Description
Once a company valued at over $60 billion, Global Crossing’s complex bankruptcy process has masked an excellent investment opportunity. Global Crossing’s IP Network, which cost more than $10 billion to build, can now be had for a little over $1.35 billion. A number of catalysts should occur in 2004 that should drive the stock to $50 a share.
Complex Bankruptcy Process
Global Crossing has been in bankruptcy since January 2002, a considerably long time. Gary Winnick and former management had made Global Crossing a far flung empire with massive debts and misleading financials. Unraveling the revenue swaps and other underhanded financial dealings took time. Also, Global Crossing has been losing lots of money during the bankruptcy process. Then the process was complicated when Hutchinson Whampoa wanted to majority purchase Global Crossing. This riled up politicians and regulators fearful of a foreign owner of its valuable assets. In particular law enforcement agencies were worried Hutchinson would be able to compromise FBI and other agencies’ telecommunications. This has been resolved after Hutchinson dropped out, and Singapore Technologies Telemedia made the purchase instead, after undergoing vigorous government negotiations.
As part of its complex bankruptcy, Global Crossing has been very slow releasing financial information. In fact, they just released their 3 10-Qs for 2003 on December 23rd, which means analysts are still digesting news released about two and a half weeks ago.
The company exited bankruptcy on December 9th, 2003.
Capital Structure and Ownership
The new Global Crossing has $200 million in debt, owed to STT (should be about $20 million a year in interest expense) and $244 million in capital leases (mainly due to their marine subsea fiber installation unit). The company will have 40 million shares, including 16 million shares in the float. STT owns the rest (broken down as 6 million shares common stock and a convertible preferred that converts at 1-1 and represents 18 million shares). In summary, STT will own 61.5% of the company.
As of December 9th, the company had $367 million in cash and another $12 million in restricted, which should be released as it was restricted because of the bankruptcy process. So, currently net debt is only $65 million. So, the entire enterprise value is about $1.35 billion. Assuming the company burns through $100 million from exit costs and burns another $100 million from operations (unlikely, but let’s assume for conservatism’s sake), the enterprise valuation is about $1.55 billion.
This is a strong balance sheet for a company that once had $12 billion in debt, and even in the worst scenarios of cash burn, has a majority owner to depend on with substantial resources (STT is worth around $14 billion).
What does Global Crossing do now?
Global Crossing (GC) operates two divisions now, Telecom Services and Global Marine Systems. GMS installs marine fiber optics, and should be deemphasized going forward and only represents around 6% of revenue.
The business GC now focuses on is Telecom Services using its Internet Protocol (IP) based network, which consists of nearly 80,000 miles of fiber in over 200 cities, most of whom are in the U.S. GC’s fibers transmit voice and data from wireline, wireless and Voice over IP connections.
The markets in the cities GC operates in represent 85% of the world market for telecommunications services. The Company serves many of the world’s largest corporations, including more than 75,000 carriers, enterprise and government customers worldwide. Telecom Services represents 94% of 2003 estimated revenue.
Business has been hit hard by bankruptcy
Revenues were hit hard during the bankruptcy process as commercial and industrial customers were not willing to rely on a bankrupt provider of essential voice and data services.
For example, even though conferencing service revenue has been up across the industry, in the first nine months of 2003, conferencing services revenue for GC was down a whopping 31%. Commercial channel sales fell 17% as a whole through the first nine months of 2003. Data revenue was down 13.3% year over year. These three sources of revenue make up the commercial revenue. The main clients of commercial revenue are the corporations that for two years have fled GC.
Encouragingly, the revenue declines have dramatically slowed sequentially, and in some cases shown flatness sequentially. For example, data revenue was essentially flat from q2 to q3. Telecom revenue in total was down only $2 million in q3 from q2.
Interestingly carrier sales channel saw a 7% increase in revenue year over year. “Our bankruptcy has had less of an impact on carrier revenue as carriers often use several suppliers to meet their traffic demands and many of our competitors have also filed for bankruptcy protection in 2002, which has allowed us to attract additional carrier customers and increase our sales to certain existing carrier customers.” (q3 10-Q)
I expect that commercial revenue will start showing increases now that the company is out of bankruptcy. This increase should not need significant extra expenses.
Restructuring in Bankruptcy
Beyond shedding $12 billion in debt, the company took advantage of bankruptcy by reducing employee headcount from 9,754 to 5,245, and reducing facilities from 1,100 to 900. Operating expenses including depreciation and amortization fell from $5.8 billion in 2001 to $3.6 billion in 2002, and operating expenses should be about $3 billion in 2003.
Further restructuring gains should come from the Global Marine division in the form of restructured capital leases. I expect the company to manage this division to a flat EBITDA from a loss of about $6 million a quarter.
Access Costs Should Fall
Access Costs primarily includes usage based voice charges paid to local exchange carriers and inter exchange carriers to originate and/or terminate switched voice traffic; charges for leased lines for dedicated facilities and local loop (“last mile”) charges from both domestic and international carriers; internet exit charges incurred in transporting IP traffic and other enhanced services usage based charges; and third party maintenance costs incurred in connection with maintaining the terrestrial network, subsea fiber optic network and its cable landing stations. (Q3 10-Q)
Access Costs are the major cost item for GC. In 2003, access costs are estimated to be 73% of revenue. This is down from 2002’s level of 76% of revenue. What is fascinating is that the company has used bankruptcy to renegotiate facilities based charges to lower its access cost as a percentage of revenue. The company also has optimized their IP network to more efficiently use facilities. Data and conferencing services are higher margin products and result in lower access costs. So, for voice revenue to increase and data and conference revenue to plunge, but access costs as a percent of revenue to still fall around three percentage points is a big deal.
When commercial business ramps back up access costs should fall, and in the second half of 2004 as this revenue returns, access costs could fall substantially. The real opportunity is what access costs could be in 2005 and beyond.
A play on Voice over IP (VOIP)
Voice over IP is real time voice conversation between computers. Your voice conversations are sent in data packets along the internet as opposed to over the telephone wires. Costs are a fraction of the price of telephone conversation. The big problem to date has been the quality of the phone call, but with fiber and broadband this is all changing.
GC could benefit in two ways from VOIP. First revenue could expand as companies who normally do not do much business with GC, such as cable companies, start using GC’s IP network to sell long distance service to consumers.
But more importantly, as cited above, data is a higher margin product for GC. Margins should be much higher and access costs should fall.
VOIP could be a cause for a higher multiple on cash flow going forward, once people realize how GC benefits from VOIP.
A current darling of the VOIP crowd is Net2Phone (NASDAQ: NTOP), sells for over five times revenue, and has been very strong recently. While an extreme example, it nonetheless shows the cache bestowed on companies involved in perceived exciting companies.
Estimating 2004 and Beyond
In 2004, I estimate GC will see sales growth of 3.6% in telecom sales to $2.9B, and total revenue of $3B. I assume access costs will fall to 72% of telecom revenue and that other expenses will run slightly less than the current $58 million a month, management said it was running at in December. With those assumptions, GC throws off $222 million in EBITDA. Capex should run at $150-$160 million, though that may be high. Management has said capex is running at $14 million a month.
In 2005, I estimate 5% sales growth in telecom to $3.05B, and total revenue to $3.2B, and I estimate access costs will fall to 70.5% of revenue. I also estimate other expenses falls to less than $56 million a month. In 2005, GC should produce close to $350 million in EBITDA and pre-tax FCF of $200 million.
In 2006, I estimate 7% sales growth in telecom to $3.3B, and total revenue of about $3.4B. Access costs should be around 68.5% of revenue, and other expenses are estimated at $58 million a month again, producing EBITDA of over $450 million and $300 million of pre-tax FCF.
Hopefully, these numbers give an example of how much operating leverage there in GC’s model. That EBITDA can go from its current $50 million annual run rate to over $200 million in one year, just on a 3.6% revenue rise and a 1% drop in access costs is stunning.
Operating Leverage and Option Value
There is enormous operating leverage with $3 billion in revenue. Any slight increase can easily cause cash flow to soar. And more importantly as mentioned above, access costs remain the key variable in the GC earnings equation.
The real option value in owning GC is the potential for revenue to uptick on higher margin sales, while access costs fall, creating a powerful mix for surging cash flow. Add in the potential for VOIP to drive revenue into data revenue, and GC could be looking at substantial upside to its numbers in 2005 and 2006.
For example, if GC’s revenue forecast is increased 2%, and if access costs fall 1%, that translates into $50 million of additional cash flow, or $1.25 a share. Play with the numbers; you can get some crazy EBITDA numbers.
Risks
1) Slowdown in the economy
2) Renewed build-out of fiber, causes prices to plunge
3) GC plans big SG&A spend in first half, which depresses early results and scares investors
4) GC trades on the pink sheets and can be illiquid, but they should be on the NASDAQ in the next three months
Comparables
While Global Crossing has stayed flat to slightly down in the past month, its comparables are up 10-20%.
One comparable, LVLT sells for over two times revenue and over 18 times EBITDA on an enterprise value. I just exclude this one, because I think its valuation is silly.
XO Communications (Bulletin board: XOCM), Primus (NASDAQ: PRTL) and Equant (NYSE: ENT) average EV to sales multiples on 2004 numbers of 0.82 and a 9 times EBITDA/EV multiple. On a sales basis, that would get a $55 price target for GC and a $45 price target on a cash flow basis.
Summary
The risk/reward situation is very powerful here. The downside is probably to the mid to low 20s. That is what I would estimate the downside would be in case guidance going forward is weak and the company takes longer than expected to grow cash flow. The risk of a liquidity crisis is small, with a majority owner that is so well capitalized.
Now look at the upside, in two years, could GC trade for 7 times a 2006 EBITDA estimate of $500 million? That would indicate a stock price of $88 a share, a 175% increase over current prices.
My end of the year target is $50 a share. This represents the in between number of its comparables trading on sales and EBITDA and is also 10 times my 2005 pre-tax FCF estimate of $200 million. That would represent an increase of 56% over current prices.
Catalyst
1) 10-K filing in February
2) Approval to trade on NASDAQ
3) Analyst Coverage
4) Highlight as a VOIP play
5) Second half growth in cash flow
6) Evidence of rising prices for some GC’s services