BTAB: WCII: Initiating Research Coverage Of WinStar Communication -
Strong Buy
WINSTAR COMMUNICATIONS INC. (WCII) "STRONG BUY"
Initiating Research Coverage Of WinStar Communications With A "Strong
Buy"
Investment Rating On The Shares -Part 1/2
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Date: 09/28/1998 EPS: 1997A 1998E 1999E
Price: 25.5 1Q (1.27) (2.59) (2.86)
52-Wk Range: 48 - 17 2Q (1.78) (2.77) A (3.09)
Ann Dividend:0.0 3Q (2.01) (2.62) (3.29)
Ann Div Yld: 0.0 4Q (2.56) (2.80) (3.45)
Mkt Cap (mm):1,696 FY(Dec.) (7.66) (10.79) (12.70)
3-Yr Growth: FY P/EPS NM NM NM
CY EPS (7.66) (10.79) (12.70)
Est. Changed No CY P/EPS NM NM NM
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HIGHLIGHTS:
-- We are initiating research coverage of WinStar with a "strong buy"
investment rating on the shares. WinStar is a wireless access company
(better known as a wireless competitive local exchange carrier, or
CLEC) with a nationwide footprint of licenses to offer low-cost voice
and high-speed data services, primarily to business users.
-- The local business phone market is estimated at 35 billion
annually, which we believe will grow to 60 billion in 10 years.
Today, the incumbent local exchange carriers hold a virtual monopoly
on local phone service. We believe as competition heats up, CLECs can
ultimately win around 0% market share, up from essentially zero
today, and perhaps an even greater share of the data and private
network business.
-- We expect so-called point-to-multipoint (PMP) technology to be
introduced commercially later this year that should significantly
improve the returns on high-end subscribers and open up the lower-end
market for penetration. This event will likely mark the true
emergence of wireless as a viable local loop strategy.
-- WinStar is currently operating in 22 markets, and is in the early
stages of migrating its resale customers to its own networks. We
expect WinStar to increase the amount of traffic on its own networks
substantially as PMP technology becomes available.
-- Stock Price Performance: WCII has gained 0% (flat) YTD, versus a
22% rise in our CLEC index and an 8% gain in the S&P 500.
- Valuation: Based on our 10-year DCF, using a 20% equity discount
rate and a 10x terminating multiple, our 12-month price objective for
WCII is $49/share.
DETAILS:
INDUSTRY POINTS
-- The wireless access industry is not a battle between the existing
CLECs.
The real competitors are the incumbent local exchange carrier (ILECs)
-- in most cases the regional bell operating companies (RBOCs)--which
currently control nearly 90% of the total access lines in the U.S. As
with most CLECs, the wireless access companies' (WAC) initial focus is
on the business market, which we estimate spends $35 billion annually
on local phone service.
-- We believe the wireline and wireless CLECs taken together could
command 50% market share of local phone revenue within 10 years, up
from essentially 0% today, and perhaps an even greater portion of data
and private network traffic.
-- The principal alternative to broadband wireless access is fiber
optic lines (although that may change in the future). Of the
estimated 750,000 commercial office buildings in the U.S., only 3% are
connected to fiber today (with some higher percentage actually
"passed" by or touched by fiber). Wireless economics allow for
provisioning of smaller buildings/accounts that are not close to the
fiber ring.
-- Once a network hub, or node, is located in a market, the pool of
potential customers includes all buildings with which a line-of-sight
can be established. Therefore, the buildout costs for a market is
directly related to the demand in that market. In other words,
incremental capital expenditures are success-based.
-- As a company's communications needs expand from voice and data to
high-speed data and multimedia and video conferencing, wireless access
providers have the ability to scale the amount of bandwidth to the
customer commensurately, meaning it can capture incremental
communications revenue at little or no incremental cost. Adding
additional capacity does not require a hardware change.
-- Traditional CLECs are largely dependent on the existing ILEC
infrastructure, while wireless access providers can completely bypass
the copper facility.
-- By late 1998 or early 1999, point-to-multipoint technology (PMP)
should begin to compliment the point-to-point (PP) technology that is
available today. Basically, PMP cuts the capital cost of adding a
subscriber roughly in half by eliminating one of the two radios
necessary to complete a "link" (which allows the carrier to target
lower-end subscribers). Wireless Access Companies (WACs) retain the
benefit of increased spectral efficiency by allowing dynamic bandwidth
allocation, while an overlaid PP link efficiently serves
bandwidth-hungry customers.
--We believe these companies represent a consolidation play, as well.
It is likely just a matter of time before a major long-distance
carrier seizes on the opportunity to completely bypass the Regional
Bell Operating Companies (RBOCs) in offering its own local services,
or before an international carrier sees the opportunity to gain a
toe-hold in the $140 billion U.S. telecom industry.
-- We expect a fair amount of deviation from our models and even
stated objectives because these businesses are so new, but we expect
the stocks to appreciate as the stories become "reality" over the next
several quarters.
COMPANY DETAIL
WinStar owns licenses predominantly in the 38 GHz band in 120 major
markets, including the top 50 MSAs, covering approximately 200 million
POPs, and an estimated 80% of the country's business access lines.
WinStar also successfully bid on 15 licenses in the recent 28 GHz LMDS
auctions, where it paid $43.4 million for 16.8 million POPs
($2.58/POP). This purchase, along with spectrum recently acquired
from CellularVision, brings WinStar to an average of almost 750 MHz in
its top markets.
One of the differences between WinStar and the other wireless access
companies is that WinStar aggressively resells service prior to
launching commercial operations of its own network as a means of
growing its subscriber base. In a sense, WinStar is "pre-selling" its
wireless network. WinStar has elected to launch service in 3 phases
in its deployed markets.
-- Phase 1: Resell voice service. This is typically low-margin
business, but provides the company with a marketing "hook" when its
own systems are available
-- Phase 2: On-Switch. When WinStar deploys a switch in that market,
it begins to migrate its resale base over to its own switch from the
ILEC switch. At this point, WinStar is reselling the "unbundled"
local loop from the ILEC and serving the customer with its own switch,
and margins rise commensurately.
-- Phase 3: On-Net: A wireless link is established between the
WinStar hub and the customer site, thereby completely bypassing the
ILEC local loop facility, at which point margins are highest.
WinStar plans to be offering service in 30 markets by year-end from 27
today and 40 by YE 1999. Obviously, the highest margins are attained
by keeping as much traffic as possible on net. Ultimately, we believe
WinStar can attain gross margins of 50% to 60% depending on the amount
of traffic that remains "off net."
WinStar's initial focus is on the small-to-medium sized business
market.
However, WinStar began growing a large-accounts salesforce in 1Q 1998
that will target Fortune 100-type companies and competes directly with
fiber-based carriers. We expect WinStar to have 15 markets staffed
for large account sales by YE 1998 and 30 by YE 1999.
Recently, WinStar announced that it provides local number portability
(LNP) in 15 of its 27 operating markets, and will be nationwide with
the service--a requirement of all telecom carriers by mid-1999-by the
end of 1998. With LNP, WinStar's customers can retain their phone
numbers when switching over to facilities-based service.
Projections
WinStar has 19 switches in the ground today with over 15% of all
access lines on net and 35% of lines on-switch at June 30, 1998. As
such, most of WinStar's revenue is currently derived from resale
business, although the company is aggressively adding wireless links
to bring its customer base on-net. We expect WinStar to aggressively
migrate customers "on-net," and therefore expect the consolidated
percentage of on-net and on-switch traffic--which is where WinStar
makes the highest margins--should rise proportionately to new
subscribers. We estimate 80% of total traffic will never cross the
RBOC network by 2007. Currently, WinStar has over 3,000 roof rights
and should reach about 4,000 by year-end.
Our terminal assumptions are for WinStar to reach 5.8 million access
lines by 2007, or about 7% of the total business lines in its markets.
We expect WinStar to successfully offer LD service to 80% of its local
customers within 10 years and be providing data services to over 40%.
Because WinStar resells services in new markets and to clients where
it can not establish a line of sight, we believe it will reach a
slightly higher penetration level but with slightly lower margins than
those companies that adopt strictly facilities based strategy. We
currently forecast a 53% gross margin in 2007 with a corresponding 32%
EBITDA margin.
Acquisitions
The WinStar network is/will be a hybrid circuit-switched/ATM network.
WinStar has acquired some of its data capacity, and in fact closed a
pair of strategic acquisitions in 1998, including GoodNet and MIDCOM
Communications.
In January 1998, WinStar paid $22 million for GoodNet, a nationwide
provider of Internet access services with ATM POPs in 27 markets and
peering agreements with an additional 130 ISPs. In keeping with
WinStar's "on-net" strategy, this acquisition provided an in-house
means of providing Internet access to the company's growing base of
data subscribers.
WinStar paid about $92 million for MIDCOM, a long distance provider
serving primarily the west coast, Midwest, and New York. The MIDCOM
acquisition provides WinStar with an existing revenue base, but also a
cache of subscribers to market local services to, which would serve as
a "hook" for their respective buildings. Remember, once a single
customer is identified in a commercial office building, incremental
subscribers only "cost" a nominal amount of wiring and labor to
install. As importantly, as part of the MIDCOM deal, WinStar acquired
the assets of PacNet, which include frame relay POPs in 20 markets
throughout the western United States (since expanded into some eastern
markets). PacNet is also a member of Unispan, a consortium of frame
relay carriers, which gives WinStar access to frame relay services
throughout the U.S. and internationally.
WinStar also recently closed a deal to lease dark fiber connecting its
Northeast Corridor properties. The deal is structured for 25 years
with total payments of $40 million, and will allow WinStar to offer
"on-net" long distance services throughout the Northeast. By
providing both local and long distance service on a facilities-basis,
WinStar is able to capture the access fees that IXCs normally pay to
LECs and pass through to the end user. We believe this is the model to
which all-wireless access companies will gravitate.
A wholly owned subsidiary, WinStar New Media, focuses on providing
media content to the broadcasting and computer industries. New Media
develops programming for cable operators and radio stations, as well
as electronic content and value-added services for distribution across
the Internet.
We believe WinStar will ultimately spin out the New Media business and
concentrate on its core telecommunications business, but recognize the
value of the business and its potential for growth given the Internet
distribution.
In April 1998, WinStar purchased 3.3M shares of Advanced Radio Telecom
from private investors for shares of WinStar stock. The deal valued
ART shares at $17.39 per share. WinStar issued 1.525 million shares
in the deal, which resulted in a 14.9% ownership of ART. After giving
effect for recent spectrum acquisitions for stock by ART, WinStar's
ownership currently stands at 12.9%.
Financial Position
We expect WinStar to reach operating cash flow breakeven in late-2001
after incurring incremental losses beginning 3Q 1998 of approximately
$1.8 billion as follows: $477 million EBITDA loss, $1,068 million
CapEx requirements, and $273 million of cash interest payments.
WinStar's war chest includes a $725M cash balance, which should fund
operations for the next 12-18 months under the current buildout
schedule.
WinStar's capital structure includes Sr. notes, discount notes,
convertible preferred, common equity, and bank debt. At June 30,
1998, WinStar's total long-term debt amounted to $1.3 billion,
including:
$216M accreted value of 14% sr. disc. notes due 2005 with par value
of $305M, cash pay in 2001, $108M accreted value of 14% convertible
disc. notes due 2005 with par value of $152M cash pay in 2001, $116M
accreted value of 14.5% sr. disc. notes due 2005 with par value of
$171M cash pay in 2001, $111M accreted value of 15% sr. disc. notes
due 2007 with par value of $430M no cash pay $250M of 12 \'bd% sr.
notes in two tranches due 2004 $200M of 10% sr. notes due 2008
$257M accreted value of 11% sr. disc. Notes due 2008 with par value
of $430M cash pay in 2003
Management believes it will establish an equipment facility with
manufacturer of its PMP radios. In total, the facility could cover as
much as $200 million and account for two-thirds of WinStar's 1999
capital spending requirement. If WinStar is successful in this regard,
the company would be fully funded for its initial 40-market roll out.
Management
William J. Rouhana is a founder of WinStar Communications and has been
chairman and CEO of WinStar since 1994, and chairman since 1991.
Prior to forming the telecommunications firm, Mr. Rouhana ran a
merchant banking company--called WinStar Companies--with a focus on
the telemedia industries.
Steve Chrust has been with WinStar since 1995 and currently oversees
corporate development and strategic and capital planning. Mr. Chrust
was a #1 ranked analyst for 5 consecutive years before joining the
industry as vice president of Executone Information Services and
chairman and CEO of operator services company AMEX before joining
WinStar.
Nathan Kantor became president and chief operating officer in 1995.
Before joining WinStar, Mr. Kantor was president of ITC Group, which
assists and consults competitive telecom providers, and from 1985 to
1990, was president of the Northeast Division of MCI and developed
MCI's international business strategy.
Charlie Dickson joined WinStar as chief financial officer in late
1997. Mr. Dickson's previous positions include CFO of broadband
networking equipment supplier General Instrument Corp. from 1993 to
1997 and various positions within MCI's finance department.
There is a (are) convertible issue(s) outstanding on WinStar
Communications Inc.. |
