Market Tremors Don't Shake Strong Secular Telecom Trends-Part 2
Global Crossing Ltd(GBLX)#*
Rating: 1S
19980908
Salomon Smith Barney ~ April 17, 2000
--SUMMARY:----Telecommunications Services
--OPINION:------------------------------------------------------------------
On the supply side, supply of network capacity is not equal to fiber
miles. One has to light and condition a network. People do not realize
that as you offer optical carrier services, not to mention managed
bandwidth applications, there is a nonlinear relationship between supply
and demand. In other words, if you are buying a simple voice circuit,
there is no one-to-one protection for that. If you are provisioning OC-3'
s or OC-12's to corporate customers, you are typically provisioning 3 or
4 sections for every 1 section you are selling, in order to guarantee
the type of bit error rates and zero packet loss specifications that are
demanded from customers who buy optical carrier services.
Our point is that the demand for bandwidth, we think, is going to grow
exponentially which will lead to an array of bandwidth-enabled services
and applications that go well beyond what we, frankly, can envision.
All we know is that this will drive tremendous demand for network
services, and even with the normal pricing following down cost curves in
this industry, we think it will create hundreds of billions, if not
trillions, of new revenue in this industry over the course of the next
decade.
Thus, the more bandwidth-oriented names that one thinks about which are
also getting rocked in this market clearly represent very good value. As
with the CLECs, among the more bandwidth-oriented names, there are
obviously vast differences in business plans ranging from Global
Crossing, that truly is becoming a global network provider increasingly
for commercial customers, to Metromedia Fiber Network or Williams, that
are purely in the wholesale or enabling mode. Their current stock prices
come nowhere close to reflecting the fact that these new generation
bandwidth networks are acutely leveraged to the demand for bandwidth that
is going to occur over the next decade.
Consequently, we would argue that whenever you decide it is safe to go
into the NASDAQ waters again, clearly there are high quality names in
both the CLEC / integrated communications providers space and the
bandwidth space - whose current stock prices are frankly reflecting a
future that is far more conservative than what we think reality will be.
THE OVERALL INDUSTRY REMAINS HEALTHY WITH ROOM FOR LOTS OF WINNERS
As for our overall view of the industry, we continue to believe that this
industry is one where different business models work, and that Old versus
New Economy type of chatter is nothing more than MBA "mumbo jumbo".
Maybe in retail, if you are going to buy a book either online or in a
store, there is a legitimacy to the debate between bricks & mortar and
online. Although, old line companies, which have inventory and
infrastructure and learn how to create websites, may cause hurt to lots
of new B2C and B2B start-ups. However, in a trillion dollar global
industry that could easily triple to quadruple over the course of the
next decade or so, there is a lot of new revenue and a lot of
segmentation that occurs such that a so-called "horizontal" provider of
service can do quite well at the same time a so-called "vertical"
provider of service also does quite well.
For example, we believe AOL at the end of the day clearly needs WorldCom'
s depth and breadth of facilities and ability to provision millions of
ports at a snap of the finger, not to mention the ability to have its IP
packets go on a Tier-1 backbone. This was more important than buying the
cheapest bandwidth or wavelength or ports. This type of thinking is
generally true in large commercial enterprises, where the totality of the
support of the carrier is more important than whether or not you are
getting the cheapest optical wavelength. This is why so called
"vertically-integrated" companies will always rule the roost for large
corporate users who demand a full array of services and support, not to
mention scale and scope and depth and breadth of facilities and systems.
Frankly one can think of WorldCom of a bunch of horizontal clusters such
as the world's largest IP backbone, 150 local SONET networks globally,
millions of long-haul fiber miles that is vertically-integrated at the
top with regards to brand, marketing, sales, IT systems, etc.
On the other hand, you have companies like Storage Networks, or Akamai,
or Core Express, who do not deal with end-users in their own right, and
who are really buying sophisticated bandwidth to which they add value.
In their case, a horizontally-focused company in the bandwidth network
layer is probably most valuable since they will optimize the cost for
these users of bandwidth. The fact that a horizontal company does not
have a large salesforce nor the ability to provision millions of
customers, nor provide customer care for millions of customers, is
irrelevant as long as they have the network design and management systems
in place to deliver high quality, high-reliability bandwidth services.
Thus, a Level 3, Williams, or Metromedia Fiber Network can do what they
are doing all day long. We do not really think it infringes at all on a
WorldCom, Deutsche Telecom, or Bell Atlantic or whomever among the
larger, vertically-integrated companies are successfully expanding and
broadening relationships with existing customers by virtue of adding more
layers of applications over existing infrastructure.
In other words, we would argue that there really is a barbell approach to
telecom. On one hand, there are the 30 or 40 large telecom operators
around the world. They own the legacy revenue in this industry, and
their challenge is to diversify assets such that they can participate in
the growth part of the industry, namely global Data/IP solutions while
mitigating natural share loss and devaluation of legacy revenue: Voice
Revenue.
Clearly WorldCom, with its array of assets around the world, is
best-positioned to meet the challenge. Actually, it is doing that today
given that it can grow its revenues at 14%, despite the fact that 60% of
its revenues are Voice, which is barely growing. Those RBOCs that
successfully evolve from regional voice-oriented, consumer-oriented
companies to more national or even global providers of data for
sophisticated business customers, will also evolve as good
vertically-integrated providers of service. This is especially important
for the RBOCs given that there has been $60-70 billion of capital
formation by the CLECs over the last several years, targeting the best
RBOC assets that generate the most RBOC cash flow.
Clearly, the other end of the barbell is populated by many companies who
are focused new entrants that will either leverage the explosion of
bandwidth in a rather pure sense, such as Level 3, Williams, and
Metromedia Fiber Network, or those companies that should evolve as
integrated communications providers to the vast middle business market
that continues to be neglected as the big guys get bigger and hunt the
large corporate user.
Telephony is interesting in how revenues split out. Of the trillion
dollar global industry, 50%-60% or revenues are Wireline Voice. About
20% is Data/IP. Slightly over 20% is Wireless. However, less than 10% of
growth will be in Wireline Voice, 60% of the growth in Data/IP, 30% of
the growth in Wireless. Another way of looking at this is
geographically: 70% of global telecom revenues is from Europe and North
America. 15% is in the Asia Pacific and half of this 15% is in Japan.
We would argue that over the next 5-6 years, Europe and North America
will be 50%-60% of global telecom revenue while Asia Pacific will be over
30% of the revenue in global telecom. Finally, another way of looking at
this trillion dollar industry: $600 billion is generated by business
customers and $400 billion is generated by consumers. Probably 50,000
large corporates who average about $5 million per year of telecom
spending generate $240 billion, while 30 million business customers
around the world who average $10,000 per year of telecom spending
generate $360 billion.
The challenge for the mega gorilla telecom companies around the world
will be to leverage global infrastructure to pursue Data/IP services for
the large corporations on a global basis. However, the other 30 million
businesses continually get ignored by the evolving mega-gorillas on a
global basis and leave a lot of opportunity for high-quality, integrated
communications providers such as a McLeod, NEXTLINK, Winstar, Adelphia
Bus. Solutions, Focal, MPower, Broadwing, Colt, etc. These integrated
communications provider companies come in and offer an array of services
ranging from Voice to Data to IP to ultimately e-commerce services for
the SME market.
Given all this, we continue to see more consolidation in this industry.
At the high end, the major companies around the world continue to be in a
land-grab as they attempt to have global infrastructures that, to be
blunt, mimic what WorldCom looks like. We clearly think Global Crossing
has the best set of independent assets in the world. We think it will
drive value in its own right on those assets, especially by using IXNet
as a front end into the commercial market place. Furthermore, Global
Crossing will sell ILEC and global marine assets for $5 billion which has
the consequence of shedding non-core assets yet leaving the FV/EBITDA
multiple unchanged, while increasing EBITDA growth by 800 basis points.
Clearly, over time, companies with lots of customers to follow around the
world such as France Telecom and Deutsche Telecom will be increasingly
looking to marry companies that have new network infrastructure.
Meanwhile, at the other end of the barbell, the name of the game is to
expand geographic reach and expand product capabilities. We think there
will be more mid-tier type of M&A along the lines of McLeod-Splitrock and
NEXTLINK-Concentric as high-quality management teams in this space with
relatively good currencies look to add to their geographies or
capabilities.
The bottom line: we think that the health and vitality of this industry
is actually quite good. The gating factor will be the continued creation
of new demand, spurred by available, cheap bandwidth which will drive new
revenues into this industry that will allow high quality new entrants to
go from nothing to something. At the same time, this will allow "big
guys" who get it to increase their relative share of the overall global
market. In other words, we envision that there could be 15-20 new
entrant names around the world that collectively account for 20%-30% of
the growth in telecom over the next decade. Clearly, these are the
stocks one wants to own as core holdings. At the same time, we would
argue that of the 30 or so largest telecom operators around the world, 5
or 6 will emerge as true global players that will gain a few share points
on a relative basis in an industry that is tripling to quadrupling.
Thus, we want to own the best-in-breed of both ends of the barbell. It
is not mutually exclusive to own the high-quality new guys and to own the
so-called "old" guys who happen to be evolving into global providers of
telecom services, especially the providers to large corporate users.
NET/NET: Similar to our actions in October 1998, and as is our nature,
we do not run and hide when things get bad. The secular trend in this
industry represents tremendous opportunity, the well-run companies (in
all categories) will create a ton of value for shareholders and we would
be taking advantage of current stock prices to buy the best names in each
segment of the telecom industry.
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