Hodulik PW E*Infrastructure Weekly - Weekly Wrap Up on CLEC and Internet Infrastructure Sectors
January 10, 2000
KEY POINTS
Weekly Wrap Up on the CLEC and Internet Infrastructure Sectors Volume I
KEY POINTS
* This week PaineWebber's CLEC Index increased 1% while the Internet Infrastructure Index decreased 2% compared to a 2%
decrease in the S&P 500 composite. The weakness could be primarily attributed to the pullback in the technology sector due to
inflationary fears.
* McLeod USA announced a $2.1 billion acquisition of Splitrock Services (SPLT), an enhanced network operator. The 22% premium
to the stock's prior close highlights the value of Splitrock's data service assets.
* Allegiance Telecom announced the expansion of its previous business plan, a deal with Metromedia Fiber Networks to expand
the company's reach, and a 10 million share offering to help finance the new initiatives.
* Strong performance of web hosting stocks such as Exodus, Globix, Digex and NaviSite highlight the strong demand for data
center space that we believe will continue for the next 3-5 years despite additional capacity and smaller form factors of supporting
equipment.
WEEKLY COMMENTS
We launch the PaineWebber E-Infrastructure Weekly with a quick look at demand for out-sourced web solutions. Simply put, this
demand has never been stronger and threatens to accelerate as enterprises look to reallocate IT dollars in this post-Y2K era. Some
simple math can illustrate our contention that the market for these services is likely to continue to grow rapidly for the next 3-5
years. Today, large enterprises and dot.com companies generally require 20,000-30,000 square feet of data center space in a
colocation environment to support their evolving full-service platforms. We are of the belief that the majority of the Fortune 2000
will soon develop these platforms and look to outsourcing as increasing complexity makes the benefits more obvious.
This would equate to 40-60 million in required colocation space were all the Fortune 2000 to chose colocation over a managed
environment. Even if we assume that only half of these large enterprises chose a colocated solution, this leaves 20-30 million in
data center space required. This compares to our estimate for 4-5 million square feet of useable Class A data space in existence
today. Exodus, for example, boasts 1.5 million square feet of data center square footage, with almost 900,000 square feet of
useable space. Other providers generally manage much less space. Over the next 24 months, we expect Class A data center space to
triple, making only a small dent in the amount that will ultimately be necessary on a global basis.
CLEC INDEX & INTERNET INFRA. INDEX VS. S&P 500
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Source: PaineWebber and FactSet.
Price Change FOR WEEK ENDING 1/7
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Source: PaineWebber and FactSet.
A managed environment, of course, requires far less space than the colocated solution. Aside from eliminating the need for
separate, secure cages, managed data centers employ common platforms and central planning to optimize the revenue generating ability
of its plant. As enterprise customers become the main source of growth in the web outsourcing market, managed hosting will take a
larger share than in the earlier days when hands-on, early adopters make colocation (largely in the dot.com arena) the obvious
winner.
The amount of data center space required of any one client in a managed or colocated environment depends on the amount of complexity
of the web site and the storage, processing and bandwidth required to support it. While these components of a successful platform
continue to grow rapidly, form factors of the equipment itself are shrinking. Servers that just two years ago were the size of a
small filing cabinet are now 1-2 inches in height, taking up very little space on a shelf. As managed data centers take advantage
of this equipment, the economics improve as more customers are supported with the same cap ex dollars. This can only go so far,
however. Despite the ability to pack more servers in smaller spaces, providers are running into problems of heat, power and
connectivity. Placed so close together, the servers get extremely hot while current wiring systems remain bulky, unwieldy and
difficult to manage.
Added functionality to web platforms should continue to drive the need for increasing space per company. We believe the market will
develop in other parts of the world similar to the U.S. example. Eventually, colocation and, to a lesser extent, managed data
center space will be required to support users in every major developed city of over 10 million people. The only real question is
how soon will the market in other parts of the world develop.
COMMENTS AND NEWS RECAP
Verio (VRIO-$57.25)[2](ATTRACTIVE): Hosting Initiatives Likely to Boost Growth; Target $70, January 4, 2000 - Later this month,
Verio is expected to announce its strategy to roll out additional data centers, which we believe, could act as a catalyst for the
company's shares. Verio is the leader in the shared web hosting space with over 305,000 sites under management at the end of the
third quarter. Through its acquisition of DigitalNation, a high-end hosting provider, Verio had roughly 1,800 dedicated hosting
servers under management at the end of the third quarter.
In the company's initiatives, we expect the company to add roughly 500,000-750,000 square feet of data center space, creating more
space for its complex platform. This should allow the company to align closer to companies such as Digex, Exodus and Globix, who
are pure-play, high-end hosting and colocation providers that trade at multiples ranging from 25x-40x our estimates for 2000
revenues.
Although we are not changing estimates at this time, we expect the new data center roll out should boost revenues in the latter half
of 2000 and a slightly decrease EBITDA. We continue to expect the company to report EBITDA of roughly $2.2 million off of revenues
of $74.8 million in the fourth quarter. Currently we expect Verio to report $401 million in revenues in 2000. Although we have
received no guidance from management, we believe a decrease of more than 10-15% percent of $50 million to be unlikely.
WinStar Communications (WCII-$69.25)[2](BUY): Pre-announced the addition of 1,500 building licenses during the fourth quarter,
beating our expectations for 1,200 additions, for a total of 8,000 buildings. We expect the company to meet or exceed our estimate
of $137.7 million in total revenue and $61.3 million in EBITDA losses for the fourth quarter. WinStar currently trades at 11.9x our
2000 revenue estimates, a significant discount to the closest fixed wireless comparables, NEXTLINK and Teligent, that trade at 32.8x
and 30.1x, respectively. Additional details regarding the company's data center roll-out, designed to support its ASPs services
platform, were also released which helped boost the stock.
GST Telecom (GSTX-$9.47)[2](BUY): Poised for January Rebound, January 3, 2000 - We believe asset sales, long haul capacity deals
and attempts to monetize other investments will likely improve the company's liquidity, giving it time to reestablish a track record
of solid results after its third quarter let down.
First, the sale of the company's stake in its Hawaiian network which is expected to close by the first quarter that could net the
company roughly $25-30 million. Second, additional capacity sales similar to the Williams contract could net the company roughly
$20-40 million in cash. Third, liquidation of the company's holding of GBT should provide roughly $44 million in cash. Lastly
management has suggested that the company was close to receiving an investment in excess of $100 million. Such an investment could
improve the balance sheet and provide affirmation from "smart money." These potential sources of liquidity should fund the company
into 2001.
We believe these funds would allow the company to concentrate on its core business, allowing it to regain its footing for a more
solid growth trend.
Allegiance (ALGX - Not Rated): The company pre-announced select operating results for the fourth quarter. The company added
roughly 59,500-61,000 access lines, a slight improvement to the 59,100 net additions in the previous quarter. Total revenues are
expected to come in at roughly $38.5-40 million, equating to a sequential growth of approximately 20-25%. EBITDA is expected to be
relatively flat at roughly $26-27 million.
The company also announced that new dark fiber arrangements with Metromedia Fiber Networks and Level 3 should allow it to enter 16
additional markets by the end of 2000. In addition, management expects to offer services in 12 more markets than originally
expected by year-end for a total of 36 markets by the end of 2001.
To fund these expansion plans, the company has registered the sale of 10 million shares of equity of which 4 million shares are from
existing shareholders and a $500 million in senior secured credit.
McLeodUSA (MCLD - Not Rated): announced definitive plans to purchase Splitrock Services (SPLT) for roughly $2.1 billion, pending
shareholder approval. This acquisition allows McLeod to quickly build its data strategy to compliment its infrastructure within
Tier 2 and Tier 3 markets.
Based on our estimates, this deal took place at roughly 10.9x 2000 revenues for SPLT, a significant premium to a close comparable,
ICG Communications, which currently trades at a multiple of roughly 4.1x. Although we do not expect this to spur additional
consolidation within the group, we believe this transaction highlights the value of CLECs with data platforms such as ICG,
Intermedia and GST. |
