IDT Corp IDT
January 29, 2002 - 10:44pm EST by
jay347
2002 2003
Price: 18.43 EPS
Shares Out. (in M): 0 P/E
Market Cap (in $M): 1,256 P/FCF
Net Debt (in $M): 0 EBIT 0 0
TEV ($): 0 TEV/EBIT

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Description

IDT Corp is a niche telecommunications company that operates as two distinct entities -- IDT Telecom and IDT Ventures. The company has some unique attributes which include:

• A sterling balance sheet with $1.05 Billion in cash. ($663 Million net of deferred tax liability)
• An EBITDA profitable telecom unit with an annual revenue run rate of $1.3 Billion.
• An entrepreneurial management team with a history of contrarian thinking and successful implementation.

IDT Telecom
IDT Telecom has a proven history of identifying and exploiting niche markets. Current business lines include prepaid calling cards, domestic long distance, private label calling cards, and wholesale bandwidth sales.

Followers of IDT would have noticed the company enter (and exit) many business lines in its 12 year history. Management has quick reflexes and prides itself on taking limited entrepreneurial risks. One venture that was launched in 1996 and subsequently sold to the AT&T was Net2Phone, a pioneer in IP telephony. The cash on the balance sheet is primarily the result of this sale.

Ongoing businesses in the telecom division look robust. Revenue has risen fairly steadily despite the economic downturn. Q1 2002 telecom revenue increased to $333 million, a 24.5% increase from the same period in 2001. Gross margins improved to 20.2% from 14.7% in the year ago period due to capacity utilization and efficiency. This segment had EBITDA of $16.2 million in Q1 2002. (2001 was a year of restructuring for IDT so I believe it is more instructive to look at this quarter and beyond as apposed to fiscal 2001.) Let’s look at the prospects for both the retail and wholesale divisions.

Retail sales have risen sharply to $265 million, a 69% increase over Q1 2001 and an 8.7% advance from the previous quarter. This is the result of increased acceptance of IDT’s prepaid calling cards, as well as IDT’s entrance into the consumer long distance market. Prospects for this segment are bright for a number of reasons:

• Currently, 50% of IDT prepaid calling cards are sold in the NYC tri-state area and used to call internationally. There is much room to grow this business domestically.
• There is even more room to grow this business internationally and IDT has plans to penetrate England, Europe and the America’s. The pre-paid model should be well received in light of the higher average per minute costs currently paid by consumers in those markets.
• The international markets (which primarily drive the usage of pre-paid cards) are growing faster then the overall long distance market.
• The company has a rational cost structure.

The wholesale business is in transition. IDT has been selling it excess network capacity to CLECs and other marginal carriers opportunistically. This business has seen steep declines in revenue as those customers have disappeared. IDT believes that going forward excess network capacity can be absorbed by its growing retail business. In addition, IDT is also focusing its wholesale business towards the RBOCs and other Tier 1 carriers who will need well priced access to international switches as deregulation broadens their service offerings. IDT believes that its strong relationships with foreign monopolies as well as existing data pathways will allow it to be the low coast provider of access to international wholesale telecom markets.

One aspect of IDT’s approach that is unique is the manner in which it has acquired its network. Using a “smart build” approach, IDT enters new markets with leased capacity. As business grows and traffic warrants, the company transitions to ownership of capacity. IDT has time and time again proved to be a savvy buyer of telecom infrastructure, and in fact much of its current capacity has been acquired with a cost close to zero. As the result of a lawsuit, IDT has access to Tycom’s global network for fifteen years free of charge. In addition IDT recently purchased Winstar Communication’s $3.3 billion worth of assets out of bankruptcy for $42.5 million.

In this matter IDT has taken the CLEC model (if you build it; they will come) and turned it on its head. Instead of raising tons of capital, building a huge infrastructure, and waiting for business to arrive, IDT has slowly and steadily built up a formidable retail business. Only when this business has warranted capacity has it bought it, and often done so at pennies on the dollar. This is emblematic of how management thinks and should facilitate further increases in telecom gross margins going forward.

IDT Ventures
As stated earlier, the management of IDT is entrepreneurial and willing to take some limited risk developing new businesses. This has led to the purchase or development of businesses ranging from calling card distribution, to tow truck dispatching, to talk radio syndication. All of these operations are relatively small in both revenue and impact on the bottom line. The Ventures division reported a $5.5 million EBITDA loss in Q1 2002. Results have improved in this division as management has rationalized SGA expenses and focused on businesses that are more realistic and closer to profitability.

It is not easy to understand management’s motivation to enter these diverse businesses, beyond the hope that there may be some synergy with IDT’s non-traditional distribution and advertising channels. Certainly the company would be easier to value without this uncertainty going forward. I believe Management looks to the venture’s division as an incubator for future business lines. They do not appear to be tied to any one endeavor and have willingly pulled the plug on businesses which hold no prospects. Therefore, I’m willing to give them the benefit of the doubt and assume that they won’t blow the $1 billion in cash on corporate pet projects.

Valuation
Accounting for three classes of stock (Class A super voting shares held by the Chairman do not trade but are convertible into common) total market cap is $ 1,256,701,497. Net cash is $663,261,000. Enterprise Value is $593,440,000.

2001 will likely show FCF (defined as NOP before charges + depreciation – capex + interest income) of about $29 million. 2003 could see FCF of $41 million. These 2002 figures assume sequential quarterly revenue growth of 6% in the calling card business, as well as 1 million consumer long distance customers by the end of Q4 (a stated company goal). I’m assuming steady gross margins and a 70 basis point improvement in SGA expense.

This results in an EV/FCF of 20 for 2002 and 14 for 2003. Backing out the interest income brings those numbers to 43 and 30. While not extraordinarily cheap, this is a reasonable valuation for a cash rich, under-followed and under-owned company successfully implementing a disruptive business model in an industry where competitors are dropping like flies.

Catalyst

Going forward I believe that IDT will increasingly be viewed as the “Southwest Airlines” of the telecommunications world because they have the lowest cost structure in the long distance market, their balance sheet is the inverse of most of the competition, and they have avoided the institutional imperative that has proved unsuccessful for most competitors. They have a history of making their own way and creating their own markets.

Continued improvement in operating results, investor’s preference for a clean balance sheet, and the ongoing opportunity to build network infrastructure on the cheap should lead to increasing investor interest. There is also an approved 25 million share buyback in place.
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