10:46am EDT 17-Aug-99 CIBC World Markets Corp.
(Cannon Carr 212-667-****)
IDTC
IDTC: Partnership with Telefonica a Positive Move P1-3
Part 1 of 3
CIBC Oppenheimer
August 13,
1999
Telecom Services IDTCorp.
Cannon Carr (212) 667-**** Partnership with Telefonica
a Positive move.
Timothy Horan, CFA (212) 667-****
Investment Conclusion
We continue to believe the market is noT Rating: STRONG BUY
recognizing hidden value in IDTC. With its IDTC-OTC(8/12/99) $15 1/16 57% stake in Net2Phone yielding $14 per 52-week $40 1/4-9 1/2 share for IDT, the market is assigning Shares Out 35 Million virtually no value to IDT's core business, Float 18.3 Million
Shares
which we value at $15-$16 per share. With an Market Cap $527
Million
implied price target of $29-$30, we Div/Yield
Nil/Nil
reiterate our Strong Buy rating. Fiscal Year
July
Book Value $6.81 per
Share
On August 12, IDT and Telefonica de Espana FY 1999E ROE
NM
entered into two broad strategic LT Debt $271
Million
initiatives: 1) a joint venture to provide Preferred
Nil
phone card and Internet services to Hispanic Com Equity $245
Million
customers in the US and Latin America and 2)
a 10% equity stake by IDT in Telefonica's
announced South American undersea fiber
optic cable, with agreement to buy $100 Earnings per Share
million in capacity ownership over five FY 1998 $0.54
years. FY 1999E $0.33
FY 2000E $0.57
Although financials are limited (we expect a
conference call by IDT early this week), we P/E Ratio
offer our initial insights. FY 1998 27.9X
FY 1999E 45.6X
The announcement is positive for IDT, in our FY 2000E 26.4X
view. If the partnership executes
effectively, it should enable IDT to expand
its existing Hispanic customer base, create
a lower cost basis for its traffic into
Latin America, and increase strategic Company Description:
flexibility to enter new routes (i.e. into IDT offers international long
Asia-Pacific) on favorable terms through distance services, including
fiber swaps. wholesale and prepaid calling
cards. It also provides
Internet
Importantly, the partnership can leverage access services and Internet
each party's strengths: IDT's existing telephony (the Net2Phone
brand).
calling card distribution channels, billing
platforms, and prepaid expertise and
Telefonica's extensive investments and
customer base throughout Latin America. The
traffic patterns between the two regions
present very favorable cross-marketing
opportunities.
Revenue potential is difficult to estimate.
We guesstimate the additional US Hispanic
revenue opportunity could be a conservative
$400 million (with the JV taking some
portion of that). Cash sales for undersea
STM-1s, independent of timing, could be $200
million for IDT, assuming 80 Gbps.
The JV does face significant start-up challenges, not the least of which are
translating the Telefonica brand into the US and ensuring that the undersea
cable is finished on time. We estimate three cables are currently underway,
with several more in the works, which means over-capacity is a risk. With
Tyco's equity participation, we believe Telefonica is first or second to
market, with full completion scheduled for first half 2001.
Our thesis is that IDT has a proven ability to develop high- growth niche
opportunities early while maintaining a conservative balance sheet.
Net2Phone
is a recent example. If it executes effectively, we believe IDT has the
potential to leverage this partnership into a unique position in the
Hispanic
market over the next 18-24 months.
ADDITIONAL COMMENTS AND ANALYSIS
Overview
IDT Corp. and Telefonica de Espana have agreed to form a joint venture to
market prepaid calling cards, Internet access, and other services to the
Hispanic market in the US and related markets in Latin America. Telefonica
is
to own a majority stake in the venture (probably 51%-55%), and IDT will
invest
$10 million initially. In addition, IDT intends to acquire 10% of
Telefonica's
undersea fiber cable around Latin America and will buy at least $100 million
for the cable venture over the next five years. The cable is a self-healing
ring with connections expected in Brazil, Argentina, Chile, Peru, Colombia,
Central America, the Carribbean, and the US. It is scheduled to be
operational
in various phases during 2000 and 2001. While initial capacity is probably
in
the 40-80 Gbps range, the maximum capacity is 1.28 terabits per second and
is
expected to cost $1.5 billion.
Revenue Potential
Sizing the market opportunity for the partnership is admittedly very
difficult. To get a rough idea of revenue potential, we use the following
scenarios:
Possible Incremental International Calling Card Opportunity of US Hispanic
Market: Assuming 11 million Spanish-speaking households in the US, if an
additional 10% take telecom calling cards for $20 per month, this would
yield
Part 2 of 3
an incremental $270 million in revenues. We note that it is not clear how
many
households currently take these calling cards.
Possible Opportunity for US Hispanic Internet Access: An estimated 27% of
Hispanic households in the US own a PC. Assuming 30% of those households
take
online service (up from 11% currently) at $15 per month, this would yield
$160
million in revenue opportunity for the Telefonica/IDT partnership. (This
obviously would include revenues with existing online providers.)
Potential Cash Sales from STM-1s: Assuming 80 Gbps of capacity, this would
represent 512 STM-1s available for sale. At $4 million per STM-1 in 2003,
this
would imply $2 billion in total cash sales, independent of timing (i.e., the
annual recognition would be some portion of that). IDT's 10% equity
ownership
would mean $200 million in total cash sales. Revenues could be $50 million
annually, by our guesstimates.
Why the Partnership Is Positive for IDT
We consider the partnership to be positive for several reasons:
It validates IDT's Hispanic marketing strategy. IDT currently derives about
40% of prepaid card revenues (or 22% of total revenues) from selling calling
cards to the Hispanic community in the US and Dominican Republic. It also
recently announced its Internet access service targeting this group, which
is
being jointly marketed with Telemundo. Telefonica has been investing in
Latin
American telecom properties for the past several years and is strategically
targeting Spanish-speaking customers. It seeks to leverage IDT's
distribution
channels, platforms, and expertise to become a significant player in the
Hispanic market in the US (a 30 million target market).
It introduces unique cross-marketing opportunities and potentially
accelerates
IDT's penetration of the Hispanic market. Telefonica has extensive an
customer
base throughout Latin America. Many of its customers make expensive collect
calls to the US, or vice-versa. The JV intends to make use of Telefonica's
customer databases to create targeted offers, such as prepaid calling cards,
prepaid mobile phone cards, 1+ dialing, Internet access, etc.
Cable ownership should bring IDT cost advantages, starting in about 12
months.
IDT currently sends about 45% of its traffic to Latin America. Migrating an
increasing share of it onto owned facilities should lower unit costs and at
least sustain gross margins once the cable is operational. This is important
as over 90% of IDT's core business (wholesale and prepaid calling cards) is
experiencing pricing pressures and margin erosion. Quantifying this effect
is
admittedly difficult.
IDT can use its equity ownership for fiber swaps to access new routes (i.e.,
into Asia-Pacific) on favorable terms. Without phased capx, it is difficult
to
determine the initial cost per STM-1. Assuming 80 Gbps (which would imply
512
STM-1s) would imply around $2.9 million per STM-1. We estimate current
STM-1s
cost between $3-$5 million. IDT's share would be 10% of that, which would be
a
very favorable rate for swapping along certain routes.
Expected Challenges for the Venture
The JV does face significant start-up challenges:
Telefonica has yet to translate its brand into the US market. We believe
that
Telefonica has been trying to penetrate the US Hispanic market for two or
three years, with limited success. We expect that its brand is
well-recognized
in Latin America, where Telefonica has investments in many of the incumbents
or local operators, but that US consumers have little connection to it yet.
Early roll-out is key, since competition in the US Hispanic telecom market
is
intensifying. AT&T, MCI Worldcom and Sprint are beginning to pursue this
market. Moreover, new companies like Starmedia Network and Quepasa.com are
developing Web services for the Hispanic community.
Telefonica must be early to market with its undersea cable, and it is not
clear how far along it is in securing the multiple landing rights needed to
access the continent. Global Crossing was the first to announce its cable,
which is to be completed by 2Q 2001. Telefonica followed with its own
similar
announcement shortly thereafter the two cable are very similar in capacity,
design, and location. With Tyco's equity participation (a first for them),
Telefonica may have caught up at this point. Tyco's future is also not
certain
across these two ventures, since it is also laying Global Crossing's cable
(without an equity position).
Our quarterly EPS estimates are shown below.
1 Qtr. 2 Qtr. 3 Qtr. 4 Qtr. Year
FY 1998 Actual $0.08 $0.13 $0.16 $0.20 $0.54
FY 1999E Current $0.14A $0.06A $0.06A $0.07E $0.33E
FY 2000E Current --- --- --- --- $0.57E
Our quarterly cash flow per share estimates are shown below.
1 Qtr. 2 Qtr. 3 Qtr. 4 Qtr. Year
FY 1998 Actual $0.15 $0.22 $0.23 $0.33 $0.93
FY 1999E Current $0.42A $0.29A $0.32A $0.42E $1.46E
FY 2000E Current --- --- --- --- $2.18E
Stocks mentioned in this report as of 8/12/99:
AT&T (T-NYSE $48 7/16, Hold)
Global Crossing (GBLX-OTC $31 7/16, Not Rated)
MCI WorldCom (WCOM-OTC $76 1/8, Strong Buy)
Sprint (FON-NYSE, $49 7/8, Strong Buy)
Telefonica de Espana (TEF-NYSE, $45 , Not Rated)
CIBC Oppenheimer Corp., or one of its affiliated companies, owns
approximately
25% of the common stock of Global Crossing. Several employees of CIBC
Oppenheimer Corp., or one of its affiliated companies, are directors of
Global
Crossing.
CIBC Oppenheimer Corp., or one of its affiliated companies, makes a market
in
the securities of GTS, IDT Corp., Primus, and MCI WorldCom. CIBC
Oppenheimer
Corp., or one of its affiliated companies, has performed investment banking
services, and managed or co-managed a public offering of securities within
the
last three years for GTS. |
