4Q:04 Results
Overview
Based in Denver, Colorado, Time Warner Telecom Inc. is a leading fiber facilities-based competitive telecommunications provider. It offers local access for enterprise, carrier, and ISP customers. In addition it provides broadband connections for data, high-speed Internet access, local voice and long distance services. The company’s customers are mainly medium and large-sized telecommunications-intensive business end- users, long distance carriers, Internet service providers, wireless communications companies, and governmental entities. It is in 44 U.S. metropolitan markets in 22 states. It is 44% owned by Time Warner. The company website is-
With its unique metro fiber footprint, Time Warner Telecom seeks to leverage its fiber network by offering next generation IP/data services such as metro Ethernet. This provides TWTC excellent entrée into office parks and office buildings. It has credibility as a surviving telecom provider and has adequate liquidity for a few years. Progress is being made in enterprise sales, increased on-net buildings, sales force expansion, and operational efficiencies.
Rank within Telecom Services Industry 3 of 12
Key Positive Arguments / Key Negative ArgumentsUnique fiber footprint into office parks and office buildings / Top 10 customers provide 39% of total revenue
Strong enterprise growth outpacing carrier disconnects / AT&T and MCI acquisitions could result in revenue losses as migrate to Bell networks
Well positioned in smaller markets / Many customers have gone through restructurings and may have some collectivity risks
Solid margin progress / Continued weakness and pricing pressure in carrier market
Growth in data revenue to enterprise customers / Wholesale market weak
Growth in retail voice / Substantial debt of $1.25 billion
Strong management team / Technological substitution.
Credible track record / 44% Time Warner ownership potential overhang for investors
Adequate liquidity, fully funded business plan / Data growth slower than expected
Facilities based strategy fits well with recent FCC rulings / Inability to find sales personnel with data/IT skill sets
Introduction of VoIP products should accelerate growth / RBOC entry into LD market could threaten TWTC business relationships
Continued capital build-outs should magnify operational leverage / Regulatory risks
Potential to participate in industry consolidation as acquirer or takeover target / Longer term industry sector pressures.
Sales force expanded
Sales
TWTC Sales (M) / 4Q:04A / 2004A / 1Q05E / 2005EZacks / $168 / $647 / $170.6 / $693.0
High / $168 / $647 / $171.6 / $712.0
Low / $168 / $647 / $164.9 / $653.1
Average / $168 / $647 / $168.4 / $685.3
Please see the spreadsheet TWTC.xls for further details and estimates.
Revenue for 4Q04 was $168 million, as compared to $160.6 million for the third quarter of 2004, an increase of $7.4 million sequentially. In the 4Q 2003, revenue was $169.4 million. Excluding the bankruptcy settlement in the 4Q of 2003, the current quarter reflected an increase in revenue of $7.8 million.
Revenue generation from different segments in the current quarter:
- $5.0 million increase in revenue from enterprise customers, primarily from the sale of Data and Internet Services and an increase in favorable resolution of dispute & contract settlements.
- $2.2 million increase from carriers and ISPs, due to stronger sales and an increase in favorable resolution of dispute and contract.
Revenue generation from different segments in the year 2004:
- $12.7 million increase in revenue from enterprise customers, from sale of Data and Internet services.
- $0.4 million increase from carriers and ISPs.
- $4.0 million decrease from related parties, mainly due to a decrease in transport services being purchased by the company’s internet related businesses.
- $1.3 million decrease in intercarrier compensation due to reduced minutes of use and mandated rate reduction by the FCC.
Enterprise now contributes 53% of revenue, up from 49% at the end of 1Q:04.
The company continues to experience service disconnects.However, they decreased in the current quarter. Service disconnects resulted in loss of $2.1 million of monthly revenue for the current quarter, as compared to $2.7 million in the third quarter of 2004 and $2.9 million for the 4Q last year.
TWTC continues to grow retail voice and data revenue to enterprise customers.
The company is well positioned to benefit from growth in bandwidth demand in its metro area networks believes one analyst (Thomas Weisel). Typically it is positioned as the only last mile provider other than the local RBOC. Now in 44 markets across the U.S.,its networks cover 19,169 route miles and offers services to 19,213 buildings. These are served either entirely on net, 5,000, or providing a portion of the link through the use of another carrier’s facilities. TWTC has 40 class 5 switches and 12 soft switches.
One analyst (CIBC) considersTWTC is well positioned to capitalize on increased corporate IT spending. He thinks if TWTC sells more services per enterprise or sells bigger ticket items, the company will do well. According to the analyst (CIBC), the Carrier revenue was up an impressive $2.2 M sequentially (about $1 million adjusted), suggesting that the Carrier business continues to stabilize. In addition, the rate of disconnects decreased, a key factor for long term stability. According to the analyst, thecurrentquarter has been the best quarter for TWTC in recent memory. He considers enterprise growth the key to 2005, forecasting a 17.5% enterprise growth YOY, driving 10% core revenue growth, assuming the carrier business remains stable at about $65 million per quarter.
One analyst (Morgan Stanley) notes that obstacles with landlords seem to have been solved. Two thirds of the capital budget is planned for adding new buildings to the network as the company expands in existing markets.Growth in data and Internet revenue are key drivers for the company as it is marketing them to end user enterprise customers.
Pricing pressures remain strong and vary by product. It remains significant in Transport. In the Internet Access Market, TWTC believes it can compete well with its superior offerings and service compared to lower quality carriers who price aggressively. Data and Metro Ethernet pricing appears to be holding up well. Competition from the RBOCS, especially SBC, remains strong.
TWTC product groups are:
- Dedicated transport services
- Switched services
- Data and Internet Services
- Inter-carrier services
Carrier Consolidation: The acquisitions of AT&T and MCI by the Bells adds risk to at least a portion of TWTC’s business with those customers as the Bells could migrate these to their own networks.
New Products
The Company is building on the growing value of its networks, products and service. This includes an Ethernet foundation as a point of convergence. The Company plans to layer on VoIP applications to its network and expects to release these products in the first half of 2005.
One analyst (Thomas Weisel) feels that Time Warner Telecom’s Ethernet deployment should fuel growth because the technology is ubiquitous in PCs. Its speed is easily scalable from 10 Mbps to 1 Gbps. He feels the RBOCs have been slow to enter this product area because they do not want to cannibalize frame relay. It is expected to become a major revenue growth driver.
TWTC launched its Extended Native LAN service in the year 2003. This is delivered to enterprise customers over the company’s local and regional networks. In one analyst’s view (Morgan Stanley), this type of service represents the future growth driver. Other next generation products include Softswitch services and IP Centrex.
Operations and Structure:
Time Warner Telecom has a strategic relationship with AOL Time Warner and benefits through licensing agreements and the sharing of fiber optic infrastructure cost. This lets TWTC benefit from Time Warner Cable’s right of way, easements, poles, ducts, and conduits notes one analyst (Thomas Weisel) in 23 of its 44 markets. This relationship also enables it to derive economies of scale and extend its networks faster and more efficiently than its competitors can.
Cap exwas $49.4 million for the quarter compared to $44.9 million in the 4Q 2003. For the year, the capital expenditures totaled to $171.8 million. For 2005, the Company expects capital expenditures of $160 to $175 million, which includes the cost of continued expansion of its network and product offerings. TWTC only pursues projects with an adequate ROIC. The capex spend for VoIP will step down dramatically in 2005 from the $9 million and $8 million spent in 3Q:04 and 4Q:04 respectively.
Analyst (Raymond James) believes the company could cut cap ex to 8% to 10% of revenue based on other CLECs’ current spending levels. Another (Thomas Weisel) anticipates capex will be $175 million and sees it as indicator that business is moving through an inflection point that will accelerate top line growth.
TWTC has $433 million in cash and no debt maturities until 2008 notes one analyst (Thomas Weisel). He notes that it has a fully funded business plan. It does however have substantial debt of $1.25 billion.This analyst projects FCF by 2006.
Time Warner Telecom expanded its sales force another 5% YOY after a 30% expansion in 2003. One analyst (Thomas Weisel) projects the force of 296 at the end of 2004 to grow to 321 end of 2005, and to 341 by the end of 2006.
Time Warner’s 44% ownership could provide an overhang for investors. One analyst (Thomas Weisel) notes that its dual-class share structure in which Class B Stockholders receive 10 votes per share as opposed to 1 vote per share for Class A may cause Class A Stockholders to question whether Class B votes will be in their best interest. Approximately 93% of voting power is controlled by the Class B shareholders who essentially control all issues requiring stockholder approval.
Margin
TWTC EBITDA margin was 33% for the current quarter, compared to 35% for the same period last year, or 31% excluding the MCI bankruptcy settlement. Gross margin was 60% for the current quarter, compared to 61% for the same period last year, or 59% excluding the MCI bankruptcy settlement,
TWTC’s facilities based networks create higher margins than non facility based carriers can achieve.
Carrier revenue is high margin revenue so disconnections in this space hurt TWTC margins. As Carrier revenue becomes a smaller part of TWTC revenue mix, the company will become more stable.
For more margin details please see the TWTC.xls spreadsheet.
Earnings Per Share
For more detail, please see the TWTC.xls spreadsheet
TWTC / 4Q:04 / FY-2004 / 1Q:05 / FY 2005EZACK Consensus / ($0.31) / ($1.17) / ($0.28) / ($1.08)
High Estimate / ($0.31) / ($1.15) / ($0.25) / ($0.89)
Low Estimate / ($0.31) / ($1.15) / ($0.35) / ($1.18)
Average Estimate / ($0.31) / ($1.15) / ($0.27) / ($1.01)
The net loss per share for the full year 2004 was $1.15 as compared to a net loss of $0.78 loss per share for 2003. Included in net loss was a favorable impact for MCI bankruptcy settlements of $0.02 and $0.26 per share, for the year 2004 and 2003, respectively. The increase in net loss reflects increased interest costs, including a retirement of $8.9 million of deferred loan costs in conjunction with a refinancing during 2004, and higher depreciation reflecting the Company’s increased network investment in 2004.
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Target Price/Valuation
Out of sixanalysts,two(Janco, Thomas Weisel) gave a positive (Buy) rating.
Three have given a negative rating and oneanalyst projected a neutral rating. One (Thomas Weisel) uses a DCF model with a WACC of 14%, secular growth of 5% and a 30% public/private discount. This method results in a fair value of $6 per share, or 6.6 x 2005E EBITDA, a slight premium to the RBOCs.
Rating DistributionPositive / 40%
Neutral / 20%
Negative / 40%
Avg. Target Price / $10.00
For more detail, please see the TWTC.xls spreadsheet.
Long-Term Growth
Long term growth potential looks good for TWTC. Most of the analysts (Bear Stearns, Raymond James, CIBC, Morgan Stanley) agree that TWTC has a credible track record and is well positioned for growth with its fiber footprint to office parks and buildings. It is well positioned to access the enterprise market while providing competitive access and transport to carriers who need alternatives to the Bell networks. TWTC has a nationwide presence with metro fiber rings in 44 markets. This provides connectivity to nearly 19,000 buildings. A cyclical recovery in its enterprise market would find TWTC well positioned..
One (Thomas Weisel) views the competitive position as an improving one for the facilities-based CLECs, as the coming demise of the UNE-Ps highlights the value of last mile assets and RBOCs remain under pressure from CLECs, wireless and cable. Technological advances such as VoIP and metro Ethernet have reduced the capital requirements of competing profitably.
One analyst (Bear Stearns) sees MCI potentially continuing disconnects. Combined with other carrier disconnects, he sees this swamping growth in the enterprise market. Another analyst (Raymond James) sees the over 20% growth in the enterprise business eventually driving profitability but believes this continues to be beyond the investment horizon. A third analyst (Morgan Stanley) gives a rating of Equal-weight which reflects short term challenges, long term opportunities.
Key Events & Dates
1Q:04 Earnings Release April 29, 2004
2Q:04 Earnings Release August 5, 2004
3Q:04 Earnings Release: November 4, 2004
4Q:04 Earnings Release February 2, 2005
Individual Analyst Opinions
POSITIVE RATINGS
Janco-Buy ($10.00) Report Date: 2/2/2005: The analyst expects a continued sales momentum, improved cash flow and deleveraging to move the stock price higher. The one year target given by the analyst is $10.00.
Thomas Weisel – Outperform (No Price Target) Report Date: 2/10/2005: This analyst has upgraded to an Outperform from Peer Perform. He expects the company to report improving results for 2005 based on rising enterprise sales, improving carrier sales, and FCF by 2006.
NEUTRAL RATINGS
Morgan Stanley – Equal-Weight – (No Price Target) Report Date: 2/2/2005-
This analyst’s rating reflects a favorable long-term growth prospect and strong liquidity offset by the near term challenge of growing revenue, generating earnings, and free cash flow. He expects TWTC stock to move with the Telecom Services group. Significant growth is yet to resume, sustained FCF is at least 12 months away, the high debt load is high and EPS is negative
NEGATIVE RATINGS
Bear Stearns – Underperform (No Price Target) Report Date: 2/2/2005: Revenue growth remains elusive as carrier disconnects continue to offset gains in the enterprise area. Bear maintains the Underperform rating because of the continued weak fundamentals.
CBIC World –Sector Underperformer (No Price Target) Report Date: 2/3/2005: The analyst feels that term growth is muted due to high churn among carriers and enterprises and a slow IT sales cycle. He recommends waiting for fundamentals to improve and for a more attractive entry points for investors.
Raymond James – Underperform –(No Price Target)Report Date: 2/3/2005:According to the analyst, the stock implies the company has hit an inflection point on revenue growth However, he raises questions on the economics behind accessing buildings and spending cap ex at such high levels in the current environment. The analyst has given an underperform rating without any price target.