WCOM: Putting AT&T announcement in Perspective
Jack Grubman
Salomon Smith Barney
Tuesday, August 31, 1999
--SUMMARY:--MCI WorldCom, Inc.--Telecommunications Services
*AT&T's lowering of guidance on LD is a function of AT&T's mix
& competitive position not an overall statement about the industry.*In the
consumer segment, WCOM is growing at a positive low single-digit rate vs.
AT&T which is declining at a low to mid single-digit rate.*WCOM's
market position in consumer is still below 20% market share which is why they
continue to grow minutes, revs & profits.*WCOM's commercial business will
grow top line in the mid-teens in contrast to AT&T's mid single-digit
growth overall in the commercial space.*WCOM will post accelerating rev
growth in the 3Q relative to the 2Q and is extremely cheap selling at the
lowest P/E to growth ratio of all large cap S&P stocks w/ growth rates over
20%.
--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 (8/27/99).....:$78.50
P/E Ratio 12/99.....:39.3x Target Price..:$130.00 Prior:No Change
P/E Ratio 12/00.....:27.1x Proj.5yr EPS Grth...:28.0%
Return on Eqty 98...:N/A% Book Value/Shr(99)..:26.00
LT Debt-to-Capital(a)26.7% Dividend............:$N/A
Revenue (99)........:34933.00mil Yield...............:N/A%
Shares Outstanding..:1900.0mil Convertible.........:No
Mkt. Capitalization.:149150.0mil Hedge Clause(s).....:#
Comments............:(a) Data as of the most recently reported quarter.
Comments............:
--OPINION:------------------------------------------------------------------
We put out our note on AT&T late yesterday and we re-issued it this
morning regarding their takedown of guidance in the long distance
business. Frankly, AT&T's conference call while supposedly a call
regarding its new consumer pricing plans was, in reality, a call to lower
long distance guidance. We fundamentally believe that AT&T's lowering of
guidance is an AT&T issue relating to market share loss and mix issues
more than symptomatic of industry issues. In particular, the contrast
with WCOM is startling vis-a-vis relative growth rates in both consumer
and business long distance. The point is that WCOM, while facing the same
macro industry that AT&T is, is growing its core long distance business
at a high-teens rate versus AT&T which is not growing. This is a function
of relative weightings of voice versus data, dependence on wholesale
versus commercial for growth (AT&T the former, WCOM the latter), and the
truism of AT&T still being in a market share losing position versus WCOM
which is in a market share gaining position.
IN CONSUMER, WCOM IS GROWING WHILE AT&T IS DECLINING
First, within the consumer space, AT&T's revenue performance while
negative in the first half of 1999, nonetheless, was favorably impacted
by the one-time benefit of adding back PICC and USF line charges as of
July of 1998. We estimate this PICC/USF benefit might have added in as
much as 3-4% to revenue growth which offset what was really an underlying
decline of 6-8% in core consumer revenue for AT&T. Thus, as these impacts
are anniversaried, the result is a worsening of reported revenue growth
in consumer from -3.4% in the first half of 1999 to -5% in the second
half of 1999. We should also point out that since AT&T's WorldNet is
growing, the reality is that AT&T's pure consumer long distance revenue
growth is actually worse than these numbers indicate.
In addition, while AT&T clearly has been attempting to optimize their
consumer base relative to low volume users, nonetheless, AT&T continues
to lose share in both the transaction (i.e. 10XXX) and subscription (i.e.
Dial 1) businesses. We believe AT&T's acceleration of declining revenue
is more a result of losing Dial 1 customers mostly to WorldCom than any
overall pricing phenomena. For example, WCOM has grown 1.6 million Dial 1
customers in the first half of this year alone with the vast majority
coming from AT&T. WCOM has grown its base of Dial 1 customers by 23% over
the last 2 years with Dial 1 minutes growing 27% during that same time.
On the transaction side, WCOM's transaction revenue has grown 91% in the
last 2 years with 85% of this coming from customers who are AT&T Dial 1
subscribers. Excluding transactional revenue streams such as Dial Around,
WCOM's consumer revenues have grown $2 billion or 38% in the last 2
years. Thus, for AT&T to blame its worsening woes in consumer to the
overall market is just not correct. WCOM, which obviously has to respond
to all the same macro pricing moves as does AT&T has seen quite
phenomenal growth in minutes, customers and revenues during the course of
the last 8 quarters in the consumer long distance market. Furthermore,
WCOM after all these years, only has less than 20% of the consumer long
distance market thus WCOM continues to be in a position to take market
share in the consumer space which is resulting in positive levels of
growth for WCOM in terms of both customers and revenues.
In fact, as we pointed out in the AT&T note, any new price points
introduced by WCOM or Sprint over the last month or so were not a
significant discount of prevailing rates in the market thanks to the
monthly fees imposed in these plans. In addition, it is impossible for
pricing plans introduced in August to impact overall third quarter
results given the lag between introduction of the plans and full
resonating of the advertising in the marketplace. The reality is that
AT&T's problems in the consumer market are unfortunately unique to them
given their 60% share of the space and somewhat less than great execution
and is not symptomatic of problems in the overall marketplace.
As far as the AT&T execution is concerned, it should be noted that
virtually all of the gains of WCOM in customers have come at AT&T's
expense. The reality is that AT&T's initiatives in the consumer space
have not really resonated in the marketplace. For example, AT&T's
personal network has not been a huge success. In fact, we wonder about
its effectiveness given the introduction of AT&T's new plan. After 7
months and what advertising industry sources tell us is $150 million in
expenditures, AT&T admits to only a few hundred thousand customers and we
would be willing to bet virtually all of them are conversions of existing
AT&T customers.
AT&T's Digital One Rate, in our opinion growth in wireless has not
translated into long distance growth and WCOM has not lost a single
customer due to this wireless plan. In addition, AT&T's relationships
with Internet portals have not translated into clearly any pick up in
volume for consumer long distance. As far as WCOM is concerned, since the
launch of their $0.05 every day plan on August 9th, WCOM, we estimate has
already acquired one million customers in the marketplace, most of which
are new. In general, WCOM's customer churn in the consumer long distance
space has declined 7 of the last 8 quarters and is currently running at
the lowest level since the early 1990's.
Thus, on the consumer long distance side, we believe, AT&T's lowering of
guidance is a function of arithmetic (i.e. the PICC/USF phenomenon), the
fact that their 60% share position in consumer still makes them
vulnerable to market share loss and not great execution in the
marketplace. In contrast, WCOM for every quarter over the last two years
has seen positive growth in consumer long distance customers, minutes and
revenues--all of which will see an acceleration in the third quarter.
IN THE BUSINESS MARKET, WCOM IS SIMPLY BETTER POSITIONED THAN AT&T
On the business long distance side, WCOM's switched long distance
business revenues will grow an estimated 9.3% year-over-year in the third
quarter not including wholesale. Including wholesale, WCOM's switched
long distance revenues for business will grow roughly 6%. Including data
and local, in addition to commercial and wholesale voice, WCOM's business
services segment which would be a basket of services comparable to what
AT&T calls business services will grow roughly 15.1% in the third quarter
up from the 13% growth for this basket of services in the second quarter.
This is in contrast to AT&T's guidance of 6-7% revenue growth for a
similar basket of services in the third quarter which will likely be a
deceleration over 6.7% level of growth in the second quarter.
The point is that AT&T's business services growth rate will decelerate in
the quarter driven by the fact that a large portion of their minutes
growth is wholesale, and the fact that AT&T is still largely a
voice-centric company. In contrast, WCOM on a similar set of services
will see its business services segment revenue growth in the 15.1% range
up from the 13% level it posted in the second quarter looking at this
combination of services. This discrepancy is due to the fact that WCOM is
more data-centric than AT&T and WCOM is not relying on wholesale for its
growth in volume whereas wholesale with its accompanying lower revenue
yield is driving the majority of AT&T's business volume growth.
Therefore, WCOM despite all the volatility that is real or perceived in
the long distance industry, is likely going to post top-line growth rates
in its core business of close to 17% even accounting for impact of the
frame-relay outage. As an aside, the good news in the WCOM frame-relay
situation is that the platform which went down only carried $1.3 million
of WCOM's $21 million in daily data revenues. WCOM's overall growth rate
in core revenues will accelerate in the third quarter, in both the
consumer and business services segment area. Therefore, while AT&T is in
a position where it's growth rates are declining due to an unfortunate
mix situation and the fact that it is losing share, WCOM which is
significantly overweight in data relative to AT&T (and relative to the
industry as a whole), while also gaining share in voice, is in a position
to see top-line growth accelerate in the second half of 1999.
The bottom line is that AT&T's problems, we think, are more unique to
them given their mix and relative share position than it is symptomatic
of general problems in the overall marketplace. WCOM will post top-line
growth of close to 17% on a reported basis including the frame-relay
impact and Sprint will report overall top-line growth in long distance in
roughly the 9% range. These are both in stark contrast to AT&T that on a
blended business and consumer basis will post essentially no top-line
growth.
We believe investors should differentiate among the long distance stocks
as to what the businesses portend. We would be very aggressive on WCOM
here since we believe it is without question the cheapest large cap
growth stock in the entire S&P (selling at the lowest P/E to growth ratio
of large S&P stocks with over 20% growth) and we would take full
advantage of the nervousness in the market to "Load Up The Truck."
NET/NET: WCOM is in a far different position than AT&T. WCOM's consumer
business is growing not declining and its commercial business is growing
on any measure at more than twice the rate of AT&T's. We think investors
should take advantage of this to buy WCOM at extremely cheap prices. |
