Here is Morgan Stanleys report on IDTC from today,
-- MS: IDT CORP.: GOOD OPPORTUNITY, BUT RISKY P1 --
Morgan Stanley\DW (Davis, Myles C. 212-761-6916) IDTC
IDT Corp. (IDTC): Good Opportunity, But Risky
Myles C. Davis (212) 761-davismy@ms.com Date: August 10, 1999
Richard Lee (212) 761- rlee@ms.com
Industry: Telecommunications Services Type: Company Update
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Rating: Outperform Price: $16.38
52-wk Range: $32.00-$9.91 Price Target: $28.00
FY Ends ---- EPS ---- ---- CEPS ---- Rel. P/E
July Curr Prior P/E Curr Prior P/CE (SP 500) Pr/Bk
1998A $0.56 - 29.3x $0.92 - 17.8x - -
1999E $0.37 - 44.3x $1.09 - 15.0x - -
2000E $0.57 - 28.7x $1.41 - 11.6x - -
___________________________________________________________________________
Qtrly --- 1Q --- --- 2Q --- --- 3Q --- --- 4Q ---
EPS Curr Prior Curr Prior Curr Prior Curr Prior
1998A $0.08 - $0.12 - $0.15 - $0.20 -
1999E $0.14A - $0.06A - $0.06A - $0.07 -
2000E - - - - - - - -
___________________________________________________________________________
5 Yr. EPS Growth: 30% Net Debt to Cap.: -
Dividend:-- Yield:-- Mkt Cap./Rev: -
Shares Outst.: 35.9 MM Mkt Cap.: $588 MM
5 Yr Hist Rel P/E Rng: --- 5 Yr Est. ROE: 0%
___________________________________________________________________________
KEY POINTS:
IDT priced its partial spin-off of Net2Phone, its Internet telephony subsidiary, on July 29. The stock priced at $15, and closed on August 9 at $20.38.
In our note of June 16, we described the implications we saw for IDT stock valuation of the offering of part of the company's stake in Net2Phone. Following the pricing of the offering, we now have a public market value to use for Net2Phone.
From our analysis, we believe that investors are either misunderstanding the financial implications of the value of IDT's stake in Net2Phone, or ascribing a low value to IDT's core businesses. We note that we expect these core operations to generate over $700 million in revenue in calendar 1999, with positive net income.
We would attribute this discontinuity to a combination of misunderstanding of the ownership structure of Net2Phone, negative sentiment toward the sectors of IDT's core operations -- in international long distance wholesale and prepaid cards -- and enthusiasm for Internet stories.
We note that this analysis relies upon the valuation the market is giving to Net2Phone, which trades as an Internet stock and should be extremely volatile. We believe, though, that our twelve month price target of $27 captures a risk-adjusted portion of the upside to current IDTC levels, and that our Outperform rating reflects the upside and the risk as well.
DETAILS:
In our note of June 16, we ran through some of the implications of the
indicated valuations for IDT stock of the spin-off of the company's Internet telephony subsidiary, Net2Phone (NTOP, Not Covered). Following the Net2Phone pricing on July 29, we believe the conclusion we reached in June -- that the market is ignoring the value of IDT's post-offering stake in Net2Phone -- is confirmed by the post-offering price of IDT stock.
Our methodology is similar to the one we used in June, albeit simpler due to the public market valuation of Net2Phone. The deal priced 5.4 million shares at $15.00, out of a total of 47.5 million shares outstanding, according to Dow Jones, and is trading today This results in a market cap for
Net2Phone of $1.38 billion.
Prior to the offering, IDT owned about 66% of Net2Phone, following equity investments by SoftBank, AOL, GE Capital and others. Given the offering parameters, IDT sold about 11% of Net2Phone, as proceeds were about $81 million (we are not including the green shoe in any of our calculations) out of a market cap at offering price of $712.5 million. This reduces IDT's stake in Net2Phone to about 55%, which works out to be worth approximately $528.7 million at the July 29 closing price. (We're using market cap rather than enterprise value for the discussion, given both IDT's and Net2 net-debt-
neutral position).
Valuation of IDT Stake in Net2Phone
If we remove the value of this stake from IDT's current market cap of $599.1 million (using fully diluted shares of 36.6 million), we're left with $70.3 million as the implied value of IDT's remaining operations, which we expect to produce about $765 million in revenue in calendar 1999. This negative value clearly defines the extent of the valuation discontinuity we see between these two stocks.
To quantify the upside potential from the August 9 IDTC close of $16.38, we can take a range of valuations of companies with similar revenue streams. Given IDT's primary combination of wholesale and prepaid card revenues, the two closest comparables are Star Telecom and Pacific Gateway. Star stock took a hit recently when it preannounced an earnings shortfall, so we would take its valuation as shifted toward the downside from where we would value
IDT. Pacific Gateway has far less card revenue than IDT, and has announced a strategic redirection aimed at entering the large-scale Internet services market, so we would take its valuation as shifted above where IDT's valuation would probably play out. Using these comps, we arrive at a range of enterprise value to 1999 calendar revenues of .28x to .61x, which results in a valuation range for IDT of $203.5 million to $491.6 million.
Valuation of IDT Core Business
This translates into per-share valuation of $5.56 to $13.44 which, added to the current IDT share price, gives a price range of about $22 to $30. In our view, this range gives us comfort with our twelve-month target price of $27.
Per Share Valuation of IDTC
Risks
We note several risk factors to this analysis. First, the international
wholesale market has been in the grip of severe pricing pressure over the
past year, which, after moderating earlier in 1999, apparently reaccelerated
late in calendar 2Q1999. Two wholesale focused carriers in the group have
preannounced earnings shortfalls, and other retail-focused names have
announced that they are aggressively cutting back on their revenue
expectations for U.S. originated international wholesale. IDT actually
accelerated their wholesale minutes in their reported fiscal 3Q1999 (ended
April 30) while maintaining their gross margins, and is the lone operator
describing international wholesale as a viable business. As we pointed out
in our note of June 16, the company's ability to expand these revenues and
maintain margins as prices are contracting is a positive, but it does create
further dependence on a revenue channel that has historically been extremely
volatile.
The second risk factor concerns the prepaid card business. Although the
target market for prepaid cards tends to make calls to high revenue per
minute routes, price is the main differentiating factor between cards,
although there is some evidence that branding is having some impact in major metropolitan markets. We have stated in the past that we believe IDT is one of the best-positioned prepaid card providers, as the company owns one of the dominant debit card processing platforms. In addition, IDT owns its prepaid card distributor, which has a meaningful impact on margins, as commissions to distributors can be as high as 20%. We believe these are competitive
advantages that position IDT well in the prepaid card business, but we must note that the market has taken an increasingly dim view of the business and valuations have fallen. In short, we believe that IDT is one of the best providers in two sectors of the business that are under a great deal of pressure.
The third risk factor to our analysis is that Net2Phone is an Internet stock, and as such, should exhibit a high degree of volatility going forward. Fluctuations in the value of Net2Phone have a direct effect on both the
calculated valuation of IDT and the perception of the company, as we have
tried to lay out.
In summary, we believe our analysis shows clearly the discrepancy in the valuations of these two stocks. Net2Phone has been seen in the investor community as the prime driver of upside potential for IDT going forward, but we believe that the market is currently overreacting to this belief. We would recommend purchasing IDT stock only for investors with a high tolerance for risk to try to capture what is, in essence, an arbitrage opportunity.
The inherent riskiness of the trade leads us to retain our Outperform rating
and our twelve month price target of $27..
IDT Corp. Projected Statement of Operations
The information and opinions in this report were prepared by Morgan Stanley &
Co. Incorporated ("Morgan Stanley Dean Witter"). Morgan Stanley Dean Witter
does not undertake to advise you of changes in its opinion or information.
Morgan Stanley Dean Witter and others associated with it may make markets or
specialize in, have positions in and effect transactions in securities of
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Morgan Stanley & Co. Incorporated, Dean Witter Reynolds Inc. and/or their
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