Grubman on NXLK: RAISING PRICE TARGET TO $120: REITERATE BUY RATING
Salomon Smith Barney
Wednesday, May 26, 1999
--SUMMARY:--NEXTLINK Communications, Inc.--Telecommunications Services
*We are raising our price target on NXLK to $120 based on a new 10-year dcf
model which reflects NXLK's new data strategy driven by its fixed wireless,
long-haul & local fiber and DSL assets. *Since its Sept. 97 IPO, NXLK has
emerged from a clec into a fully-integrated communications provider. *We
view NXLK as a core holding to any telecom portfolio and reiterate our Buy
rating on the shares.
--EARNINGS PER SHARE--------------------------------------------------------
FYE 1 Qtr 2 Qtr 3 Qtr 4 Qtr Year
Actual 12/98 EPS $(1.19)A $(1.42)A $(1.57)A $(2.07)A $(6.26)A
Previous 12/99 EPS $N/A $N/A $N/A $N/A $(9.30)E
Current 12/99 EPS $(2.17)A $(2.67)E $(2.79)E $(2.92)E $(10.65)E
Previous 12/00 EPS $N/A $N/A $N/A $N/A $N/A
Current 12/00 EPS $N/A $N/A $N/A $N/A $(13.30)E
Previous 12/01 EPS $N/A $N/A $N/A $N/A $N/A
Current 12/01 EPS $N/A $N/A $N/A $N/A $N/A
Footnotes:
--FUNDAMENTALS--------------------------------------------------------------
Current Rank........:1S Prior:No Change Price (5/25/99).....:$76.12
P/E Ratio 12/99.....:N/Ax Target Price..:$120 Prior:50.00
P/E Ratio 12/00.....:N/Ax Proj.5yr EPS Grth...:N/A%
Return on Eqty 98...:N/A% Book Value/Shr(99)..:4.50
LT Debt-to-Capital(a)86.9% Dividend............:$N/A
Revenue (99)........:242.7mil Yield...............:N/A%
Shares Outstanding..:76.2mil Convertible.........:No
Mkt. Capitalization.:5800.3mil Hedge Clause(s).....:#
Comments............:(a) Data as of the most recently reported quarter.
Comments............:
--OPINION-------------------------------------------------------------------
We are raising our price target on NEXTLINK to $120 per share to reflect
an expanded business model, which is a function of NXLK having
dramatically expanded its set of assets over the last six months. As
background, when we brought NXLK public in Sept. of 1997, the company was
essentially a clec operating in roughly 20 markets addressing roughly 11
million business lines. At the time of the IPO, we viewed NXLK as being
one of the very highest quality clecs with superb management and terrific
sponsorship in the form of Craig McCaw. In fact, NEXLINK's operating
performance since the IPO justified our view on the company.
NEXTLINK EMERGES AS A FULLY-INTEGRATED COMMUNICATIONS PROVIDER
However, over the past 18 months, NXLK has dramatically expanded its
asset base and as such graduated from the ranks of clecs to clearly a
nationwide integrated communications provider. To review, NXLK now has
fixed wireless licenses in 65 markets with at least 1.1 gigahertz of
spectrum in each of these markets at the 28 gigahertz level. In
addition, NXLK has expanded its fiber network builds to 60 markets
addressing almost 30 million business lines. Furthermore, NXLK (via its
INTERNEXT purchase from Level 3) will own 24 strands of fiber plus a
spare conduit on the Level 3 network as well as the option to purchase
25% of capacity on Level 3 in conduits 6 through 10. Thus, when one
steps back, NXLK has very forcefully catapulted itself into the ranks of n
ationwide integrated communications providers selling voice, data and IP
services to business customers. NXLK has a full suite of local access
technologies with its own local and long-haul fiber, fixed wireless, DSL
relationships with Covad and others, plus its own DSL platform via
proprietary Bell collocations.
FIXED WIRELESS FILLS THE SWEET SPOT BETWEEN FIBER AND COPPER
As we detailed in our January 15, 1999 note, NEXTLINK significantly
enhanced its portfolio of assets in two separate transactions during the
quarter. First, NEXTLINK is acquiring WNP Communications for $695
million. WNP was formed solely to acquire licenses in the recent LMDS
auction of 28 gigahertz 2-way high-frequency fixed wireless spectrum.
Secondly, NEXTLINK announced a plan to acquire NEXTEL's 50% interest in
NEXTBAND. NEXTBAND was a joint venture between NEXTLINK and NEXTEL which
bid in those same auctions and owns 13 A block LMDS and 29 B block LMDS
licenses. NEXTLINK will pay $137 million in equity for NEXTEL's half of
NEXTBAND.
NEXTLINK is acquiring a huge swath of bandwidth with these transactions.
At the end of the day, NEXTLINK will acquire 39 A block LMDS licenses
from WNP covering 98 million pops and 1 B block LMDS license covering 16
million pops. With the NEXTEL deal, NEXTLINK will have full ownership of
13 A block licenses and 29 B block licenses. NEXTLINK will have full
ownership in 82 combined markets, 17 of which overlap, so they will have
ownership of 65 distinct markets with an average of 1.1 gigahertz or 1150
megahertz in each market. This will give NEXTLINK by far the largest
swath of capacity in the most places of any player in the fixed wireless
arena. We view NXLK's bullish stance on fixed wireless as a validation
of both WinStar and Teligent, which are the only two other players which
have fixed wireless spectrum on a nationwide basis.
OUR EXPANDED MODEL RESULTS IN A PRICE TARGET OF $120
As a result of this expanded asset base, we have essentially doubled the
2008 revenues from slightly over $5 billion to $10.7 billion with 80%-85%
of this incremental revenue coming from provisioning data services made
possible by NXLK's fixed wireless footprint in the local loop as well as
its owned and operated long-haul fiber facilities. We have only slightly
increased our assumptions of voice penetration and have only given NXLK
an extra 1%-2% market share in 2008.
Just as important as the revenue pick up is a significant margin pickup.
In our original model, we were looking for 35%-40% EBITDA margins in
2008. We now believe that NXLK can see EBITDA margins in the low to mid
40% range in the out years. Roughly two-thirds of this pickup is a
direct function of having fixed wireless spectrum in the local loop.
Fixed wireless is truly the sweet spot between copper and fiber. While
nothing beats light over glass, the fact is that fiber will be too costly
to put into every building in the U.S. Thus, while at the end of the day
one-third of business lines will be in buildings served by fiber,
two-thirds will not. Fixed wireless allows NXLK to provide up to an OC-3
worth of capacity to end users in buildings where fiber can not cost
effectively reach. This fixed wireless extension of the fiber network
will allow NXLK in any given market, to more than double its on-net lines
relative to a fiber only network. This has a dramatic improvement in
gross margins and thus EBITDA margins. The other one-third of EBITDA
margin pick-up versus our original model directly correlates to the
ownership of long haul facilities which allow NXLK to offer on-net voice,
data and IP services on a long-haul basis.
We derive our $120 price target from a 10-year dcf model which we believe
is the best way to value this space since each company is in a different
stage of development. Our dcf model is driven by a 15.5% discount rate
and a 10x 2008 FV/EBITDA multiple which implies a mid 20x steady state
p/e and a free cash flow growth rate in perpetuity of roughly 10% which
we view as quite reasonable. From a market capitalization perspective,
even at $120 per share, NXLK would only have a market cap less than $10
billion which we believe is quite low still for a company which will have
a set a nationwide assets both on the long-haul broadband side as well as
a full suite of high-speed broadband connectivity at the local loop.
Thus, we believe that as NXLK continues to execute its business plans
against this broader array of assets, its ultimate market capitalization
will be multiples of where our price target is.
The bottom line is that NXLK within the span of 1.5 years since its IPO
has dramatically expanded its addressable opportunity by very smartly and
opportunistically piecing together a set of nationwide local and
long-haul broadband assets that have allowed NXLK to very quietly
catapult itself into the realm of nationwide integrated communications
providers. Thus, its addressable market has expanded from islands of
clec opportunities to the entire nationwide opportunity to serve the bulk
of business customers. As a result, our new price target reflects the
reality of this opportunity and the management expertise that resides
within NXLK we believe will allow it to maximize its opportunities.
1Q RESULTS HIGHLIGHTED BY STRONG EXECUTION
We did not publish a call note when NXLK reported 1Q99 results on 4/28/99
since we were in a quiet period due to the recent equity and high yield
offerings so we will point out the highlights from the quarter at this
time.
NEXTLINK Communications reported a strong first quarter with
exceptionally strong line growth as the company continues to prove its
execution expertise. As we have stated in the past, NEXTLINK's fiber
assets, combined with fixed wireless (which expands NXLK's on-net
addressable market with significantly increased provisioning time into
hours instead of days or weeks), DSL (which allows NXLK to offer more
bandwidth at cheaper costs for customers served by copper) and long haul
assets via its INTERNEXT investment in Level 3, will allow it to further
penetrate its existing markets at attractive margins as well as expand
its addressable markets.
Specifically, the company reported total revenues for the first quarter
of 1999 of $48.6 million, up 12.3% sequentially from 4Q98 and up 83.0%
from 1Q98. CLEC revenues grew 28% to $34.9 million up from the 26%
growth seen in 4Q98. CLEC revenues included switched and dedicated
services revenues that are generated from NEXTLINK's competitive local
exchange services. We view NXLK's CLEC revenues as extremely high
quality revenues as NXLK has less than $0.5 million in revenues from
reciprocal compensation and less than 1% of revenues driven from TSR or
total system resale lines which carry low margins. Net losses for the
quarter were $2.17 per share, slightly better than our estimate of $2.36
per share.
Although NXLK reported revenues in-line with expectations, access lines
installed were ahead of expectations by 25% with an exceptionally strong
March. Access line additions of 50,531 were up 26% sequentially from
4Q98 net adds of 40,075. Since access line additions is a leading
indicator of future revenue growth we have an increased confidence level
in our revenue estimates of $250 million in 1999 growing to $480 million
in 2000. NXLK usually provides large price discounts & incentive plans
when entering new markets to start to gain a brand awareness in a market
with many sales driven by referrals in the second phase of market
rollout. In this second phase, the price discounts decrease and NXLK is
able to drive revenue per line per month higher.
Of the 224,713 access lines in service at the end of the quarter, roughly
18% are on-net, 80% on-switch and only 2% resale. This line count
reflects increasing lines per customer. Across NEXTLINK's customer base,
the average is 11 lines per customer. In newer markets, though, NEXTLINK
is averaging 16 lines per customer. With this, the company is also
increasing its take rate of long distance from an average of about 50%
across its installed base to the 60%-70% range for new customers.
CLEC revenue per line per month averaged $56, with roughly $40 from local
services and $16 from long distance. As NXLK increases is long distance
take rate this revenue per month figure could drive into the $75-$80
range. NXLK looks at its markets in three groups (the class of '96, '97
& '98) divided by the year in which operations began. For the class of
'96, revenues were in the $62 per line per month range with a positive
EBITDA margin. Also just looking at the class of '96, on-net lines
(where NXLK has fiber to the buildings) are in the 20%-30% range. As,
NXLK penetrates these class of '96 markets with fixed wireless and DSL,
we expect overall gross margins to grow from the 60% level towards the
80% level. For the class of '97 revenue per line per month averaged
roughly $57 and this group of markets is on-track to meet the goal of
being EBITDA positive in the 30 month time period after beginning
operations.
CAPEX totaled $112 million for the quarter with the company on-track to
meet its stated goal of deploying $600 million in capital during 1999 to
fuel its fast growing revenue stream. Gross PP&E ended the quarter at
$801 million. NXLK ended the quarter with 2,897 route miles up from
2,477 in 4Q98, 223,463 fiber miles up from 195,531 in 4Q98, 854 on-net
buildings connected up from 801, and 13,950 off-net (but on-switch)
buildings up from 13,443 last quarter. NXLK had 22 switches installed at
the end of the quarter up from 21 in December. NXLK ended the quarter
with 2,539 employees up from 2,299 in December with salesreps increasing
by 109 in the quarter to end March at 420. NXLK successfully staffs many
provisioning personnel as well as customer care reps in the field to work
along side the salesforce in order to not only sell effectively, but
provision effectively and offer its high quality of services to its
customers.
NET/NET: We would be aggressive buyers of NXLK. We think NXLK should be
an absolute essential core holding in any telecom portfolio. |
