Description
Description:
MCI operates one of the most extensive communications networks in the world, comprising approximately 100,000 route miles of network connections linking 150 countries. MCI owns one of the most extensive Internet protocol backbones, and is the No.2 long distance carrier.
Four years after its acquisition of MCI, Worldcom revealed a multi billion dollar accounting fraud and filed for chapter 11. MCI emerged from bankruptcy on April 2004 with $6.3 billion in cash and $6.9 billion in debt. For an interesting account of the company's emergence from bankruptcy look at
http://w4.stern.nyu.edu/news/news.cfm?doc_id=2496
MCI's CEO Michael Capellas is well known as a conservative manager (having held the post of CEO for Compaq before its merger with HP). The CFO Bob Blakely has significant turnaround experience having led companies such as Tenneco Inc. and Lyondell Chemical Co. through massive restructurings. In addition, MCI's board includes a former US Deputy Attorney General and a former chairman of the FASB.
What is interesting is that MCI did not loose any of its top 100 customers during its bankrupcty. As well, the company was cash flow positive during it's entire period in chapter 11.
In March 2004, the Company realigned its operations into three new business segments and began operating under these segments in the second quarter of 2004. MCI operates in three business segments -
a) Enterprise Markets (23% of revenues)
b) U.S. Sales & Service (44% of revenues).
c) International & Wholesale Markets (33% of revenues)
The Long distance market is intensely competitive and is suffering from price wars due to significant overcapacity. Call volume has declined as the Bells continue to make inroads into the long distance market. There is substitution threat from VoIP and wireless. As if that is not enough, recent regulatory actions will cause long distance carriers to pay more to the Bells to use UNE-P lines though this is not expected to happen until 2005.
This lead to a sequential decline in top line of 4% (Q1-Q2). Segment wise, Enterprise was about even (+0.25%), US Sales and Services was down -4% and International was down -6%. However, SG&A reductions of 18% were very impressive. Going forward, I expect Revenue to decline by 5% annually through 2005.
Customers today want converged services with audio, video and data. MCI is strong in IP and is emphasising MPLS and Quality of Service to beef up its VoIP offerings. Private IP (MCI's MPLS based VPN service) remains its fastest growing business.
CURRENT VALUATION
Market Cap = $5.6 billion (based on $17.8 stock price)
Excess Cash = $2.2 billion
LT Debt = $5.9 billion
EV = $9.4 billion
Q2 2004 EBITDA (adjusted ) = $553 million or an annualized $2.2 billion
EV/EBITDA (annualized) = 4.27
Note: - My FCF Definition is EBIT after tax + D&A - Capex
Quarterly EBIT (using Q2 2004 figures) -
Adjusted EBIT = ($16) million
EBIT after tax (40% tax rate) = ($9.6) million
D&A = $569 million
Capex = $220 million (It is $416 million for the 6 months ended Q2 2004 so just dividing by 2)
Quarterly FCF = $339.4 million
Annualized FCF = $1.3 billion
Even if we give a 30% haircut to this value, the FCF/EV becomes 9.68%.
In addition, the MCI dividend of $1.6 implies a yield of 9% (note that T is trading at a yield of 6.42%). The dividend is also very attractive as it is a return of capital and is non taxable.
COST CUTTING
MCI is going ahead with more workforce reductions to bring headcount down to 41,300 employees from 44,800 about now. These reductions are expected to yield quarterly cost savings of $150 million contributing significantly to FCF.
Access costs are also a large part of MCI's cost structure (about 51% of Q2 revenues) and MCI has unveiled initiatives to bring these down by 300 basis points including extending the reach of their network to reduce mileage charges by adding 47 Central Offices, Grooming Circuits to shorter paths and more buildings to bring more customers on net. They will also be able to convert 25% of special access circuits base on extended enhanced loops. I expect this to be offset by additional costs the company will have to incur due to the recent UNEP legislation.
OTHER FACTORS
International sales were most negatively affected by the bankruptcy. This is because, most customers would not want to deal with a company that had filed chapter 11. This might might represent the most potential for upside to this story. For example, with bandwidth in India growing at 170% over last year and China projected to grow over 300% by the end of 2004, MCIP is well positioned to support that demand.
The stock is owned by a lot of deep value activist investors noted for bargain basement purchases including RBS, Fairholme. Recently, Leukadia has also expressed interest to purchase upto 50% of the shares of the company. MCI's market cap of $5.6 billion (compared to T's $12 billion) might make it a good takeover candidate for Verizon or SBC.
Management seems to be shareholder friendly and going forward I expect them to take more actions to increase shareholder value like do share buybacks. A recent press release by MCI saying that it will invest 25% of its director's fees buying the company's common stock in the open market is also very positive.
RISK FACTORS
a) Cost reductions do not keep up with Revenue declines.
b) International operations represent significant fixed costs and MCI notes that current utilization rates are low. If International sales decline, they will significantly affect MCI's gross margins.
c) MCI has emerged from bankruptcy with strong customer relationships. Cost cuttings and workforce reductions may cause its service quality to suffer and hurt its ability to compete.
d) Wireless - MCI currently does not have a strong wireless offering and is exposed to wireless substitution.
e) MCI is strong in IP - however, this revenue stream can potentially cannibalize its existing LD business.
f) Recently enacted Do-Not-Call legislation has reduced the available consumer base.
Catalyst
a) Stabilization of EBITDA
b) Stock buybacks
c) Takeout by Verizon, SBC, LUK.