expected bullish comments/report from Jack last friday:
WCOM: New 30-Page Report Out: Reiterate Buy Rating
Jack Grubman
Salomon Smith Barney
Friday, August 27, 1999
--SUMMARY:--MCI WorldCom, Inc.--Telecommunications Services
*We have a new 30-page report on MCI WorldCom available today titled,
"Scale, Scope, and Ubiquity on a Global Basis, Plus Double-Digit Revenue
Growth -- Best Idea in Telecom". *WCOM has global scale, double-digit
top-line and bottom-line growth, and is trading at a market multiple on
2000 EPS. Load up the truck! *WCOM's second quarter results showed
continued mix shift toward data/IP/international, and we believe WCOM's
revenue growth will accelerate in the second half of 1999. *WCOM's EBITDA
margin was 32.3%, a 330-basis-point improvement over the first quarter,
driven by mix change and continued realization of synergies. *Included in
the new report are detailed earnings, revenue, margin, and DCF models.
*WCOM remains our favorite stock, and we would be aggressive buyers at
these prices.
--EARNINGS PER SHARE--------------------------------------------------------
FYE 1 Qtr 2 Qtr 3 Qtr 4 Qtr Year
Actual 12/98 EPS $0.18A $0.21A $0.21A $0.22A $0.82A
Previous 12/99 EPS $0.36A $0.45A $0.55E $0.65E $2.00E
Current 12/99 EPS $0.36A $0.45A $0.55E $0.65E $2.00E
Previous 12/00 EPS $N/A $N/A $N/A $N/A $2.90E
Current 12/00 EPS $N/A $N/A $N/A $N/A $2.90E
Previous 12/01 EPS $N/A $N/A $N/A $N/A $3.80E
Current 12/01 EPS $N/A $N/A $N/A $N/A $3.80E
Footnotes:
--FUNDAMENTALS--------------------------------------------------------------
Current Rank........:1M Prior:No Change Price (8/19/99).....:$75.75
P/E Ratio 12/99.....:37.9x Target Price..:$130.00 Prior:No Change
P/E Ratio 12/00.....:26.1x Proj.5yr EPS Grth...:28.0%
Return on Eqty 98...:N/A% Book Value/Shr(99)..:26.00
LT Debt-to-Capital(a)26.7% Dividend............:$N/A
Revenue (99)........:34933.00mil Yield...............:N/A%
Shares Outstanding..:1900.0mil Convertible.........:No
Mkt. Capitalization.:143925.0mil Hedge Clause(s).....:#
Comments............:(a) Data as of the most recently reported quarter.
Comments............:
--OPINION:------------------------------------------------------------------
We have a new 30-page report available today titled, "MCI WorldCom,
Scale, Scope, and Ubiquity on a Global Basis, Plus Double-Digit Revenue
Growth -- Best Idea in Telecom". We believe that WCOM is the single best
idea in telecom. The stock is, in our opinion, a must-own large-cap
growth stock, since there is no telecom company of any size anywhere in
the world that possesses a better combination of assets, strategy,
management, and valuation relative to growth within the entire global
telecom sector. In fact, WCOM is the benchmark against which every
telecom company in the world is measuring itself against.
The reason that WCOM is our favorite stock is very simple, the company
has deployed more of its own capital around the world, to build more
network around the world, to get to end-user business customers in more
places around the world, than all other telecom operators combined. On
top of that, WCOM has the largest IP backbone, by a factor of 3x or more,
on the planet, and those assets will drive incredible value creation as
WCOM combines its customer facing infrastructure, back-office systems,
sales, and marketing muscle to drive data and IP services over its own
network to the millions of customers it already has. WCOM is outgrowing
an industry which is outgrowing the overall economy yet WCOM sells at an
average multiple to the S&P as a whole. If investors choose to ignore
this absurdity--fine--just don't come crying when WCOM is 40 points
higher and one missed an historic opportunity to buy a mega-cap growth
company at a market multiple.
Within the report, we discuss an overview on why WCOM remains our
favorite stock, we address the current issues surrounding the stock, and
we detail the second quarter 1999 results. The following is a brief
summary of the report.
WCOM HAS THE BEST SET OF ASSETS
WCOM's array of global assets puts it in a position to be the only big
carrier to be able to generate high growth and high returns via new
applications, using owned facilities to existing and new customers,
building-to-building as well as desktop-to-desktop. WCOM's capital
deployment is skewed toward data/IP, which drives a favorable revenue
mix.
WCOM is clearly targeting capital to areas of greatest growth potential
and for services that are furthest up the value chain. This means that
WCOM's capital efficiency and hence ROI will steadily rise from what are
already industry-leading levels. In fact, we expect that WCOM will
generate $0.80 of revenue per dollar of new capital, up from $0.53
historically and below $0.35 for other large telecom players
CURRENT ISSUES DISCUSSED
New 5 Cent Plan is Positive to NPV.
WCOM's new 5 cent plan is actually a positive contributor to net present
value, since it puts traffic on idle off-peak network capacity and is an
offensive move against aggressive RBOC long distance entry. WCOM's 5
cent minute plan for off-peak calls during the week is only a slight
variation to WCOM's existing rate schedule which is 5 cents per minute on
Sundays but 10 cents per minute off-peak every other day. Both the new
plan and the old plan charged consumers 25 cents per minute during
daytime peak hours and both have monthly fees. In fact, most of the
current residential minutes on WCOM's network, already come from
discounted calling plans. Thus, the impact to overall revenue per minute
is modest especially when one factors in the monthly fees.
This type of discounting has been going on in the consumer long distance
business for a decade as long distance carriers attempt to stimulate
demand during off-peak hours while networks are idle and industry
revenues grew despite what on the surface was severe price cutting. As
access charges declined, pricing has followed.
Moreover, with churn in consumer long distance running 4% per month, if
these type of plans can reduce churn by 1-1 ½ percentage points per
month, then the net present value is very clearly positive of taking
rates down to $0.05 per minute for off-peak calling. Futhermore,
lowering rates can be seen as a pre-emptive move versus RBOC entry.
No matter how you slice it, RBOCs lose on a trade of a local business
customer for consumer long distance customer.
We believe the trade-off between losing a small to medium business
customer in local vs. gaining a residential or consumer customer in long
distance (this is the likely trade-off for the RBOCs in the first year or
two after LD entry) is a trade that does not work well for Bells. Since,
in the report, we raised the notion of premptive competitive moves by
WCOM vs. the RBOCs in consumer LD, we thought it would be interesting to
include in the report (and here) a table which analyzes the net impact to
the Bells of losing a small business customer in local vs. gaining a
residential LD customer. In fact, we believe it would take at least four
to eight residential long distance customers to make up for the loss of
one business customers. The assumptions behind this statement are that
the average RBOC business customer has ten lines, generating $700 per mon
th in revenues ($70 per line) and $350 per month in EBITDA (a
conservative 50% EBITDA margin-which could be low since we estimate that
the RBOCs make an average EBITDA margin of 60% on business customers).
Even if we assume that 43% of the cash costs are variable or avoidable if
the RBOC loses this customer (RBOCs claim less than 30% of costs are
avoidable), the hit to the RBOC's EBITDA line would still be $200 per
month. On the residential long distance side, we are assuming that the
average customer makes $50 per month in long distance calls (in fact, 85%
of households make $25 or less of long distance calls per month), so
even if the EBITDA margin is 100% (AT&T's current consumer long distance
EBITDA multiple is 35%-40%), it would take four residential long distance
customers to make up for the loss of one business customer. Furthermore,
if one assumed that the RBOCs' foray into long distance only nets
customers that look like the average AT&T customer, the Bells would need
20-25 consumer customers to make up for one lost business local customer.
Impact to RBOC Financials from Local Competition and Long Distance Entry
Nirvana Positive
Average
Scenario Scenario AT&T
LD
for RBOC for RBOC
Customer
Impact From Lost Business Local Customer/a
Average Rev. Per Month $700 $700 $700
EBITDA 350 350 350
EBITDA margin 50% 50%
50%
Avoidable costs (150) (150)
(150)
EBITDA loss to RBOC 200 200 200
Impact From New Residential LD Customer
Average Rev. Per Month $50 $50 $25
EBITDA margin 100% 50%
35%
EBITDA gain to RBOC 50 25 9
# of Res. Custs. Needed to
Offset the loss of 1 Bus. Cust. 4 8 23
a/ average 10 lines per business customer.
Source: Salomon Smith Barney Estimates.
We do not believe that any potential AT&T/AOL deal will hamper WCOM's
relationship with AOL.
Another reason WCOM's stock got hit recently was the hot topic of the
AOL/AT&T deal for Internet access. Putting aside any potential deal
between AT&T and AOL (we think the odds are below 50/50 given AT&T's
fiduciary responsibility as an At Home shareholder), WCOM's contract
with AOL was signed in September 1997 and runs five years, until
September 2002, thus we have more than three years to go. WCOM is
guaranteed an embedded level of business which runs roughly $400 million
per year of annualized revenues from AOL. In addition, AOL each year
goes out and bids on revenue growth above this level to all industry
backbone players. WCOM has been getting the same allocation of AOL's
growth as what its embedded base of guaranteed contract revenues are,
which is equal to roughly one-third of AOL's backbone business. Sprint,
GTE/BBN, and others get the rest of AOL's backbone business. WCOM has
4x-5x the number of dial banks in the UUNET backbone vs. any other
backbone provider and probably has 6x or greater the number of dial banks
that AT&T does, and UUNET has more NAPs, more peering arrangements, and
triple the IP POPs of any other IP backbone carrier. In fact, AT&T is
not even a tier-1 peering IP provider.
Thus, by definition UUNET is the lowest cost provider of wholesale,
dial-up, IP backbone services which is why AOL, despite competitively
bidding each year for backbone services continues to use WCOM for at
least as pro-rated a basis for its growth as what is in the guaranteed
commitment. In the second quarter of 1999, the AOL business was $197.6
million for WCOM (or less than 3% of total revenues) up from $181.5
million in the first quarter of 1999 and roughly 50% above the $130
million in the second quarter of 1998. In contrast to how WCOM traded on
8/9/99, we believe that the net impact of an AT&T/AOL access deal could
be a positive to WCOM since AOL's customer base could expand causing a
larger amount of traffic over UUNET's backbone.
Partial Frame Relay Outage is Unfortunate But Part of Doing Business
The recent partial frame relay outage is unfortunate but a reality given
the industry's increasing reliance on more sophisticated software-driven
networks. Any impact to financials from the partial outage will be
separately identified and nonrecurring. We are not changing any
estimates.
The partial frame relay outage that WCOM experienced in early August 1999
affected one of its four platforms, or 30% of its frame customers (3,000
customers at most, which range from $1,000-per-month customers to up to
six-figures-per-month customers) for roughly 10 days. WCOM was
attempting a software upgrade, but while installing a new software
package (which would allow for more features as well as handle more
customers on the network), a problem with the software was detected. The
original creator of the software was Cascade, which was acquired by
Ascend, which in turn was acquired by Lucent. Lucent and WCOM itself had
both tested the new software extensively prior to installation but the
bug was not detected until the actual installation.
We estimate that the top-line impact from the outage would be in the low
$10s of millions. Since WCOM has stated that it will refund customers
for the ten-day outage plus give another ten days of free service, there
will also be a cost impact (probably to SG&A) which will have a larger
impact than the revenue line. The impact to WCOM's financials will be
separately identifiable and non-recurring. As WCOM will post some gains
from stock sales during the quarter (Verio and Premiere), the
nonrecurring losses should be offset by one-time gains. We estimate that
WCOM's frame relay revenues are roughly one-third of total data
revenues, or roughly $640 million for the third quarter of 1999,
excluding any impact from the outage. We have not changed our models to
include any revenue impact or bottom-line EPS impact due to the outage.
WCOM IS A MUST-OWN!
The bottom line is that WCOM is a $35 billion revenue company with
top-line growth in the high teens, generating free cash flow, growing EPS
an estimated 45% in 2000 versus 1999 and at a five-year CAGR of 28%. In
addition, WCOM possesses the greatest set of strategic assets on a global
basis in its industry, and is trading at only 27x reported earnings for
year 2000, which is roughly a market multiple to the S&P. On a cash
earnings basis, WCOM is trading at only 22x 2000 earnings, a 15%-20%
discount to the S&P if the S&P traded on cash-type earnings. The last
time WCOM approached a market multiple on forward EPS was October 1998,
after which the stock doubled in nine months. When a company is
generating more than $8 billion in quarterly revenue and can grow
revenues at a 16% clip while expanding margins sequentially by 300 basis
points, that company should be valued at significant premiums to the S&P
as opposed to the mere market multiples at which WCOM is being valued
today. |
