<..Kastan and Reingold are almost right on and even more bullish @ $140 for NXLK..>
Investment Highlights:
· Upgrading to a Buy opinion for both the
intermediate and long term.
· Raising 12-18 month DCF-based price
objective to $140 or 84% upside based on the
average of our YE'99 and YE'00 estimates.
Fundamental Highlights:
· Successful completion of follow-on equity &
high yield offering gives NXLK strongest
funding position in sector. Current plan now
funded into 1H01.
· National data strategy announced which we
estimate will contribute almost $5B in
revenues and $2.2B in EBITDA by '08.
· Revising FY'99 and FY'00 forecasts to reflect
slightly slower growth in non-CLEC revenues
and wider EBITDA losses to fund the rollout
of data and wireless broadband services.
· Raising long term revenue and EBITDA
forecasts to reflect both the new data initiative
as well as an increased est. of NXLK's
addressable market -- both local and LD.
· Potential to expand business plan into Europe
via network swaps with European telecom cos.
Follow-On Stock & Bond Offerings Done, Data
Strategy Announced; Reinstating Coverage With A
Buy Opinion, Raising 12-18 Month Price Objective to
$140 or 84% Upside
Following the successful completion of both a $580M
follow on stock offering (4.2M primary shares and 3.4M
secondary shares) and a $1B high yield bond offering, we
are upgrading our opinions on NEXTLINK
Communications (NXLK) to a Buy for both the
intermediate and long term. Our previous opinions were
intermediate term Accumulate and long term Buy.
Our more aggressive stance on this stock is based on 7 key
factors:
1) National data strategy announced which we now
estimate will contribute almost $5B in revenues and
$2.2B in EBITDA by '08;
2) Increased estimate of NXLK's addressable local
market in light of the increased local reach afforded
by company's LMDS (28 GHz) wireless broadband
licenses;
3) Increased estimate of NXLK's addressable long
distance market as a result of network agreement with
Level 3;
4) Strongest funding position in CLEC (competitive
local exchange carrier) sector further enhanced by
recently completed equity and high yield offerings.
We view NXLK's access to capital as an important
strategic asset – one that clearly differentiates the
company from most other CLECs. This proven ready
access to capital gives us a high degree of confidence
that the company will be to fund new internal growth
opportunities as well as possible acquisitions.
Available funds totaling $2.5B (cash on hand, offering
proceeds plus an anticipated $500M bank facility)
should fund the company's current business plan into
1H01;
5) Impressive portfolio of broadband network facilities
including 2,400 local fiber route miles in 23 markets,
wireless broadband licenses covering 150M POPs in
total and 95% of the POPs in the top 30 US markets,
DSL both in-house with 150 central office colocations
and via the Covad partnership, as well as 16,000 miles
of long haul fiber and an empty conduit from Level 3;
6) Potential to significantly expand the current business
plan into Europe via local/long haul/wireless network
facility swaps for fiber network and/or wireless
broadband capacity in Europe; and,
7) Attractive current valuation vs. our revised 12-18
month price objective of $140 which is an average of
our YE'99 and YE'00 private market value estimates
derived from our 10 year DCF model.
New Data Strategy Announced: Coincident with the
announcement of the combined equity and high yield bond
offerings, management announced a national data
initiative. This new strategy will expand the company's
product set to include data services (i.e., internet services,
web hosting, frame relay and ATM) for the first time and
will leverage NXLK's local fiber, broadband wireless
licenses and long haul fiber facilities. As detailed in Table
1 below, we estimate that NXLK's national data market
opportunity totals $20B today, growing 26% per year on a
compound average basis to $164B by YE'08. Our model
assumes that NXLK's share of this data opportunity grows
from minimal levels beginning in '00 to 3% by '08.
Incremental profitability of this new service initiative
should be quite attractive as NXLK will leverage its
existing sales and network infrastructure to a high degree
and we expect that data EBITDA margins should reach
45% by '08.
Table 1: National Data Opportunity & Forecast
($ in millions) 2000E 2003E 2006E 2008E
Data Market 30,000 65,800 117,000 164,400
NXLK Data Rev's 10 658 2,575 4,931
Share NM 1.0% 2.2% 3.0%
EBITDA Contribution 1 250 1,133 2,219
Margin 10.0% 38.0% 44.0% 45.0%
Source: Merrill Lynch estimates
Expanded Addressable Local And Long Distance
Market Forecasts: We have revised our forecast model
to reflect, for the first time, the significant expansion of
both NXLK's addressable local and long distance market
from: 1) the utilization of its LMDS licenses which will
complement existing and planned local fiber network
deployment to broaden local network reach; and, 2)
meaningful expansion of NXLK's addressable long
distance market via the utilization of the 16,000 fiber route
miles (24 strands) of long haul capacity, one empty 16,000
mile long conduit plus the right to purchase, at cost, up to
25% of the dark fibers pulled through conduit #6 and
above in Level 3's long haul network.
Addressable Local Market Assumptions: As detailed in
Table 2 below, we now estimate NXLK's addressable
local market at $31.5B for '00, eventually reaching $50.7B
by '08 or a 34% expansion vs. our previous estimate. No
change to our assumption that NXLK's share of its
addressable local market grows to 5.5% by ‘08.
Addressable Long Distance Market Assumptions: Also
as detailed in Table 2 below, we have revised our estimate
of NXLK's addressable long distance. We now peg the
‘00E long distance opportunity at $12.0B or a 38%
increase vs. our previous estimate, eventually growing to
$19.1B by '08 or a 38% expansion vs. our previous
estimate. Our model now assumes that NXLK's share of
its addressable long distance will reach 8.6% by ‘08E, up
70 basis points vs. our previous forecast.
Estimate Changes: As shown in Table 3 below, we have
revised our '99 and '00 forecasts to reflect: a) a slightly
more conservative revenue forecast as increased switched
revenue growth coupled with the rollout of data service in
'00 is more than offset by slower growth in dedicated and
"other" revenues (i.e., long distance resale and shared
tenant services); b) a widening of EBITDA losses due to
the additional costs associated with the rollout of both data
and wireless broadband services; and, c) higher cap exp
associated with accelerated investment in local market
infrastructure combined with extra spending tied to the
rollout of data and fixed broadband wireless services.
Table 2: Revised Addressable Market Forecasts
($ in billions) 2000E 2003E 2006E 2008E
Local Addr. Market - Old 25.7 29.7 34.4 37.9
Local Addr. Market - Revised 31.5 37.6 44.9 50.7
% Change 23% 27% 31% 34%
Long Distance Addr. Market - Old 7.4 9.4 11.8 13.8
Long Distance Addr. Market - Revised 12.0 14.3 17.0 19.1
% Change 62% 52% 44% 38%
Source: Merrill Lynch estimates
Table 3: Forecast Revisions -- '99 & '00
($millions)
Old
'99E
New
'99E % Chg
Old
'00E
New
'00E % Chg
Revenue
Switched (Local & LD) 130.4 168.2 29% 357 367.7 3%
Dedicated & Data 69.6 33.9 -51% 77.3 60.0 -22%
Other 61.0 57.5 -6% 59.2 55.8 -6%
Total Revenue 261.0 259.6 -1% 493.5 483.5 -2%
EBITDA (206.2) (220.0) NM (148.1) (278.0) NM
Line Adds (000's) NA 228 -- NA 290 --
Cap Exp 550.0 616.0 12% 700.0 1,200.0 71%
Source: Merrill Lynch estimates
As shown in Table 4 below, we have adjusted our long
term forecast model to reflect: a) a more aggressive
outlook for revenue growth as a result of the newly
announced national data initiative, an expanded
addressable local market and deeper assumed penetration
of the long distance opportunity; b) slower ramp up of
positive EBITDA until 2H04 when stronger margins more
than offset additional start up costs associated with data
and wireless broadband services. EBITDA break-even
now estimated to occur during 1H03 vs. our prior
expectation of 2H02; and, c) higher cap exp spending
associated with both the new data initiative and rollout of
wireless broadband facilities.
Table 4: Long Term Forecast Revisions
($millions)
Old
'02E
New
'02E
%
Chng
Old
'05E
New
'05E
%
Chng
Old
'08E
New
'08E
%
Chng
Revenue
Switched 992 1,066 7% 2,066 2,495 21% 3,453 4,222 22%
Ded & Data 95 358 277% 130 1,886 1351% 178 5,109 2770%
Other 57 53 -7% 54 53 -2% 54 55 2%
Total Revs. 1,144 1,477 29% 2,250 4,434 97% 3,685 9,386 155%
EBITDA 23 (89) NM 641 1,219 NM 1,437 3,989 NM
Margin 2% NM 28% 27% 39% 43%
Cap Exp 550 1,100 100% 100 950 850% 50 900 1700%
Source: Merrill Lynch estimates
Europe May Be In The Cards For NXLK Via Swaps Of
Network Assets: We understand that management is
considering the expansion of its business plan to include
the European telecom market – CLEC, intra and inter-country
long haul and we suspect transatlantic services as
well. Market entry most likely would be accomplished via
a swap of NXLK's US broadband network facilities (local
fiber, broadband wireless and/or Level 3 long haul
capacity) for similar network infrastructure in Europe
and/or under the Atlantic Ocean. Although we would view
the announcement of a definitive European strategy as a
major positive, we make no change to our 10 year model at
this time until we have a better understanding of the
timing, magnitude and costs involved.
Raising 12-18 Month Price Objective To $140 Or 84%
Upside: As a result of the significant forecast revisions
detailed below, we are raising our 12-18 month price
objective to $140. Our new price objective is based on the
average of our YE'99 and YE'00 private market value
estimates which is derived from our revised 10 year DCF
(discounted cash flow) model. Key assumptions in our
DCF analysis include a 15% discount rate, an 11.0x
multiple on terminal year EBITDA, a 42.5% terminal year
EBITDA margin, 5.5% share of its addressable local
market by '08 and no public market discount.
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