Global Crossing Ltd. (GX)#
GX: Update on Liquidity Outlook; GX gets thru 02 1S (Buy, Speculative)
under any reas. scenario Mkt Cap: $1,683.6 mil.
October 1, 2001 SUMMARY
* The impact of EXDS Chapt. 11 filing on GX's viability
TELECOMMUNICATIONS appears minimal. Plus, we believe GX has liquidity
SERVICES through YE'02 even under draconian outlook.
Jack B. Grubman * Rev. contr. from EXDS in '01 & '02 min. (~$50M);
addl'y, GX has never counted on val of EXDS stock for
its funding position; finally, $70M/yr. in related EXDS
Christine R. leases very small in comp. to over $2B CapEx budget for
Gochuico 2002.
* Acknowledging the overall environment, we are assuming
flat '02 cash revenue and adjusted EBITDA vs 01.
Charles Simonds Additionally, we are lowering our price target to $5
from a stale $30 which is more realistic from current
levels given macro & micro risks. However, our
dcf-driven target is $15 which is reasonable if clarity
on business/balance sheet increases.
* Upshot: Believe GX can have adj. EBITDA cut in half,
IRU sales drop 75% and still fund cash requirements thru
YE'02. Meanwhile, GX is gaining traction in commercial
accounts and IRU demand remains reasonabally good.
FUNDAMENTALS
P/E (12/01E) NA
P/E (12/02E) NA
TEV/EBITDA (12/01E) 5.5x
TEV/EBITDA (12/02E) 5.4x
Book Value/Share (12/01E) $9.95
Price/Book Value 0.2x
Dividend/Yield (12/01E) $0.00/0.0%
Revenue (12/01E) $6,430.1 mil.
Proj. Long-Term EPS Growth 0%
ROE (12/01E) (29.3%)
Long-Term Debt to Capital(a) 51.3%
GX is in the S&P 500(R) Index.
(a) Data as of most recent quarter
SHARE DATA RECOMMENDATION
Price (10/1/01) $1.90 Current Rating 1S
52-Week Range $25.75-$1.61 Prior Rating 1S
Shares Outstanding(a) 886.1 mil. Current Target Price $5.00
Convertible Yes Previous Target Price $30.00
EARNINGS PER SHARE
FY ends 1Q 2Q 3Q 4Q Full Year
12/00A Actual ($0.44)A ($0.61)A ($0.65)A ($0.70)A ($2.11)A
12/01E Current ($0.69)A ($0.69)A ($0.93)E ($1.01)E ($3.32)E
Previous ($0.69)A ($0.69)A ($0.93)E ($1.01)E ($3.32)E
12/02E Current NA NA NA NA ($3.46)E
Previous NA NA NA NA ($3.46)E
12/03E Current NA NA NA NA NA
Previous NA NA NA NA NA
First Call Consensus EPS: 12/01E ($3.13); 12/02E ($3.24); 12/03E NA
OPINION
Global Crossing has been under a lot of pressure over the last week due to
concerns about the impact from Exodus' bankruptcy filing and GX's own
solvency and survivability. We address two issues later in this note in
some detail: 1) the impact of EXDS' bankruptcy filing and 2) whether, under
a catastrophic scenario can GX actually make it through 2002. The bottom line
is we believe that GX is not a potential bankruptcy candidate in the near
term, with about $2.1 billion of cash and equivalents on its balance sheet at
the end of Q2'01 and $1.7 billion available under their credit facility.
We would argue that scenarios which range from flat year-over-year EBITDA to
EBITDA declines of 50-55% in 2002 straddle any likely or even worse case
eventuality. If GX has flat EBITDA in 2002 it will end 2002 with excess
liquidity of almost $400 million and even under a scenario of a 50% drop in
EBITDA (incorporating a 75% decline in IRUs) GX is breakeven or slightly
positive in terms of yearend 2002 liquidity. Thus, to argue GX is in
immediate danger of insolvency is incorrect given that even under rather
draconian forecasts, GX can clearly make it through 2002. Obviously, that
would not be a particularly great recipe for equity value recovery, but
survivability is a different manner. In contrast, a positive growth scenario
eliminates all issues of solvency and could boost the stock.
However, given a weakening economy, we are reducing our 2002 numbers to a no-
growth scenario for revenue and EBITDA versus 2001 (i.e. roughly $6.4 billion
in revenue and $1.6 billion in EBITDA). This of course assumes GX makes its
second half 2001 adjusted EBITDA of $700 million to reach the low end of full
year '01 guidance of $1.6 billion in adjusted EBITDA. We are currently
assuming $290 million in Q3 which means GX needs to see adjusted EBITDA grow
sequentially in Q4 to over $400 million for it to make its numbers, a
situation not without risk of shortfall. Obviously, any shortfall in GX's
numbers relative to current guidance has a ripple effect into 2002 and of
course puts added pressure on liquidity calculations.
Therefore, acknowledging that the stock is below $2 and that there needs to
be clarity on the business outlook as well as the balance sheet, we are
reducing our price target to $5 from a very stale $30. This price target
represents two and a half times current levels and implies firm value to
adjusted EBITDA of 7.2x, essentially in-line with incumbent telecom carriers.
While GX has an array of global network assets unmatched by most incumbent
telcos and, we believe, clearly superior growth potential, nonetheless, it is
highly leveraged with legitimate questions over its fully funded status if
there were to be material slippage in business metrics and/or unforeseen
surprises with respect to other sources of liquidity. It should be noted
that our DCF-driven fair value for GX is $15, which could become our price
target if there was visibility in clarifying both macro and micro issues.
GX does continue to gain traction in commercial accounts with its backlog
building and its performance receiving good reviews in the aftermath of the
Sept. 11 tragedy. In fact, GX put up circuits between NY and major financial
centers around the world (especially Tokyo) for several large financial firms
on an overnight basis versus 30-45 day intervals being quoted by other
carriers. GX's array of global network assets allowed it to provide
specialized services and capabilities which could bode well for its ability
to penetrate large enterprise customers. Corporate enterprises want
certainty and are willing to pay for it---which is why WCOM's and AT&T's
stranglehold at the high end of the corporate market is strengthened.
However, GX is increasingly differentiating itself with specialized skills
based on its global network that bodes well for it attaining a small foothold
in this segment.
IMPACT OF EXODUS BANKRUPTCY FILING
We do not believe that EXDS will have a significant impact on GX's results or
cash flow and funding situation. GX, as mentioned in its Q2 press release,
will post an extraordinary non-cash charge to earnings in Q3 related to the
revaluation of its EXDS investment.
By way of background, GX sold its Global Center webhosting operations to EXDS
in exchange for 108.2 million shares of EXDS stock. The transaction, which
was originally announced in September 28, 2000, and closed on January 10,
2001, also provided for GX and AX to be preferred providers of capacity for
EXDS through a 10 year contract whereby GX would provide at least 50% of
EXDS' incremental network services outside of Asia, and at least 60% in Asia
through AX. GX would also resell EXDS web hosting service to its customers.
We believe that expected revenues from EXDS amounted to less than $50 million
in aggregate over the 2001-2002 period and are immaterial to GX's results.
GX current 2001 revenue guidance is $6.4-6.9 billion which they lowered from
their previous guidance of $7.1-7.3 billion in August. From a cash flow
situation, GX was not relying on liquidating their EXDS stake (which GX was
unable to do until January of 2002 when their lock-up period ended) in order
to pay down their debt. In a presentation in August, the company reiterated
its fully funded status, which did not rely on the EXDS stake.
Also in connection with the sale of GlobalCenter, GX agreed to guarantee
certain obligations related to real estate leases assumed by EXDS. The
annual lease payments average approximately $70 million per year over the
life of the leases. GX has consulted with a third party real estate firm
(Cushman-Wakefield) and believes that they should be able to sublet at least
$45 - 50 million of this a year, making GX's maximum exposure about $20 - 25
million a year. About one-third of these leases were in the NYC area where
obviously there is need for class A commercial space. On a CapEx basis of
approximately $2.0-2.2 billion for 2002, we do not find even the full $70
million commitment a serious threat to funding.
LIQUIDITY THROUGH 2002 EVEN UNDER CATASTROPHIC SCENARIO
Disaster Scenario Liquidity Analysis
(a negative growth outlook)
Ending 2001 liquidity: $1.7 billion
2002E Service EBITDA
(based on current run-rate): 0.2 billion
Clear Cash Sources: $1.9 billion
Cash Uses:
Interest Payments $0.7 billion
Preferred Dividends 0.25 billion
No-growth CapEx Level $1.5 billion
Total Cash Uses: $2.45 billion
Shortfall Needed to be Covered by
'02E IRUs: $0.55 billion
2001E IRU Sales: $2.0 - 2.5 billion
Implied % drop in IRU Sales
'02 vs. '01: 75%
OR
Total Cash requirements in '02: $2.45 billion
YE 2001 Liquidity: 1.7 billion
Required '02E EBITDA: $0.75 billion
Implied % drop in '02 EBITDA
vs. low-end of '01 Guidance: 54%
Source: SSB.
In the table above, we display what we consider to be a catastrophe case
scenario for 2002 to illustrate how GX can meet its cash requirements for
2002 given its current liquidity even assuming draconian forecasts for its
business. GX can withstand a 75% drop in IRU sales and an overall decline of
50-55% in EBITDA and still be solvent throughout 2002 while paying its cash
obligations for interest and preferred dividends. This scenario would not add
much value to the equity since a company like GX is expected to grow, but its
ability to survive a very tough climate is reasonable not to mention the fact
that its global assets are very virtuous in a time of pending industry
consolidation.
We believe GX will be able to meet at least the low-end of their guidance
range for 2001 of $1.6 billion in EBITDA and is expected to have capex less
than $4.5 billion. Based on these assumptions, plus cash requirements for
interest and preferred dividends, GX expects to end 2001 with $1.7 billion of
excess liquidity. For 2002, GX is assuming capital expenditures of below
$2.5 billion in a normal growth environment. However, if growth is non-
existent, then capex will be far less, since at least 50% of capex is volume
related or success-based. Hence, under a scenario of flat to down revenues,
GX's 2002 capex would probably be no more than $1.5 billion, more than
covered by GX's ending 2001 liquidity. GX estimates interest expense in the
$600-$700 million range and preferred dividends of $250 million (which they
can opt to pay in additional preferred shares). Thus, GX needs 2002 EBITDA
of $700-$800 million to fully meet all its cash obligations (less if they
choose to not pay preferred dividends in cash), representing a 50-55% decline
from the low end of 2001 guidance.
In order to be able to finance this, GX has recurring service revenues of
$4.5 billion that generate roughly $200 million in EBITDA with reasonable
growth. Thus, GX will need $500-600 million of IRU sales in order to meet
their minimum funding needs. This year (2001), GX is expected to sell $2.0-
$2.5 billion of IRUs; therefore, even assuming a disastrous economy next
year, GX should be able to sell $500-$700 million of IRUs. This level of
required IRU sales represents a 75% drop from 2001 levels, a very unlikely
scenario. In fact, despite the overall economic climate---or maybe because
of it---several very large foreign PTTs have told GX they are likely to need
a wavelength per month (10 gigabit) of transoceanic capacity. This comes at
a time when planned subsea capacity builds from 360, Viatel, Level 3, Flag
and others have been scrapped. Actually, it would not shock us to see GX's
IRU business grow in 2002.
RISKS
GX's likely fully funded status is predicated on having the $1.7 billion
credit facility available to them, which may not occur if they do not meet
their covenants which for 2002 is debt to EBITDA of no more than 4:1,
although there is always room for negotiation. Furthermore, it assumes that
GX is successful in entering into tax shelters to offset the $500 million of
taxes GX owes from the sale of their ILEC. In addition, the risk to our
investment thesis for GX and other emerging telecom stocks is that the market
has a defensive bias right now and GX is not yet free cash flow positive with
approximately $7.1 billion of debt on its books. If GX is unable to grow its
operations and reach free cash flow positive, it may be difficult for GX to
repay its debt obligations. We do not anticipate that the defensive bias
will be indefinite but near-term, the market sentiment could keep GX below
$5.
CHANGES TO OUR MODEL AND TARGET
Given the weakening economy, we believe it is prudent to take a more
conservative stance on expectations and have revised our model. We are
reducing our 2002 cash revenue estimate to $6.4 billion from $8.1 billion and
our adjusted EBITDA estimate to $1.6 billion from $2.3 billion. In addition
given our lower revenue estimates, we are reducing our capex estimate from
$2.2 billion to $2.0 billion. Based on our estimates and assuming that GX
will be able to draw down on the $1.7 billion credit facility, GX remains
fully funded. In fact, under our forecasted model of flat revenue and
EBITDA, GX would end 2002 with excess liquidity of between $300-$400 million,
and perhaps more since our cap ex estimate is probably too high if there is
no revenue growth and GX can choose to not pay preferred dividends in cash..
Based on our updated model, our 10 year discounted cash flow model results in
a $15 theoretical stock price using an 9x terminal FV/EBITDA calculation and
a 15% discount rate. Although our target price using a DCF model is $15 per
share we are still lowering our near-term price target to $5 per share down
from $30 per share to acknowledge that the stock has fallen, and $15 seems
lofty versus the current price of below $2.00 At $5 per share (more than
double the current stock price), GX would trade at a FV/EBITDA multiple of
7.2x 2002 EBITDA and 1.8x 2002 revenues which are valuation metrics that
clearly do not reflect GX's growth potential nor array of global network
assets but which acknowledge the current uncertainty. When the sentiment in
the market is more palatable for growth stocks and when there is increased
visibility to GX's business and less uncertainty to GX's liquidity
situation, we believe a price target near our DCF-driven $15 might be
appropriate.
NET/NET:
We believe GX can make it through 2002 and meet its cash obligations even
under a rather draconian set of assumptions. Thus, given that and GX's
global set of assets, we certainly think the stock should trade to the mid-
single digits. Once clarity of business growth and balance sheet health is
visible GX's stock could trade into the teens, but that is likely to be a
2002 event, by our analysis.
COMPANIES MENTIONED
AT&T (T#, $19.02, 3M)
Flag Telecom Holdings Ltd. (FTHL#, $1.45, 3S)
Level 3 Communications, Inc. (LVLT#, $3.62, 3S) |
