recent Lehman initiation on NXLK: NEXTLINK Communications: Initiating
Coverage With a Buy Rating
by Bill Garrahan, B. Bath, and G. Stricker
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EPS 1997 1998 1999
QTR. Actual Old New Old New
1st: -0.83A - -1.19A - -2.16E
2nd: -0.98A - -1.42A - -2.11E
3rd: -1.08A - -1.57A - -2.32E
4th: -1.09A - -1.86E - -2.53E
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Year:$ -3.91A $ - $ -6.04E $ - $-9.12E
Street Est.: $ - - $ -6.05E $ - - $-8.88E
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Price (As of 2/18): 36 3/16 Revenue (1999): 247.3 Mil.
Return On Equity (99): N/A Proj. 5yr EPS Grth: N/A
Shares Outstanding: 52.4 Mil. Dividend Yield: - -
Mkt Capitalization: 1.90 Bil. P/E 1999; 2000 : N/A; N/A
Current Book Value: $-2.63 /sh Convertible: Yes
Debt-to-Capital: 110.0 % Disclosure(s): C
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* We are launching coverage of NEXTLINK with a 1-Buy rating and a price
target of $51. NEXTLINK is building a national end-to-end local and long
distance network using fiber and broadband wireless to bypass the RBOCs to
provide high-speed data and voice services to business customers.
* NEXTLINK is building a set of end-to-end assets that few others have. We
believe the value of this national network will increase as demand for high
bandwidth service accelerates and as demand for integrated local/long
distance services pushes the long distance carriers to add local
capabilities.
* This end-to-end multitechnology network should provide the most cost
efficient method of reaching all but the smallest business locations. This
should allow NEXTLINK to carry up to 70% of its traffic on its network where
gross margins are 20 to 25 percentage points higher than leasing RBOC loops.
* Catalysts include: continued strong execution, the success of their
wireless deployment as well as WinStar (WCII - 31 3/4; rated 1) and
Teligent's (TGNT - 34; rated 1) wireless deployment and the increasing
possibility of long distance company or RBOC wholesale deals or acquisitions.
* We've valued NEXTLINK using our standard discounted cash flow (DCF)
analysis. NEXTLINK's current firm value is $3.7 billion, which is 4 times
year-end 1999 PP&E. This compares to MFS and Teleport, the other two large
national CLECS, which were both bought for about $12 billion, or 6 times
PP&E.
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Summary and Description
NEXTLINK is in the process of building a nationwide long-haul and local
network in the top 30 U.S. markets, using both fiber and wireless. No other
company has put this set of assets together. NEXTLINK is building just the
third, and only independent, nationwide local fiber network. AT&T and MCI
WorldCom own the other two, and they have little wireless (AT&T has some
wireless and Williams now owns 2% of WinStar's network). We believe that the
combined long distance and fiber and wireless local assets gives NEXTLINK the
ability to carry up to 70% of its traffic on its own network.
Local Fiber - NEXTLINK's local fiber networks are its crown jewel. NEXTLINK
is operational with 2,150 miles of local fiber networks in 10 of the top 30
largest markets today and 36 cities overall, currently over 750 buildings are
connected to the fiber network. Plans are to expand to 20 major markets by
the end of 1999, and 30 by the end of 2000.
Local Broadband Wireless -- The company recently purchased 40 LMDS (28 Ghz)
licenses from WNP group to add to the 42 LMDS licenses it held. NEXTLINK now
has licenses that cover 136M POPs, 27 of the top 30 markets and 39 of the top
50. The company plans a limited rollout of its wireless network in 1999, with
more extensive deployment in 2000 and 2001.
Long Distance Fiber -- NEXTLINK has bought 24 fibers, one empty conduit and
options on additional fiber, on Level 3's 16,000-mile nationwide long
distance network. This network is planned to be complete in 2001.
NEXTLINK focuses on selling a bundled product of local/LD (and data in 2000)
to business customers. The company has recently begun to sell Internet
access, and plans to ramp its data product initiatives later this year and
into 2000 as its long-haul network becomes operational. NEXTLINK has a solid
financial track record, meeting analyst expectations each quarter since its
IPO. Revenue is currently growing at a 70%-80% annual rate and we expect
three-year CAGR of 65%. We estimate that the company will hit its low point
EBITDA loss in 4Q99 or 1Q00 and hit EBITDA breakeven in late 2002. Craig
McCaw owns about one-third of NEXTLINK's stock and has voting control.
NEXTLINK Qwest WinStar
1998 Revenue Estimate 247M 3.5B 437M
Local Fiber 2150 Route Miles none Some in 6 Cities
Leased to MFN
Wireless Spectrum 136M none
POP Coverage
Long Distance 24 Fibers, 16kMiles 48 Fibers, 18.5k Miles 4 Fibers, 24kMiles
Fiber
Major Markets 10 fiber 70+ long distance 30 wireless
In Operation
Local Bottleneck Persists
Over the past few years, we've seen increasing investment at both the high
end of the business market (fiber CLECS) and the residential market (cable
modems and ADSL) in bypass technologies. Despite the investment, fiber
reaches less than 5% of all buildings and about 25%-30% of all lines. Demand
for high-capacity services has driven growth rates of 35-40% in T1s over the
past few years pushing RBOC installation times to 30-90 days. We expect this
growth will continue, driving a four-fold increase in T1 demand over the next
four years. We also see the possibility that new bandwidth-enabled
applications could drive bandwidth demands much higher over the next several
years.
Bypass
Customer Segment No. of Lines RBOC Technology Technology Acquisitions
Residential 100M ADSL Cable AT&T/TCI - $48B
Mid Sized Business 25-35M HDSL/SDSL Wireless
Large Business 25-35M Fiber Fiber AT&T/Teleport- $12B
WorldCom/MFS-$12B
Fiber/Wireless Provides Bypass for Majority of Market
Based on our analysis, we think that the combination of fiber and wireless
will provide the cheapest bypass for all but the smallest buildings. Fiber
costs between $100,000-$200,000 per building and is most economical for very
large buildings, and wireless costs about $20,000 per building, which means
lower capital costs per T1 for midsized locations.
$Capital/T1
Number of T1's Per Building 3 8 15 30 60 150
Size of Building* (sq ft) 10k 25k 50k 100k 200k 500k+
Fiber $19k $9k $5k $2k $.5k- $1k
Wireless 7k 4k 2.2k 1.7k 1.3k 1.0k
HDSL/SDSL 2.2k 2.2k 2.2k 2.2k 2.2k 2.2
Leased RBOC T1 19k 19k 19k 19k 19k 19k
*Assumes a 5x increase in demand and 20% market share for both wireless and
DSL CLEC.
BUSINESS DESCRIPTION: NEXTLINK is building a national end-to-end local and
long distance network using fiber and broadband wireless to bypass the RBOCs
to provide high-speed data and voice services to business customers.
1999 Should Be Key Year for Proving Wireless Model
We believe 1999 will be the key year for proving that the wireless model
works and we think NEXTLINK's, WinStar's and Teligent's success will be a
catalyst for NEXTLINK. Key milestones in 1999:
- Wireless lines increasing from 64,000 today (WinStar) to 27,000 by year-
end (WinStar + Teligent).
- Multipoint wireless technology deployed in 50% of Teligent's and WinStar's
hubs. Multipoint deployment is important because it provides the most
economical and practical architecture for large scale wireless deployment.
Point to point works today but multipoint is just being rolled out
commercially.
- Improvement in WinStar's gross margins from 12% in 4Q98 to 36% in 4Q99.
Our level of confidence is supported by recent events:
- WinStar has said it has reached 6% penetration in Millenium buildings and
that 90% of November and December sales in New York were to wireless
buildings. The company has radios deployed on all 1,000 Millenium buildings
today.
- WinStar has said that revenue in New York grew 30% from 2Q98 to 3Q98 and
that gross margins improved from 27% to 36%.
- Williams Communications Group struck a deal to buy 2% of WinStar's
capacity and Lucent has teamed with WinStar to help build the network. Both
provide evidence of outside endorsement of the technology.
We believe that long distance companies are potential wholesale customers or
acquirers of national fiber and wireless assets with the chances of deals
increasing as 1) the wireless model proves itself, 2) demand for high-
capacity services grows, and 3) the demand for integrated local/long distance
services pushes the long distance companies (including the incumbents, Qwest,
Level 3 and others) to add local capabilities. As RBOCs move closer to entry
into long distance we think long distance companies' need for integrated
local and long distance products increases.
WinStar and Williams struck the first such deal in December with Williams
buying 2% of WinStar's capacity. AT&T and MCIWorldCom bought high-bandwidth
national fiber CLEC assets (Teleport and MFS) as these models began to prove
themselves in 1996 and 1997. More recently, AT&T struck a deal with TCI to
provide high bandwidth services to the low end residential and small business
customers. The purchase price for Teleport and MFS was $12 billion apiece,
six times PP&E and about $350 per addressable line ($12 billion/35 million
lines). We note that none of the long distance companies have sizeable
wireless assets (AT&T has some) and Sprint, Qwest, Level3 and others don't
have any (or very little) local assets.
Valuation
We've valued NEXTLINK using a DCF assuming that NEXTLINK captures 5% share
of the $100 billion 2008 addressable market (so far NEXTLINK plans to cover
the top 30 markets, or roughly 50% of the 2008 $200 billion business telecom
market). We also note that we expect that wholesale revenues could reach $1+
billion per year, which reduces the retail share required. We've used 2008
EBITDA margins in the high 30%, 14%-15% discount rate and terminal EBITDA
multiple of 10-11, with a 25% public market discount. We believe that the
share and EBITDA estimates are reasonable given the cost advantages we expect
that national fiber and wireless technology will provide. CLEC models
generally assume that a CLEC captures 7%-10% market share by the terminal
year and has EBITDA margins in the high 20% to mid 30% range.
While NEXTLINK is trading at high near-term multiples versus other CLECS, we
believe that the cost advantages, national scale and scope and strategic
value justifies the premium. Teleport and MFS were both purchased for about
$12 billion, 6 times PP&E or about $350 per addressable line compared to the
current valuation of NEXTLINK of $125 per addressable line and 4 times year-
end 1999 PP&E.
Fully Current FV/Revenue(1) FV/PP&E(2)
Price Dil. Shrs. Net Debt FV '99 '00 '01 '99 '00 '01
NEXTLINK $36 3/16 62M $1.4B $3.7B 14.9x 11.6x 9.5x 3.9x 3.2x 3.1x
WinStar $31 3/4 60M $1.4B $3.3B 7.4x 5.5x 4.2x 3.5x 2.9x 2.5x
Teligent $34 62M $0.2B $2.3B 70.4x 21.3x 11.1x 6.2x 4.5x 3.8x
ICIX $20 5/16 49M $2.7B $3.7B 4.0x 3.3x 2.8x 2.2x 2.0x 1.8x
ICG $16 1/2 55M $1.2B $2.1B 3.7x 3.2x 2.7x 1.7x 1.6x 1.5x
McLeod $34 1/4 80M $0.8B $3.5B 4.0x 3.3x 2.7x 3.9x 3.1x 2.5x
Stock prices as of 2/18/99
NOTES
(1) Multiples are pro forma for projected net debt. Beginning of year firm
value vs. next 12 months revenue
(2) Multiples are pro forma for projected net debt. End of year firm value
vs. end of year PP&E.
Estimates
4Q98 1Q 2Q 3Q 4Q '99 '00
Revenue 43.1 50.1 57.5 65.6 74.2 247.3 409.6
EBITDA (41.4) (47.0) (52.6) (58.8) (65.1) (223.4) (224.4)
Lines 174.2 216.1 259.5 305.4 354.6
Major Markets 10 20 30
In Operation
Total Cities 36 45 60
BUSINESS DESCRIPTION: NEXTLINK is building a national end-to-end local and
long distance network using fiber and broadband wireless to bypass the RBOCs
to provide high-speed data and voice services to business customers. |
