reseller, was not living up to expectations and that it was
exploring ways to fix the situation. The termination of the
contract eliminates this overhang and benefits RSL in 3
additional ways: (1) Through negotiations, RSL was able
to secure a DM24 million ($13M) termination fee, (2) RSL
keeps the 70,000 customers Debitel was able to sign up,
and (3) RSL can now more freely negotiate a more
economical resale agreement with Swisscom, Debitel?s
new majority owner. While there will be a modest loss of
revenues and EBITDA over the next few quarters, we feel
that RSL will benefit from the retention of the 70,000
customers signed up by Debitel as well as the ability to
market its own services directly into the retail market,
using the dialing prefix that Debitel had exclusive rights
to use.
Despite Reduction in Forecast, Valuation is Extremely
Attractive, Particularly as a Consolidation Target:
RSL is currently trading at 0.9x 1999 revenues and at 0.7x
2000 revenues. These are significantly below the
estimated 3.0x 1999E revenues paid by GTS for Esprit
(European retail), 4.3x 1999E GTS agreed to pay for
Omnicom (European retail), 1.5x 1999E revenues paid by
Swisscom for Debitel, and 1.9x 1999E paid by Qwest for
LCI (US retail). Based on our sum-of-the-parts analysis,
in our view, RSL could easily justify a weighted average
revenue multiple of 1.7x or $50/share.
Table 1: Sum of the Parts Valuation
Revenue Target Implied
Region 2000E Mulitple Value
North America 724 0.8 580
Europe, Excl. Wireless 712 3.0 2,135
Europe Wireless 342 1.5 513
Asia/Pacific 249 1.0 249
weighted average 1.7
Total Enterprise Value 3,476
Less: Debt 787
Equity Value 2,689
Shares Outstanding 54
Value/Share $50
% upside 270%
Source: Merrill Lynch Estimates
$ Millions
Even at much more conservative multiples of only 2.0x
European wireline and 1.0x Europe wireless, RSL's
weighted multiple would be 1.3x or $34/share (149%
upside). To address the issue of pricing and sustainable
revenue growth, we took a 20% cut to our revenue target -
which yielded a $37 price objective (174% upside) based
on a 1.7x weighted multiple. Under our most conservative
assumptions (20% haircut to revenues, 1.3x weighted
multiple), we get $24/share or 77% upside--still justifying
a Buy rating on the stock.
Table 2: Conservative Sum of the Parts
Valuation (20% Revenue Cut, 1.3 Multiple)
Revenue Target Implied
Region 2000E Mulitple Value
North America 580 0.8 464
Europe, Excl. Wireless 569 2.0 1,139
Europe Wireless 274 1.0 274
Asia/Pacific 199 1.0 199
weighted average 1.3
Total Enterprise Value 2,075
Less: Debt 787
Equity Value 1,288
Shares Outstanding 54
Value/Share $24
% upside 77% |
