WCOM - MCI Some Thoughts
Lehman Brothers (Blake Bath/Dan Fletcher 1(202)452-) WCOM - WorldCom, Inc.: Key Growth Drivers Strong In Q2, Raise Target
Jul 23 1998 14:36
Ticker : WCOM Rank(Old): 1-Buy Rank(New): 1-Buy
Price : $56 5/16 52wk Range: $56-28 Price Target (Old): $65
Today's Date : 07/23/98 Intraday @12:25 Price Target (New): $75
 WorldCom reported excellent second quarter results with revenues up 32% to $2.61B, EBITDA up 70% to $827 million, and EPS of $0.21, all nicely ahead of expectations. Core revenue growth was 38%.
 Revenues from the key growth areas (data, Internet, international) grew 54% in the quarter, and 15% sequentially, and now represent 52% of revenues.
 We also expect MCI's results to come in strong, with at least 10.5% topline growth. We are raising our MCI WCOM estimate to $2.00 for 1999 and $2.85 for 2000 from $1.98 and $2.66, respectively.
 Investment Summary: With key regulatory hurdles overcome, the stage is set for the company's unique positioning in the upper echelon of large cap blue chip growth stocks and we expect meaningful multiple expansion over the next few years.
 Valuation: We are increasing our price target to $75 from $65, which is a 15% premium to the market on year 2000 earnings, a multiple which appears highly conservative given strong strategic positioning, and the high growth of the company.
Key Growth Areas Deliver
The growth engines we expect to significantly propel the company's EBITDA over the next few years performed well in the second quarter. Overall, WorldCom reported solid results, with 32% revenue growth (pro forma CNS/ANS and pooling of Brooks), 38% core revenue growth, 54% revenue growth from the key growth areas (now 52% of revenues) 70% EBITDA growth on a 700 basis point expansion in the EBITDA margin, and $0.21 in EPS. The operating margin in the quarter was 19.0%, up 870 basis points over second-quarter 1997 and the significant EBITDA and operating margin expansion was driven by realizing merger related synergies (i.e. MFS), bringing traffic on-net, and scale efficiencies/lower line costs.
WorldCom Q2 Growth:
(1) Annual (1) Sequential
($M) Q298a Q297a Growth Q198a Growth
Domestic Switched 1208 981 23% 1162 4.0%
Domestic Private Line 536 382 41% 496 8.1%
International 299 197 52% 257 16.3%
Internet 526 303 73% 392 34.2%
Core Revenues 2569 1863 38% 2310 11.2%
Other 42 72 -42% 40 5.0%
Total Revenues 2611 1935 35% 2350 11.1%
Data/Intl./Internet 1361 882 54% 1184 15.0%
(1) Pro forma for CNS/ANS, and pooling of Brooks Fiber, and the sale of
operator services and broadcast operations. We have increased our 1999 and 2000 estimates to $2.00 and $2.85, respectively from $1.98 and $2.65, on solid and rising expectations for merger related synergies (particularly international termination) strong growth trends from key areas such as Internet and international.
Raise Target To $75 From $65
WorldCom occupies a unique position, in terms of growth, in the realm of large capitalization companies. Pro forma the MCI merger, it will be a company with over $38 billion in revenues (1999 estimated), yet we expect EBITDA growth to average more than 20% in the next few years. We expect this growth to result from its strong/large scale positioning in the key growth areas (data/Internet - UUNET, local - significant CLEC presence (United States and Europe), international - significant Europe network and presence) resulting in 15% topline growth, with powerful merger related cost and capital synergies augmenting topline growth, and creating substantial shareholder value. With the key regulatory hurdles regarding the combination behind the company, we believe the stage is set for greater appreciation of the company's positioning and growth prospects. We have increased our 12-month price target to $75 from $65, this based on the assumption of a 15% premium to the market on forward earnings (2000) which appears highly conservative given the high growth trajectory of the company, and its strong strategic positioning in the key growth segments/regions. DLJ Securities (Timothy N. Weller, Ph.D.)
WCOM MCIC - WORLDCOM INC: Another Routine Blowout Quarter
Jul 23 1998 15:04
DLJ ****** DONALDSON, LUFKIN & JENRETTE ****** DLJ
RATING: Buy Change: None 12-Mo. Target: $70
VIEWPOINT: WorldCom (WCOM*+) reported 2Q98 EPS of $0.21 versus a $0.08 a year ago, easily meeting the high-end of Street estimates. The quarter was rock solid across the board. In particular, the company reported that over 52% of its revenue is now in Internet, data, international, and private line, all outside the highly competitive and slower-growing domestic switched business. The quarter included full impact CNS/ANS, but even without the purchased revenue, pro forma growth was astounding and easily the best among its large-cap telecom peers. The MCI (MCIC*+) merger should be closed by Labor Day with only the FCC and California hanging in there on approvals. All in all, nothing not to like in the quarter, although domestic local continues to deserve scrutiny as the RBOCs are doing warm-up laps for long distance entry in 1999. WorldCom is still the core position to hold in any large-cap portfolio in our opinion.
SEGMENT HIGHLIGHTS
1. Domestic Switched-Strong internal growth of 24% is the best is many quarters. The company added 85,000 local access lines in 1Q98, and has a goal to bring this to 300,000 per quarter by fall. Although the net adds were below the 130,000 of last quarter, John Sidgemore expressed confidence that with MCI's salesforce the net adds could go well above the 100K per month target by early 1999. Something worth tracking.
2. Private Line and Data-Up another amazing 41% as customers scramble to get connected to Internet, Frame Relay, and ATM networks. Additionally, the network providers themselves, such as ISPs, continue to gobble up private fiber lines at record pace from WorldCom.
3. International-Overall revenue growth of 52% showed good sequential trends with European deregulation kicking in.
4. Internet-Again, over 100% y/y growth at UUNET, "diluted" by 47% y/y growth at CNS/ANS, for 73% overall. The CNS business is slower as anticipated since CompuServe's dial-up base is flat and because the systems integration side of the business simply does not scale as fast as the network side. The Internet business continues to be the jewel of WorldCom and actually appears to be accelerating a little just like in 1Q98.
BOTTOM LINE AND VALUATION:
WorldCom is still our favorite big-cap name. Yes, the stock looks good at roughly 9 times 1999 EBITDA, but we think investors love WCOM since it is a large-cap earnings growth stock at an attractive forward P/E. With our $2.00 and $2.80 for the 1999 and 2000 EPS in our model, the company is right there with Microsoft (MSFT), GE#, and the rest. This is how we have always positioned it and this is how it trades. Historically, after recovering from a merger dip, the stock has seen forward P/E multiples in the 20-25 times range, or a 10-30% premium to the S&P. At its current size, the same premium may be difficult to achieve (although warranted), but certainly 25 times should be an easy multiple. Therefore, our new $70 target is 25 times $2.80 and could be seen within 12 months. Furthermore, if the proper premium gets into the multiple, the stock could see $84 at 30 times $2.80 within 18 months.
NATIONSBANC MONTGOMERY****NATIONSBANC MONTGOMERY****
July 24, 1998 TELECOMMUNICATIONS SERVICES NASDAQ:
WCOM
William D. Vogel, CFA (212) 583-8170; wdvogel@montgomery.com First
Call
(1) Pro forma for ANS/CNS and before non-recurring charges.
 NationsBanc Montgomery Securities LLC currently maintains a market in this security. Second Quarter Results Outperform Expectations; Raising 1998 EPS Estimates We are reiterating our BUY recommendation on WorldCom, Inc. and our $87 price target based on the company's outstanding volume and revenue gains, significant margin improvement and solid earnings performance for the second quarter. WorldCom reported EPS from continuing operations of $0.21 compared to our estimate of $0.20, and the consensus estimate of $0.20. This compares to $0.02 per share for the second quarter of 1997 when restated on a pro forma basis, after taking into account the purchase accounting impact of the America Online and CompuServe (ANS and CNS) transaction and eliminating merger charges related to the Brooks Fiber transaction.
We are looking for third quarter EPS to come in at $0.23 per share compared to $0.05 in 3Q97, and we are raising our 1998 estimate from $0.88 to $0.89 per share. We are maintaining our 1999 estimate of $2.00.
Strong Core Revenue Growth: 1Q98 Core Revenues up 38%
WorldCom grew core communications revenues 37.9% in the second quarter to $2.569 billion from $1.863 billion in the second quarter of 1997, adjusted for the CNS, ANS and Brooks Fiber transactions. The company exceeded our core revenue estimate by $43 million or 1.7%. This compares to a 35.7% gain in the first quarter. Second quarter revenue growth for WorldCom was the highest in the industry, or 6.0x the industry average (see table below). The company demonstrated strong internal growth across all communications services. Domestic private line and data services, international and Internet growth made the strongest contribution. Traffic volume for the second quarter increased by 39% over the previous year.
WorldCom is generating domestic switched revenue growth in excess of 23%-- five times the industry average. Domestic switched revenue represents 50.3% of total core revenues. Domestic private line, or data revenues, increased 41% for the quarter driven by tremendous commercial end-user demand for high-speed data and by Internet- related growth on both a local and long-haul basis. On the local front, WCOM had 632,000 access lines at the end of the second quarter, an increase of 85,000 from the end of the first quarter. The company is targeting an increase of 100,000 new access lines per month by the end of the year. As of June 30, 1998, the company had 41,000 buildings connected up from 21,000 at the end of the first quarter of 1998. WCOM added four local switches in the second quarter to arrive at a total of 72 local switches in the U.S. and 20 local switches in Europe. International revenues were up 52% on a year-over year basis to $299 million and were up 15.1% compared to the first quarter. With the transatlantic cable now activated and pan-European network now operational, WorldCom can connect more than 5,000 buildings in Europe with over 30,000 buildings in the U.S.-all over high capacity circuits. Favorable cost decreases more than compensated for increases in international access charges. International volumes (minutes of use) increased 85% year-over-year. WorldCom is the only company at this point that offers all of the following services:
(1) U.S. Local service,
(2) U.S. Long Distance,
(3) Undersea cable to Europe,
(4)Europe Long Distance, and
(5) Europe Local.
Internet revenues increased 73% for the quarter to $525 million, when adjusted for the ANS and CNS acquisitions, with growth being driven by both dial up and dedicated connectivity to the Internet as more and more business customers migrate their data networks and applications to Internet-based technologies. ANS/CNS contributed $256 million in revenue for the quarter, an increase of 47% from the year ago period while UUNet contributed $271 million, an increase of 115% over 2Q97 and a 20% gain over the first quarter.
Other revenues were $42 million in the second quarter, down 63% compared with the second quarter of 1997. Other revenues include MFS Network Technologies of $32 million and systems and consulting sales of $10 million.
Revenue Growth is 6.0x the Industry Average
REVENUE
Absolute Market
2Q97A 2Q98A % Change Change Cap
AT&T $12,728 $12,858 1.0% $130 $96,335
Sprint $3,668 $3,967 8.2% $300 $32,129
WorldCom (core, pro forma) $1,863 $2,569 37.9% $706 $56,249
Frontier $590 $648 9.9% $58 $6,078
EBITDA Margin Expansion Continues
Second quarter EBITDA margins as a percentage of core revenues improved to 32.2% from 30.7% in the first quarter and 26.1% a year ago as a result of access cost savings and continued realization of merger synergies related to the MFS Communications transaction. Line costs as a percentage of revenue declined significantly from 52.2% in 2Q97 to 48.3% in 2Q98 while SG&A as a percent of total sales declined from 23.1% in 2Q97 to 20.1% in 2Q98 as efficiency measures continued to improve. Revenue per employee increased from $452,000 per employee during the second quarter of 1997 to $492,0000 per employee for the second quarter of 1998. A more profitable mix of revenues also contributed to margin expansion as the company migrated its focus towards higher-margin, non-access charge related, local, data and Internet services in the U.S. and overseas.
WorldCom's EBITDA Growth is 3.4x the Industry Average with the
Highest Margins
EBITDA
Absolute 2Q97 2Q98
2Q97A 2Q98A % Change Change % Margin % Margin
AT&T $2,496 $3,525 41.2% $1,029 19.6% 27.4%
Sprint $1,015 $1,144 12.8% $130 27.7% 28.8%
WorldCom $487 $827 69.8% $340 24.7% 31.7%
Frontier $125 $135 8.2% $10 21.1% 20.8%
(1) Margins are as a % of total revenue, as a percent of core revenue
margins were 32.2% in 2Q98 v. 26.1% in 2Q97 - still the highest in the industry Operating income (EBIT for the second quarter, before merger charges, was $495 million-an increase of 143% compared with $203 million on a pro forma basis for the prior year period. In addition to cost savings from merger synergies and a more favorable mix of higher margin revenues, second quarter EBIT benefited from operating leverage related to the fixed quarterly level of amortization expense.
Summary
We believe that the second quarter's results confirm our thesis, and renew our confidence in designating WorldCom as a core position. With approval granted already from the European Commission and the Department of Justice in Washington, D.C. we believe the WorldCom/MCI merger is on track to close on schedule.
We remain as confident as ever that the WorldCom - MCI merger will realize the substantial savings and enhanced profitability that we have forecast. Our model estimates that free cash flow from operations after capital expenditures should jump from negative $284 million in 1998 to more than $4.4 billion in 1999.
We continue to recommend purchase of WorldCom with a $87 price objective. WorldCom is the single most aggressively and, in our opinion, accurately positioned telecom services company. As a result, we believe it should be a core holding in all value as well as growth-oriented portfolios.
($ millions) 2Q97A (1) 2Q98A % Change
Core Revenue 1,862.9 2,568.7 37.9%
Other 111.6 41.8 (62.6%)
Total Revenue 1,974.5 2,610.5 32.2%
Line Costs 1,031.6 1,260.0 22.1%
SG&A 455.8 523.8 14.9%
EBITDA 487.0 826.7 69.7%
D&A 283.7 331.8 17.0%
Operating Income 203.3 494.8 143.4%
EPS Recurring $0.02 $0.21 857.8%
Shares Outstanding 1,062 1,045 (1.6%)
(1) Pro forma for ANS/CNS and Brooks Fiber
Lachesis |
